One of my clients sent me a link to this story, asking me to comment on whether it was really newsworthy. My response was not really; the U.S. Securities and Exchange Commission’s (SEC) decision to allow a listing of Terra Tech Corp. is not a major surprise. It is progress, yes, but it was also somewhat inevitable, as the SEC does not really exist to enforce federal controlled substances laws. It exists to protect investors from fraudulent offerings. Since the signs point to the legitimacy of Terra Tech’s goal of raising money to fund legal cannabis operations in Nevada, the SEC does not have the statutory authority to stand in the way. That does not however mean that the SEC does not retain some hostility toward the marijuana industry and we should look at what the SEC actually did in this scenario.
Let’s get some basics out of the way. I have previously discussed general securities law and its relation to marijuana. Here, we are dealing with Terra Tech’s raise of $6.8 million, already raised by Dominion Capital LLC, an institutional investor. Terra Tech is the party that actually wants money — the issuer of the securities. Terra Tech is not simply issuing a bunch of stock and hoping that the public will buy it. Prior to filing its registration statement, Terra Tech sold convertible notes and warrants (stock purchase options) directly to Dominion Capital. The registration statement that it filed, then, is a way to allow Dominion Capital to sell those convertible notes and warrants (or the equity that they can be converted into) on the open market.
The structure of the deal is vitally important, as the SEC really did not do Terra Tech any favors. The standard rule is that a registration statement for public shares will go active 20 days after it is filed. In general practice, the SEC rapidly accelerates that process upon request when the issuance is underwritten, as the Terra Tech issuance was. In this case, the SEC, citing its policy that acceleration of this kind of transaction was not in the public interest, declined to provide acceleration, forcing Terra Tech and Dominion Capital to wait the full 20 days. To those of us that do not live in the world of corporate finance, that may not seem like a huge deal, but market participants understand that this unwillingness to accelerate would have torpedoed the deal if the original sale had not been of convertible notes. Because those notes allow for varying equity positions for the same amount of capital, Dominion Capital is not dependent on knowing where the market is on the day of registration. If, on the other hand, Dominion was holding onto a fixed amount of stock, the market fluctuations during the 20-day waiting period would likely have been too much risk for it to take on, and the chances are good that it would not have funded the deal.
This was not Terra Tech’s first time raising money that was registered with the SEC. Multiple times in the past, Terra Tech has filed S-1 registration statements that were successfully accelerated. The difference is that in those prior statements, Terra Tech (truthfully) told the SEC that it was just in the business of selling equipment. So, it appears that the SEC is drawing lines between businesses directly involved with marijuana cultivation and distribution and those that are simply ancillary to the marijuana industry.
The last word on Terra Tech’s capital raise is this: the SEC allowed registration because it pretty much had to, but it refused to accelerate that registration in a way that would have been vital had the deal not been deliberately structured to survive the 20-day window. This came at significant cost to Terra Tech. Though registration and listing make raising money cheaper than working on the fully private market, the convertible notes had to be sold at a 30%-40% discount to actual share value, as Dominion has to wait six months to let the shares “season” before it sells them. The SEC’s policy has a direct, somewhat negative effect on those looking to raise large sums of money.
The SEC still is not lying down on the job in its effort to protect investors. Remember the SEC’s decision to suspend trading of five marijuana companies back in May? It will continue to do that any time it believes fraud is occurring or that investors are not receiving appropriate disclosures. If you want to take a look at what marijuana industry disclosures look like, take a look at Terra Tech’s S-1 registration statement starting on page 12. It is enough to put fear into the heart of any investor, which is exactly what the SEC wants these disclosures to do.
The SEC will let marijuana businesses raise money, but it is not going to make that easy.