Social Equity in California Cannabis Needs to be more than a Political Photo-opportunity

By Richard P. Ormond

Starting in the 1930s when the modern era of drug enforcement laws was launched, communities of color were disproportionally caught in the crosshairs of the criminal-justice system in the United States, with prison populations looking nothing like a true cross-section of society. It is no secret that 1930s marijuana legislation was designed to target Amerindian, Mexican and Black communities by singling out their medicinal and cultural self-medication tools.

The generational damage to communities, families and society leveled by the subsequent Drug War was devastating.  With modern liberal leanings, lawmakers are hopeful that a new batch of cannabis decriminalization laws coupled with “social equity” incentives will erase many of these injustices.  The intent to rectify these pains is well-placed, but many of these Social Equity laws and regulations are harming rather than helping these intended beneficiaries.

Cities and states alike are rushing to pass new laws that not only create a quasi-legal pathway to the sale and distribution of cannabis products that contain THC, but they are passing those laws with incentives and requirements to provide opportunities to those persons that were previously impacted by the draconian drug laws that preceded this new cannabis enlightenment. It is only a quasi-legal pathway because the Federal government, to date, has not taken any meaningful steps towards normalizing cannabis laws and bringing them into parity with most of the states.

Thus, the cannabis business landscape is still fraught with legal risk at the Federal level and significant economic risk of entering a nascent industry. With these benefit programs, State and local governments are effectively asking former convicted felons to go back into the cannabis industry despite these risks.

What we now have is an inconsistent and sometimes counterintuitive blend of laws, regulations and legislative-intent that creates a mosaic of requirements that is difficult to navigate, inconsistent at the best of times, and, creates unintended consequences that may be harmful to those they are intended to help. Many of the results may even be unconstitutional, resulting in restraints on trade that harken back to a twisted, reverse “Jim Crow”.

These local and state requirements are locking persons of color into unsavory business deals where money dictates and where those “beneficiaries” become a stereotypical “token” that politicians and savvy businessmen can hold up as progress whilst they line their pockets with real profits leaving little behind for those that are truly seeking equity. Not all programs are equal or equally bad, but enough are that warrant heightened scrutiny and criticism.

First it is difficult to define who a beneficiary of these new opportunities should really be. Should it be someone convicted of a state or federal felony? Someone who served time for that felony? Or should it be someone who is from a community of color? Or should it be someone who is in a particular economic class or zip code? Or, someone who has faced discrimination for their gender, race or creed?  There is no right answer and many local governments have passed laws intending to benefit one, some or all of the people that fit these categories with very mixed results.

California, in  Senate Bill 1294, referenced Federal data from the Department of Justice that demonstrated that from 2006 to 2015 Black Californians were five times more likely to be arrested for cannabis felonies than white Californians. Further, Latinos were 35% more likely to be arrested for cannabis crimes than white people. This was despite the fact that sales in white communities were on par with cannabis sales in Latino and Black California communities.

California’s stated purpose is to establish “a grant program for the state to provide funding to
local jurisdictions to develop and operate programs that focus on the inclusion and support of individuals in California’s legal cannabis marketplace who are from communities negatively or disproportionately impacted by cannabis criminalization.”

To that end, over the past five years the State of California has awarded $40 million to local jurisdictions in equity grant funding to support local equity programs. California was initially appropriated only $10 million in equity grant funding. In October 2019, the Bureau awarded those equity grant funds to 10 local jurisdictions out of the hundreds eligible. Additionally, the State was appropriated $30 million in equity grant funding over the next five years. As allowed by the Equity Act and subsequent legislation, the state, through its intermediaries, awarded $30 million in grant funding.  Mind you that Cannabis is a $5.6 billion industry in California alone and you can see how the impact is truly marginal.

One of the biggest cannabis markets in the world can be found in Los Angeles, California which has enacted its own social equity program. It states that, “The Mission of the Social Equity Program is “to promote equitable ownership and employment opportunities in the cannabis industry in order to decrease disparities in life outcomes for marginalized communities, and to address the disproportionate impacts of the War on Drugs in those communities.”  Los Angeles looks at income, criminal record, zip codes with higher arrests rates and other non-race based factors to determine eligibility for its social equity incentives.

However, as is required in almost every jurisdiction in California, a cannabis license applicant must own or lease real estate, in a cannabis approved “green zone”.  This creates an immediate barrier to entry into the cannabis market requiring the economic wherewithal to lease or buy a “green zone” property.  Not coincidentally, real estate owners that found that their “green zone” property was now eligible for a cannabis business immediately raised rents or sale prices making the real estate component even more unreachable. So, while states and local governments are yelling “social equity” from the mountaintops, the reality is that money and property remains a significant barrier to entry.

Enter private money. Because traditional lenders are, mostly, not keen on taking cannabis depositors or borrowers due to the Federal illegality (and the continued regulation by the Treasury and the FDIC of local and community banks); and because most lenders will not typically lend to a convicted felon who likely does not have a stellar work history or other assets, private lenders and “strategic” money partners, looking to qualify for a license, are approaching social equity “qualifiers” to provide the necessary financing and business experience to gain the license and open a cannabis facility or storefront.

Predictably, these financial deals are costly, many times with onerous business terms that give up all actual control from the beneficiary to the money partner.  Even legitimate investors with benevolent motives find themselves trapped in this game due to the requirements set up by local governments. Creative business deals where the majority ownership, on paper, belongs to the social equity beneficiary have triggers, contingencies, conditions and even “side-letters” that say otherwise.  Think about it, someone putting up most or all of the money is not going to give up control or the right to control as it sees fit or necessary.  Cities and states, however, play along, because the social equity licenses, whence granted, make for great headlines.

Even legitimate investors, of which there are many, are stymied by the social equity inconsistencies. Many potential investors have decided to “sit out” the industry because of the unfair restrictions on their investments or their potential partner’s options to eventually sell their interests.

What happens after a license is issued is less important than the photo-shoot opportunity of handing a person of color or an ex-felon a cannabis license. Los Angeles, despite its full media press to show its compassionate programs, is still stuttering to make a successful social equity business five years after its first social equity programs were initiated.  Even those that are better known operators still have complex financial deals that inure to the benefit of the investor and less, if at all, to the beneficiary.

In most other non-cannabis industries, this is atypical.  An investor should and does benefit from their risk taking, but, here, in this cannabis industry, that investment must be intentionally convoluted so as to give the politicians the sound-bite victory they seek, despite the reality on the ground.

The City of Oakland, takes pride to highlight its successful social equity program holding up certain social equity beneficiaries as their “poster-children” of success. However, just beneath the surface there are abuses untold in the process and system resulting in multiple lawsuits. The City of Oakland proudly states that, “the City Council enacted an Equity Permit Program that addresses disparities in the cannabis industry by prioritizing the victims of the war on drugs, and minimizing barriers of entry into the industry.”

And, true, it has elevated many of its social equity beneficiaries. But today, the City of Oakland, struggles with transitioning out its beneficiaries as it did not contemplate that these beneficiaries may want to eventually sell or leverage their ownership for their own financial benefit. A beneficiary, under Oakland’s current system, has no way out unless they identify someone to supplant them and take their place that fits the social equity qualification. So, if you’re a successful beneficiary that builds up your business and wants to sell it for millions of dollars, you cannot, as your business is mandated in perpetuity to be owned by a qualified and vetted (by the City) social equity beneficiary. It is illogical and harmful to the folks the program was intended to assist.

In Oakland, there are a number of successful social equity owners that are frozen from selling their interests despite being offered millions of life-changing dollars for their ownership shares.  This is a clear restraint on trade. It will take either a strategic lawsuit against the City; or, the City Council will have to legislate an exit for these successful beneficiaries by changing the laws. Neither solution is imminent or forthcoming. Quite frankly, isn’t it the purpose of these social equity programs to create successful outcomes for the beneficiaries?  Not yet in the City of Oakland.

What is the solution?  The solution lies in two places.

• First, the State of California needs to remove local governments from the licensing equation.There should be a statewide criteria for cannabis licenses and local governments, other than zoning and taxes, should be removed from the licensing process altogether. This will eliminate rampant local corruption, ill-fitting laws and regulations, and will create a consistency for applicants and operators alike.

• Second, social equity components, at the State level, should not require that social equity recipients own the majority of the cannabis business and it should not require that social equity recipients be restrained from selling their interests to anyone they choose, ala to the highest and best bidder. That way, monied partners will have the modicum of control they seek without having to create a façade of compliance.

This way, the social equity beneficiaries can monetize and benefit from their participation. The states can consider minimum requirements such as length of time of ownership, or valuation components that incentivize both the money partner and the beneficiary, but those should have short fuses allowing the parties to negotiate freely their own business interests. Just like any other industry in existence.

A deli shop owner, a textile manufacturer, or a shop owner aren’t required to hold their interests or only sell them to a small universe of qualified persons (a universe in the cannabis industry which is narrowed by zip code, social class and having criminal records).

Better yet, why not remove the social equity component for cannabis-business ownership altogether?  Rather, take a percentage of taxes collected from the industry and simply create a state-run trust that benefits “social equity” recipients regardless of the business they want to start. Why does a cannabis felon need to stay in cannabis (or for that matter, who is to say they want to stay in cannabis)?  This would allow true investors to build the industry without gimmicks, with the benefit of helping people that are true and proven victims of unfair incarceration and drug laws.

Social Equity programs read-well and make for great sound-bites or photo-ops, but they do more harm than good by not helping those they are intended to help and, in many instances, holding those beneficiaries hostage in an industry they may not want to remain in or in a business they cannot sell.   Change is needed and having a State-wide policy is a good start.