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A Prescription for Progress?

Would a Schedule III Reclassification of Psychoactive Cannabis Help or Hurt State Operators?

By Benton Bodamer, Member, Dickinson Wright PLLC, Adjunct Professor of Law, Drug Enforcement and Policy Center, Moritz College of Law, The Ohio State University

I. Introduction

On August 30, 2023, the US Department of Health and Human Services (HHS) concluded a scheduling review of psychoactive cannabis and recommended that the Drug Enforcement Administration (DEA) “re-schedule” psychoactive cannabis (i.e., cannabis that doesn’t qualify as “hemp” also known as “marijuana” and parts of the cannabis plant with more than 0.3% Delta-9 THC) from Schedule I to Schedule III under the Controlled Substances Act (CSA). If you think “Schedule III” will save the struggling cannabis industry, you might want to sit down. The next 6 to 12 months could be among the most transformative for the US cannabis industry, but progress will not happen without a requisite dose of regulatory confusion, conflicts of federal laws, and bizarre unintended consequences. If anyone tells you they know precisely what’s about to happen, you would be wise to question that certainty.

II. Why Is Psychoactive Cannabis Even on Schedule I Given its Medical Uses? In 1970, the CSA established five “Schedules” with “Schedule I” being the most restrictive (defined for substances with no medical value and high risks of abuse and harm), and “Schedule V” being the least restrictive, often a truck stop on the highway to “over the counter” status. Although the CSA originally placed cannabis on Schedule I, the authorizing legislation required a presidential commission to study proper placement of cannabis on the schedules. To paraphrase, the results of that study (the 1972 Shafer Commission Report “A Signal of Misunderstanding”) basically said that psychoactive cannabis shouldn’t be on Schedule I – but instead probably Schedule II or Schedule III. President Nixon effectively chose to pocket veto his own commission’s report and took no action to effectuate the Shafer Commission’s recommendations, and the Schedule I status has persisted to this day. As a footnote: Marinol (dronabinol), a synthetic form of THC, has been on Schedule III since 1999.

III. Is Cannabis now on Schedule III?

No. The HHS recommendation is now under review by the DEA and the DEA can choose to either act immediately within its authority to reschedule, or (more likely) make a recommendation for rescheduling, which would be subject to the lengthy and complicated process set forth in the Administrative Procedure Act (APA). The APA process would likely take over three months, would include a public comment period, and then would result in an administrative law court recommendation that the DEA could accept.

IV. Would a Move to Schedule III Effectively Legalize All Existing State-Compliant Cannabis Companies?

Absolutely not. At least initially, all state medical and adult use cannabis companies would remain federally non-compliant following a move to Schedule III. Individual states conceivably could seek to align state-licensed manufacturing with the Federal Food, Drug, and Cosmetic Act (FDCA) and the associated standards of Current Good Manufacturing Practice (CGMP) regulations in anticipation of a national legalization push and interstate commerce, but this would not impact the CSA non-compliance of a dispensary distribution model. Forcing strict FDCA and CGMP compliance would likely harm many existing state operators based on heightened requirements of pharmaceutical grade manufacturing, advertising, and distribution, so states are unlikely to do so.

V. 280E Relief

One promising development for the cannabis industry is certain: Section 280E of the Tax Code only applies to trafficking in substances that are Schedule I or II and illegal under federal or state law. This means that a Schedule III reclassification would give all state-compliant operators relief from the restrictions of 280E that have long prevented ordinary business expense tax deductions for the pioneers of cannabis. (For certain “hemp” businesses trafficking in allegedly federally compliant synthesized cannabinoids like Delta-8 THC, THCO (which are actually classified as Schedule I per DEA’s recent guidance), 280E would continue to apply.) One open question around 280E is whether the timing of a DEA recommendation to reschedule will allow operators to take advantage of the change on 2023 tax returns. A December versus a January action could mean millions of dollars in tax deductions for current operators. Of further interest could be the ability to file amended returns for prior years. It would seem remarkably inequitable if the “legitimate” state operators that have actually filed returns and paid taxes (and therefore been harmed the most by the effects of 280E based on the Schedule I misclassification of cannabis), were unable to recapture previous years’ draconian penalties from past operations. 280E was designed in 1982 to punish illicit drug dealers and has instead indirectly subsidized them for decades by harming state-legitimate operators.

VI. Advertising Relief?

Although some foresee a possible loosening of advertising restrictions based on a Schedule III status, the reality of state-compliant advertising would remain subject to the individual state restrictions of the various state regulators. If states open mutually agreed interstate markets (as contemplated by certain East Coast states, for example), FDA oversight of advertising via the FDCA could also come into play.

That said, a federally relaxed status could be a catalyst for leniency by social media companies with a longstanding history of prohibiting direct advertising for cannabis manufacturing or distribution.

VII. Would a Move to Schedule III Open up Banking for Existing Cannabis Companies?

Probably not, unless currently non-participating banks suddenly find a new tolerance for slightly less egregious violations of federal law. Technically, even with Schedule III status, all state-compliant medical and adult use companies would initially remain non-compliant with federal law, meaning the risks of violating the CSA, and related violations of the Bank Secrecy Act, would continue following a Schedule III re-classification, absent some legislative movement on the topic. Although the penalties for banking a Schedule III operator could be lower than existing Schedule I penalties, the financial institutions would still be taking on criminal risk, and the attendant Suspicious Activity Report (SAR) compliance obligations of providing financial transactions for a federally non-compliant operator. For this reason it would remain important for industry participants to see enactment of a version of the Secure and Fair Enforcement Act (SAFE) or a similar legislative solution to specifically grant approval for financial institutions looking to enter the space with full federal compliance.

VIII. Will FDA / DEA Now Go After State Compliant Cannabis Operators?

Probably not. Why not? It is worth recalling that the long-standing “War on Drugs” has been funded and
enforced predominantly by states, states that would obviously not enforce federal laws in contravention of state adult use markets. Additionally, Rohrabacher-Farr, the rider to the continuing budget resolution that restricts federal prosecutorial funding for enforcement against state-compliant medical cannabis operators, will still be in effect, limiting DEA’s incentive and ability to pursue prosecutions. The prosecution of state-compliant tax-paying companies is now also much less politically popular than it once was. It will, however, be interesting to see whether the next budget process involves a revisitation of the scope of Rohrabacher-Farr’s protections in either direction. For example, the move to lower the “tier” of federal CSA non-compliance from Schedule I to III might come with a new federal push to expand Rohrabacher-Farr to include state-compliant adult use operators or could trigger an attempt to tighten the protections to operators in states that revise their medical markets to reflect Schedule III compliance.

Given the FDA’s slow-moving “kryptonite” approach to non-psychoactive CBD, it seems possible that the FDA might again call for an act of Congress to move meaningfully toward the regulation of psychoactive cannabis broadly. Unlike hemp-based cannabinoid manufacturers shipping products coast-to-coast, the absence of any interstate commerce for certain state-licensed operators also could remove those businesses entirely from the FDA’s regulatory authority.

IX. Do We Even Know What Cannabis Is Anymore?

Strangely, as we march toward the seeming inevitability of full federal and state cannabis legalization “cannabis” has never been harder to define. The plant cannabis sativa l. is both “hemp” (a federally legal substance de-scheduled entirely from the CSA schedules since the 2018 Farm Bill became law), and “marijuana” (a Schedule I fully illegal substance), depending mostly on whether the plant tests above 0.3% Delta-9 THC by dry weight. The cannabinoids from cannabis (whether from hemp or marijuana) can themselves be federally legal or illegal depending on the process of their production and the means of administration. Cannabidiol (CBD) from any cannabis sativa l. plant can be either an over-the-counter FDA-approved medicine (Epidiolex) or a prohibited food and supplement ingredient that violates FDA guidance (and thereby federal law) by its very inclusion in a product intended for human consumption. Delta-9 THC from the cannabis plant could either be a legally extracted cannabinoid from hemp, a fully illegal cannabinoid extracted from marijuana, or a quasi-legal cannabinoid derived (instead of extracted) from hemp. Gas stations coast to coast are overflowing with “federally legal” cannabinoid ingestibles “from hemp” that are neither federally legal nor from hemp. This year is the fifth anniversary of the 2018 Farm Bill, meaning the legislation is up for renewal, and a slate of proposed changes could put the laws around “hemp” and “psychoactive cannabis” in a deeper state of incongruence and confusion.

X. The Road Ahead

Given all of the uncertainty that a DEA acceptance of HHS’s recommendation to move psychoactive cannabis to Schedule III would unleash, the need for incremental federal progress will be paramount. Although state operators have reason for significant excitement in regards to 280E and to the potential easing of advertising restrictions, the risks of federal enforcement remain real (albeit perhaps remote) without further federal legislative action. With multiple pieces of federal legislation already in circulation, the next several months will prove key in the race to define the formal federal status of psychoactive cannabis.

This work originally first appeared as part of The Ohio State University Drug Enforcement and Policy Center initiatives. A link to the original article can be found here.

Benton Bodamer

Benton Bodamer

Benton Bodamer has represented a wide range of public and private companies, as well as many of the leading international private equity sponsors.

He regularly advises clients on complex domestic and cross-border mergers and acquisitions, leveraged buyouts, joint ventures, minority investments, divestitures, and restructurings. Mr. Bodamer also routinely counsels privately held businesses (including sponsor portfolio companies) on general corporate matters, governance, corporate best practices, and commercial transactions.

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