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Federal Regulators Are Blocking the Cannabis Boom but Congress Keeps Them In the Way

The Federal Reserve and FDA want Congress to clarify how to regulate a product that, strictly speaking, is prohibited.

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A new era is at hand for investing in medical cannabis, which until now has been the exclusive territory of investors brave enough to venture into the risk-ridden waters of federal prohibition.

Xinhua | Liu Jie | Getty Images

But that won’t last forever. The feds are trying to play catch-up as investors, consumers and patients fuel the rapid expansion of the multi-billion-dollar cannabis industry, with legalization spreading across the U.S., Canada and elsewhere.

States that have legalized cannabis are enjoying the benefits of increased tax revenue. Gov. Andrew Cuomo of New York, where medical cannabis is legal and a plan to legalize adult-use is underway, has proposed that revenue from the cannabis excise tax be used to fix the ailing subway (the legislation is stalled by African-American legislators demanding some portion of revenues be channeled to communities most victimized by the War on Drugs).

States with legal cannabis don’t want the feds to interrupt the flow of tax revenue. The fundamental purpose behind the SAFE Banking Act that’s currently working its way through Congress is to protect institutions that provide financial services to “legitimate” cannabis businesses.

The odd thing about this is that cannabis businesses are required to pay steep taxes to the federal government that bans their product. A 1982 amendment to the Tax Code called 280E, which was originally meant to penalize drug dealers, has been narrowly interpreted by the IRS to mean legal marijuana businesses cannot deduct normal business expenses from their taxable revenue.

Related: Cannabis Advocates Want 'Unjust' Federal Tax Code Changed

Just recently, Federal Reserve Chairman Jerome Powell told the U.S. Senate that clarity in federal financial regulations in the marijuana market is increasingly necessary as more states line up behind legalization. “I think it would be great to have clarity,” Powell told members. “It puts financial institutions in a very difficult place and puts the supervisors in a difficult place, too.”

As states continue to fall like giant green bowling pins -- 35 states and the District of Columbia have legalized its use for medical purposes -- the complexity of legalization and its ramifications on banking and financial institutions are impossible to ignore. Many more states, such as New York, New Jersey and Illinois, are debating legalization of the cannabis industry. Eventually the feds are going to have to adapt as federal agencies, like the FDA, are getting involved in regulation. 

Former FDA Commissioner Scott Gottlieb said before his recent resignation that his agency is investigating “possible alternative approaches” to regulating CBD. This is after the passage of the Farm Bill last year and the FDA giving the greenlight to Epidiolex, a CBD treatment for epileptic seizures from GW Pharmaceuticals. Now the federal government finds itself in an unusual conundrum, of approving and regulating a compound that it has banned. Meanwhile, doctors and patients are demanding more clinical evidence that CBD actually works.

Related: Move Aside, CBD: New Data Finds THC Is the Real Medicine in Medical Marijuana

This, combined with the recent call for clarity from Chairman Powell, signals that a new era is at hand for investing in cannabis. There’s too much momentum, and too much money, for the feds to stuff the genie back in the bottle.

GW Pharmaceuticals led Big Pharma into medical cannabis investment and was rewarded by becoming the first drug company to get a cannabis-based treatment approved by the FDA. You might think everybody wants to be the next GW but Big Pharma has been noticeably quiet on the subject of cannabis investing.

The Novartis subsidiary Sandoz partnered with Canadian cannabis company Tilray to sell medical cannabis in countries where it’s legal. But aside from that, it’s been the smaller companies that are getting involved in medical cannabis. The ones best positioned to make investments are the biotechs capable of running clinical trials.

The future of investing in medical cannabis lies in the Second Generation: the development of cannabinoid pharmaceuticals through clinical trials which are then submitted to the FDA. Investment in Second Generation medical cannabis is coming from small biotechs that are just making themselves known, like Katexco Pharmaceuticals and CannBioRex Pharmaceuticals.

But Big Pharma seems content to sit on the sidelines as long as cannabis remains prohibited by federal law in the U.S. The smaller, cutting-edge biotechs have a greater tolerance for risk than Big Pharma. That's unlikely to change so long as federal law equates cannabis banking with money laundering.

If the U.S. government ever puts an end to prohibition, just imagine what that would do to cannabis investment on Wall Street. The pharmaceutical floodgates will finally open.