Business

California Market Contends With Illegal ‘Double Dippers’

By Willis Jacobson Oct 12, 2020
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Willis Jacobson is an award-winning journalist whose career has spanned both coasts. Now based on the Central Coast of California, he has covered cannabis news and issues since 2015.
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Willis Jacobson is an award-winning journalist whose career has spanned both coasts. Now based on the Central Coast of California, he has covered cannabis news and issues since 2015.
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When California cannabis regulators accused Kushy Punch, a brand known for its THC gummies and vapes, of simultaneously running an illegal operation alongside its licensed one, the complaint shocked several in the state’s cannabis industry.

Many were stunned that a brand as visible and popular as Kushy Punch would get accused. But to some, the allegation of a licensed company simultaneously operating in the illegal market was less of a surprise. (Representatives of Kushy Punch and its parent company Vertical Bliss did not respond Monday to requests for comment.)

Commonly referred to as “double-dipping,” the practice of legal businesses operating in both the licensed and illicit markets has caught the attention of operators and regulators alike. While the extent of it is unclear, the practice has been blamed, at least in part, for the continued vitality of California’s illegal cannabis market. A report this year by New Frontier Data suggests 80% of the state’s cannabis sales are illicit. And some business owners feel the state isn’t doing enough to curtail what they see as unfair competition from double dippers cutting into their bottom line.

Others suggest that state officials and industry operators should work together to address the root causes of the crime rather than simply focus on the punishment. Those potential causes – high taxes, lack of available licenses, an inability to export – could lead to meaningful reform, they say.

Max Mikalonis, a legislative advocate with K Street Consulting, said Monday that a partnership between regulators and operators would be key to cutting down on illicit activity. 

That’s not to say he’s pushing for businesses to “snitch” on each other. 

“But I do think legal operators can take the lessons they’ve learned through navigating the state’s compliance systems to help the state better [those systems] and identify unlicensed or cross-cutting activity, where someone is playing both markets,” he said.

A spokesman for the California Bureau of Cannabis Control, which regulates REC and MED licenses, declined to discuss the matter with WeedWeek, saying only that people who are aware of double-dipping “are welcome to file a complaint with the bureau and we will follow up and investigate, just as we do with all complaints.”

‘Bad optics’

While there are no figures to gauge the exact prevalence of double dipping, some business owners have publicly spoken out about the issue.

Dan Ripoll, CEO of distribution company Pushr, told WeedWeek in an interview last month that he was aware of different types of double-dipping schemes. One involves a business obtaining a temporary, or “burner,” license, which are less cumbersome and involve fewer inspections than an annual license. The license-holder then completes as many transactions as possible under that license, all without paying taxes, before walking away from it.

Another scheme identified by Ripoll involves companies reporting a product as waste on the state’s track and trace system or saying that a product failed testing. Instead of destroying those products as required by state law, though, the operators sell the products to illicit businesses.

Javier Montes, who owns Los Angeles-area dispensary Delta 9 THC and also serves as vice president of the United Cannabis Business Association, a state trade group, said that illegal operators have long posed a problem for legitimate cannabis businesses in Southern California. They not only potentially undercut legal shops, he said, but they help to create consumer confusion.

These “bad optics” presented to the public, he said, can be particularly troublesome in areas that are already hesitant to allow REC shops into their communities.

“It messes up the visual of what this industry can be,” Montes said.

That issue is compounded, some in the industry say, by a lack of available licensing in many California cities and counties.

Operators without other options are more likely to operate in the illicit market, which provides more options for those looking to double dip, K Street consultant Mikalonis said.

He suggested the state would be well-served to expand on the number of licenses it issues, and to look into where the illicit products are going. If a great deal of illegal product is being shipped out of state, it could demonstrate a need to explore interstate commerce pacts with other willing state-legal markets.

“If you expand the legal market, you’re decreasing the need or the desire to double dip and you’re cracking down on that illicit market,” he said.

A taxing situation

Many also cite California’s high cannabis taxes throughout the supply chain as exacerbating the problem.

Most operators must pay multiple taxes from the cities and counties in which they operate, in addition to state excise and cultivation taxes. The resulting thin margins have likely led some licensees to maintain a foot in the unregulated, and untaxed, market as a way to make ends meet.

The high taxes also lead to higher prices in legal dispensaries, which can send customers looking for better deals in the illicit marketplace.

San Diego-based attorney Jessica McElfresh, who advises cannabis clients through her McElfresh Law firm, said she doubted double-dipping is as prevalent as some suggest because it’s so risky.

Vertical Bliss, the parent company of Kushy Punch, for example, had a manufacturing and retail license revoked by the state after investigators accused the company of producing “significant quantities” of cannabis products at an unlicensed facility. The unlicensed products reported by the state include more than 3.3M gummies, valued at $64M.

Along with losing licenses, Vertical Bliss is also facing civil penalties that could amount to nearly $500M.

“It’s incredibly risky,” McElfresh said. “It’s honestly hard for me to wrap my head around, from a risk perspective.”

She said the punishments already in place should serve as enough of a deterrent for bad actors. If the problem is widespread, she said, then state regulators simply need to do a better job of enforcement.

She compared the alleged illegal activities of cannabis operators to those of doctors, who also face licensing concerns when they are accused of breaking industry rules.

“But does that mean all doctors are bad or the system isn’t working? No,” she said. “It doesn’t mean the system’s perfect, but that’s the nature of people and of life and of regulation.”

Moving forward

In order for a REC program like California’s – the largest in the nation – to survive in a fair and equitable fashion, operators will need to take a lead, according to some insiders.

Montes, the dispensary owner and industry advocate, said shops should do more in communities to educate people on what is legal and what is not. The state, he and others say, should also be involved in this campaign.

“It doesn’t help the industry when you have bad operators … who are painting a bad picture of us,” Montes said.

That education goes beyond retail stores to actual products, many of which have packaging that is easy for counterfeiters to duplicate.

Mikalonis, the industry consultant, said the best fix for the problem would be the creation of new markets, through the distribution of more licenses, and the expansion of existing opportunities, such as by allowing cultivators to ship product out of state.

He said that forcing California’s industry to remain only in California has created an “artificial constraint” that perhaps should be removed.

“Rather than demonize those who are double-dipping … I think it’s good to think about why they’re doing what they’re doing,” he said.

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