.Gray Market Ganja: Some fully permitted cannabis growers continue to sell to illicit peddlers which promises to be a problem for years to come

We all tend to think of California as having two entirely separate cannabis industries: the legal market created after the 2016 passage of Prop. 64, and the so-called “black market” which has operated here for many decades and which continues to not only thrive, but to overwhelm the legal market thanks mainly to its much-lower prices.

But there is a large gray area between the two. Some fully permitted cannabis growers continue to knowingly sell weed to illicit peddlers. That can be difficult to detect and will likely continue to be a problem for years to come. But another problem has emerged thanks to lax enforcement by state authorities, according to a lawsuit filed by a Southern California dispensary chain against the California Department of Cannabis Control. 

The lawsuit, filed by HNHPC Inc.—the parent company to Catalyst Cannabis Co. which operates six shops south of Los Angeles—alleges that the DCC has “turned a blind eye” toward cannabis peddlers who obtain state distribution licenses using “front men,” obtain legally grown weed at wholesale prices and then sell the stuff on the illicit market, sometimes within California, but often outside it.

The DCC’s “failure to perform its legal duty to implement systems to properly track and flag questionable transactions has led to the exponential rise of ‘burner distributors’ that conceal and launder state-grown cannabis for delivery to illegal dispensaries and other unregulated markets within the state as well as for the illegal transport across state lines, all without paying significant legally mandated taxes…” according to the lawsuit.

Catalyst’s CEO, Elliot Lewis, is a longtime, vociferous critic of California’s tax and regulatory regime. He told Forbes magazine last year that the main obstacle to his business was “the massive red tape we have to cut through including very high taxation of cannabis businesses and political bureaucracy which is hard to fight against and can take an unlimited amount of time.”

Right around the time he was saying that was when he and others in the industry began hearing about so-called “burner distros,” which according to the lawsuit have diverted “millions of pounds” of weed from the legal market to illicit sellers. This development only makes a bad situation worse.

The “black market” is actually a few different markets. As was the case before adult-use legalization, it includes not only straight-up criminals, but also small-time operators who, assessed individually, are relatively harmless—though as a group, they are certainly part of the problem. The burner-license people fall into the “straight-up criminals” category.

The illicit distributors might or might not pay the state’s cultivation tax, but either way, once they take possession of their legally grown weed, “DCC effectively ceases regulating or even monitoring what happens to that cannabis,” according to the lawsuit. Distributors are responsible for paying both the cultivation tax and the state’s 15% excise tax, a setup critics have long argued amounts to a major flaw in the system. Even though the state has a “track and trace” system in place, bad actors are able to circumvent it in most cases, according to the lawsuit, because the DCC “relies heavily if not exclusively on tips or complaints to instigate investigations or enforcement proceedings against illegal operators.”

The DCC is not commenting on the lawsuit, but has issued general statements declaring that it is devoted to enforcing compliance with state laws and regulations.

Why would the DCC neglect its duty to actively monitor cannabis transactions, and take action only in response to complaints? Catalyst has a theory: the department is satisfied with the cultivation taxes on the legally grown weed. The DCC, according to the complaint, “wants that tax revenue to continue flowing despite knowing it is receiving cultivation taxes on far more cannabis than ultimately is being sold in licensed dispensaries (i.e., it knows significant amounts of cannabis [are] being diverted to the black market or illegally transported out of state).”

Or, if the lawsuit’s main allegations are accurate, it could just be the usual bureaucratic failure.

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