The US Drug Enforcement Administration (DEA) has initiated proceedings to reclassify cannabis from a Schedule I substance to a Schedule III substance, marking a significant step towards cannabis reform in the country.
After months of deliberation, the Associated Press reported on April 30 that the DEA would move to reclassify cannabis from Schedule I, a category it currently shares with heroin and methamphetamines, to Schedule III, which is reserved for substances with low potential for dependence and accepted medical use.
The move from the DEA comes almost a year after the Department of Health and Human Services (HHS) suggested that cannabis be reclassified on August 29, 2023. In December 2023, the DEA sent a letter to Congress in which it indicated its intent to review the evidence provided by the HHS. This was followed by months of evaluation and consideration by the DEA, as well as discussions and advocacy for cannabis reform by lawmakers and other stakeholders.
President Joe Biden has been vocal about his stance, and first directed federal health officials to review the regulatory status of cannabis in October 2022. He also addressed the issue during this year's State of the Union address, a “historic” event for the cannabis industry that greatly increased the president’s favorability, according to a poll conducted by Politico. Cannabis reform has also been a significant aspect of Biden and Vice President Kamala Harris’ re-election campaign.
The Department of Justice (DOJ), the jurisdiction overseeing the DEA, submitted a Notice of Proposed Rulemaking (NPRM) signed by the DEA to the Federal Register on May 16. It was published on May 21, triggering a 60 day open comment period where the public can send their comments before the rule change is finalized. Biden shared the news via X, formerly known as Twitter, explaining what a change in marijuana’s regulation would mean for cannabis stakeholders.
Read on for a closer look at the impact that the rescheduling of cannabis could have for companies and investors.
How will cannabis be regulated after rescheduling?
Prior to implementing the rule change, the DEA needs to review all of the comments submitted during the 60 day comment period. If a hearing is requested, the administration must conduct one.
The DEA will issue a final ruling after the comment period closes and any requested hearings have concluded. The entire process may span a few months or more, based on the progress of the comment period.
Even after cannabis is rescheduled, it will still be subject to a dual regulatory framework. The DEA will regulate and distribute licenses for the cultivation, distribution and possession of cannabis, while the Food and Drug Administration (FDA) will be responsible for regulating the production, labeling and marketing of cannabis products.
The DEA's regulations for cannabis will also focus on preventing the diversion of the drug to the illicit market. In addition, cannabis will remain on the DEA’s list of controlled substances.
The FDA's regulations for cannabis will focus on ensuring that cannabis products are safe and effective for consumers by requiring that they undergo clinical trials to demonstrate their safety and efficacy. The FDA will also set standards for the labeling and marketing of cannabis products, including warning labels requirements and child-proof packaging.
Rescheduling would increase company profitability
In correspondence provided to INN, Michael Teller, chief operating officer at the Panther Group, highlighted the positive implications of rescheduling for both investors and businesses in the cannabis industry.
“Looking at it from an investor's viewpoint, the decision to reschedule cannabis would be a major game-changer. Even as the news trickles down, it starts to bring a sense of comfort and confidence to the investment scene, finally pushing the cannabis industry closer to widespread acceptance," he wrote. "With this impending change, more opportunities like mergers and acquisitions and consolidation will become increasingly available. In addition, businesses struggling to break even can now see a path to profitability, thanks to fewer tax headaches like 280E.”
Section 280E of the Internal Revenue Service Code is a provision that prohibits companies involved in illegal activities — such as the trafficking of Schedule I or II controlled substances — from deducting ordinary and necessary business expenses from their taxable income. Under this provision, cannabis companies are taxed on their gross income instead of their net income. The Boston Globe reported in May that most cannabis companies in the US effectively pay a tax rate of between 60 and 80 percent. For many business owners, obstacles such as Section 280E stand in the way of profits.
Limited access to banking products like business loans and payment services further complicates matters, and many operators have had to make concessions such as raising prices, often driving consumers to the black market.
Initiatives like the SAFER Banking Act would relieve companies struggling to stay open, but that legislation needs more Republican support to pass; at the time of this writing, a date for a Senate vote wasn't set. Jonathan Havens, managing partner at Cannabis Law, recently expressed to Cannabis Business Times that he hopes lawmakers who didn’t previously support cannabis reform might come around if it's placed in the Schedule III category.
Tritt concurred with Teller on the benefits rescheduling could provide for cannabis businesses.
“Companies are going to become more profitable and have more cash because of the 280E improvement. In terms of the trickle-down effect, I think companies that are doing well will start to have a better financial position," he said.
In contrast, those facing financial challenges may be more inclined to sell their assets, particularly if they have the opportunity to engage in transactions with financially secure enterprises. “I think you’ll also see similarly that the struggling people aren't going to really be impacted that much by this change; it's not going to make their business worth a lot more or make a lot more money. I think people will kind of get fatigued and just kind of give up.”
Since cannabis companies that go out of business cannot be considered for bankruptcy protection, acquisitions present a viable exit strategy. In turn, consolidation will pave the way for the emergence of financially robust players.
Better cannabis branding after rescheduling
Rescheduling is also expected to bring other benefits for cannabis businesses in th eUS.
One critical aspect is the availability of trademarks for cannabis brands and products. “With the transition from Schedule I to Schedule III, cannabis brands and products will have significantly more opportunities for federal trademarks and IP protection, thus increasing a brand’s value and relationship with its consumers,” Tritt told INN.
Currently, the Patent and Trademark Office refuses to register any trademark used in connection with unlawful goods or services. Rescheduling cannabis for medical purposes would allow it to be legally trademarked, enabling those in the medical aspect of the industry to obtain brand protection.
“So I think you'll start to see companies developing products and formulations and different things to treat certain maladies (and) effects, and the way that they're going to protect and make sure that what they've created has a brand is by using the normal protections that are afforded to businesses,” said Tritt during the interview. “It just allows the normal course of business to occur, which hasn't been the case for cannabis.”
Impact of rescheduling on medical usage
Until now, research on marijuana’s potential medical properties has been limited due to its Schedule I classification.
However, the few studies that have looked at the medical properties of cannabis have revealed that analysis has been oversimplified. For example, cannabis has been found to relieve pain and nausea, stimulate appetites and is sometimes used to treat sleep disorders and glaucoma. CBD, the non-psychoactive compound found in cannabis, may have even more medical properties than its psychoactive counterpart, THC — it is used to help treat migraines, inflammatory bowel disease and seizures, as well as mental health disorders such as anxiety and depression.
Reclassifying cannabis to the Schedule III category would open the door to opportunities to conduct more thorough research into its benefits and identify further tangible uses.
Richard Shain, CEO of Maridose, a DEA-licensed bulk cannabis manufacturer, told MJBizDaily that he expects demand for cannabis for research purposes to “skyrocket” once rescheduling happens.
However, Tritt highlighted the potential new challenges that could come with this transition.
“The exit for these cannabinoid businesses is to pharma, so we need to understand what they're acquiring and what it takes to get them interested — the studies that they need in order to get comfortable with it. That's what the industry is going to start being faced with," he explained to INN. “Like everything in this industry, I could see it going totally sideways and people going down a path and then not realizing (they) can't even get protection for (something), so it creates a whole other set of challenges for an industry that operators have never dealt with. It makes picking the right team that much more critical at this point than it ever has been, just because now the stakes are getting really serious."
Will cannabis rescheduling be successful?
Although the NPRM is a significant step forward for cannabis rescheduling, some experts have raised concerns.
Law firm Ropes and Gray notes that the NPRM doesn't include explicit support for rescheduling from the DEA, implying a difference in viewpoints between the DEA, DOJ and HHS. Although technically issued by both the DOJ and DEA, only Attorney General Merrick Garland, not DEA Administrator Anne Milgram, signed the NPRM, which according to the firm is unusual in such rescheduling actions. The NPRM emphasizes that the DEA hasn't decided on the appropriate schedule for marijuana and expects more information from the rule making to help determine it.
On a different note, McGlinchey Stafford, another law firm, points out that the US is party to international drug control treaties that require the control and regulation of certain substances, including cannabis. This could potentially complicate the country's efforts to reschedule cannabis at the federal level.
The US election could also complicate rescheduling efforts and undo the momentum set by the Biden administration. The Congressional Review Act allows the Senate to vote to undo regulations finalized in the waning days of a president’s term, and only a simple majority of senators are needed to overturn a rule. For now, Democrats control the Senate, but only by a slim margin, and some Republican senators have been outspoken about their opposition to rescheduling.
Another significant element is a proposed amendment to the Farm Bill, a piece of legislation that is renewed every five years. In 2018, the Farm Bill legalized the production of hemp, defined as cannabis with less than 0.3 percent THC. It also allowed for the interstate sale of hemp products, but not cannabis flower.
The bill will expire on September 30, and a proposed amendment seeks to federally ban all ingestible hemp products containing any level of THC. This could have a significant impact on the hemp industry.
Tritt pointed out that the Farm Bill has aided in the development of low-THC products. Hemp-derived cannabinoids like Delta-9 THC, THCA and Delta-8 THC are available in various forms and have gained popularity due to their perceived health benefits, subdued psychoactive effects and availability, including in states with strict or non-existent recreational cannabis laws.
“There's a lot of education that still needs to happen. And so we're paying attention to trends and opportunities where you may get access to mainstream consumers not through the regulated cannabis channels, and brands are going to ultimately develop through those channels as well. So there's some crossover with brands and things … but it's in flux because of the Farm Bill. That would change the dynamic significantly.”
Investor takeaway
Overall, the rescheduling of cannabis is a complex issue with both potential benefits and challenges.
“At the end of the day, having the ability to clearly see where cannabis will be housed for the foreseeable future allows us to have visibility into the medium to longer-term investment horizon,” said Tritt.
“The legal and regulatory shift of cannabis will influence the international community. The US is signaling that cannabis isn’t going anywhere (except higher, pun intended). As such, investors and companies from industries like pharma, alcohol, tobacco, etc., can now begin mapping the industry trajectory and the various implications.”
Only time will tell how it will ultimately impact the industry.
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Securities Disclosure: I, Meagen Seatter, hold no direct investment interest in any company mentioned in this article.