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AN ANALYSIS OF ADULT-USE CANNABIS LEGALIZATION IN ILLINOIS:

PART 2

An Analysis of Adult-Use Cannabis Legalization in Illinois: Part 2

PREPARED MARCH 2019

JOHN HUDAK, PH.D. Senior Policy Advisor of Freedman & Koski, Inc.

ANDREW FREEDMAN Senior Director and Co-Founder of Freedman & Koski, Inc. Former Director of Marijuana Coordination for Governor Hickenlooper

LEWIS KOSKI, MBA Senior Director and Co-Founder of Freedman & Koski, Inc. Former Director of the Colorado Marijuana Enforcement Division.

WRITTEN BY:

AN ANALYSIS OF ADULT-USE CANNABIS LEGALIZATION IN ILLINOIS: PART 2

This independent project was funded by Senator Heather Steans and Representative Kelly Cassidy

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TABLE OF CONENTS

Executive Summary ...................................................................................... 4

The Impact of Public Policy on Initial Supply ..................................6

Conclusion .......................................................................................................30

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EXECUTIVE SUMMARY

This analysis makes specific recommendations about a prospective legal cannabis system in Illinois, suggests policy alternatives, advises on practices to be avoided, and highlights regulatory goals that must be achieved in order to meet public expectations. The highlights of this section of the report include several top-line takeaways:

kAdult-use cannabis legislation must include a reasonable, definitive timeline for implementation and the commencement of commercial sales that allow regulators to develop an effective system and present industry with clear expectations for compliance.

k The state should prioritize robust emergency rules, with significant stakeholder input, to establish the initial regulatory system. The state should also engage in permanent rulemaking, with a more robust stakeholder process, to create a long-term solution for the system.

AN ANALYSIS OF ADULT-USE CANNABIS LEGALIZATION IN ILLINOIS: PART 2

The first portion of this study sought to conduct a snapshot of demand for cannabis in Illinois, estimate expectations for the current medical market to supply a portion of that demand and considerations fortaxation.

This portion of the study adds additional insight into what a legal,adult-use cannabis system may look like in the state of Illinois. As mentioned in the first section, the goal in any legal system should be to provide safe, regulated, consistent cannabis to consumers, whilee�ecting greater social justice, displacing illegal markets, decreasing problems related to substance abuse, and maintaining public safety.

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k Illinois must decide what agency or agencies will have regulatory authority.

k States have chosen different levels of centralization to govern cannabis licensees. Should Illinois allow multiple agencies to oversee the regulatory system, it should also establish proper, efficient coordination strategies.

kAll states that have legalized adult-use cannabis have also had legacy systems for medical cannabis in place. Successful programs have been opened by incorporating as many of the stakeholders from the legacy programs as possible, while not sacrificing the broader goals of legalization.

k Illinois should ensure the cannabis testing program protects public health without creating unreasonable disruption to the stream of commerce or adding prohibitive costs to production.

kEven though the initial focus will be on having enough safe, regulated and tested cannabis available to consumers on day one of legalization, the state may want to implement public policy that will help to stabilize the market and prevent diversion of regulated cannabis to the criminal market over the longer term.

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THE IMPACT OF PUBLIC POLICY ON INITIAL SUPPLY

Significant attention is often paid to cannabis demand estimates in advance of commercialization; yet, the key role supply plays in the proper functioning of the system is frequently overlooked. Public policy requirements in laws and regulations can have an impact on attaining the right number and type of licensees capable of producing an adequate amount of cannabis in a cost effective, safe, and timely manner. Functionally, when commercial sales begin in a state, the demand for cannabis is essentially unlimited because there is always a small number of operational businesses on day one with a limited amount of product. This next section discusses some of the public policy choices and structures that impact the cannabis industry’s ability to supply the market with adequate amounts of safe and regulated cannabis for both medical needs and adult use on day one of legalization.

LICENSEE REQUIREMENTS AND REGULATORY AUTHORITY

All of the current legislative frameworks, correctly so, provide a framework of requirements for licensees. These requirements (books and records, security requirements, inventory tracking, etc.) are either applicable to all license types or can be specific for a particular license type (i.e. closed loop extraction systems for manufacturers, identification

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checks for stores, and pesticide use for cultivations). In aggregate, these requirements could lengthen the amount of time it takes for a licensee to become compliant, which could impact the licensee’s ability to open immediately after licensing.

MANDATED TIMEFRAMES

It is common for citizen initiatives and legislation to create mandates and provide deadlines for agencies to produce specific regulatory and administrative policies. Pro-cannabis advocacy organizations will likely ask for abbreviated timelines, while opposition groups, such as law enforcement, may request more extensive timelines. Mandated timeframes can ensure that agencies tasked with implementation avoid bureaucratic inertia and take the steps necessary to breathe life into the regulated framework. Yet, those same requirements can create unrealistic timeframes, unfunded mandates, rushed decisions, limited citizen engagement, and uncertain rollouts. To set up a system in a timely manner and avoid the failures that can be associated with rushed implementation, realistic expectations and reasonable (but limited) discretion must be built into legislation.

Mandated start dates- To date, no state has opened up on day one of legalization with a fully functional regulatory framework. Nor has any state started on day one with a significant number of fully operational licensed businesses. Most states have had significant portions of the regulatory framework in place and some licensees opened on day one, but those efforts were supplemented by an existing, regulated, commercial medical cannabis segment of the market. If a

All of the current frameworks for commercialized cannabis tasked an agency or agencies to implement and administer new policies safely and e�ciently. These agencies are also tasked with and authorized to perform a myriad of regulatory functions. The breadth and scope of these regulatory functions are significant, and thus, implementation is always challenging and can lengthen the time it takes to get licensed businesses participating in the adult-use regulatory system.

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mandated start date is adopted, it is reasonable for a state to leverage implementation efficiencies gained by transitioning a regulated medical segment of the industry into the adult-use segment but there could still be additional challenges.

These challenges are discussed more in later sections, but we will introduce them here briefly. They include local approvals(licensng, environmental reviews, etc), inter-agencycooperation, populating adult-use inventories, and mandatory testing. Each of these challenges could make transitioning the current medical cannabis licensees to adult use more di�cult than it appears on the surface. To start with, the primary regulator does not have the ability to manage all of these challenges and they can’t compel other state agencies and local jurisdictions to act. Some of these challenges can be managed by the state’s primary regulator, while others require a coordinated e�ort among multiple state and local agencies. It may be more realistic to have a target date with clear expectations for state agencies but build in more time orflexibility to account for the challenges state and local agencies will face while coordinating e�orts among oneanother. This is important because accounting for all of these circumstances in legislation has been somewhat elusive in most of the legalized states.

Emergency Regulations: The initial legislation is a goodplace to design timeframes for emergency regulations. Forexample, the legislation must direct the agency or agencies responsible for licensing and monitoring to have emergency regulations in place in advance of a mandated start date. It is especially important for these regulations to cover licensing and denial processes, fees for applications and licensing, qualifications for licensure, diversion prevention, packaging,labeling, transportation of cannabis, movement of inventory between the medical and adult-use licensees, and testingrequirements. It is important to have these regulations in place to provide guidance and expectations for initial licensing andmonitoring, but it is equally important to recognize how much these rules may change once there is more time to engage the public, leverage expertise from various agencies, understand the operational realities of licensees, and reevaluate public health and safety concerns. Much of the latter work will be done during permanent rulemaking, which has its own set of deadlines and requirements that regulatory agencies have tomeet. Other e�orts to address some of these challenges may be left to future legislative action.

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Emergency rulemaking is challenging, and the time constraints reduce the margin for error and minimize a regulator’s ability to engage in collaborative processes. One way to mitigate these challenges is to have some goals in place for the initial set of regulations. For example, the legislature may want emergency rulemaking completed in advance of the first day of sales, but they may also want the rulemaking process to be efficient and open to public discourse, so that confusion is minimized, and regulatory expectations are clear. Regulations promulgated by multiple agencies could make achieving these goals much more challenging. This will be discussed more below, but it may make the creation of a cohesive set of emergency regulations challenging even with something as simple as defined terms.

For these reasons, it is tempting for the legislature to place deadlines on regulators to process applications in a given period of time. In Colorado, Amendment 64 placed a 90-day deadline on processing the applications. Ironically, it also banned state regulators from licensing before 45 days. This only allowed for 45-day window for regulators to make decisions on licensing applications. If regulators were to miss the window by not making a licensing decision, the applicant was directed to apply with the relevant local jurisdiction for licensing and the state would lose authority to regulate the business. This never happened in Colorado, but the specter of it occurring compelled regulators to prioritize new applications above all other regulatory functions.

Licensing: Other jurisdictions have been concerned about the pace at which state agencies approve applicants for licensing. Several state jurisdictions have adopted best practices from casino gambling and liquor licensing when determining the scope of background investigations. In both cases, the amount of time it takes to license applicants can vary from two tosix months and is heavily dependent on sta�ng levels and appropriated resources. Some jurisdictions, like Colorado and Massachusetts have been successful in transitioning operating commercial medical cannabis businesses into the adult-use system, while other states have struggled to get licenses processed. Because there can be a significant amount of uncertainty surrounding the length of time it can take for regulators to make licensing decisions, cannabis businesses may lobby lawmakers to place deadlines on the amount of time it takes to process an application and make a decision to approve or deny the license.

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Obviously, missing the mark placed regulators in jeopardy of failing in their duties; so, they directed a majority of their resources towards ensuring that this mandate was met. Frankly, the 90-day requirement to approve or deny may be adequate if the regulator is simply transitioning medical cannabis businesses into the adult-use program. This is especially true if the medical cannabis business owners had to undergo similar licensing requirements to get their medical licenses.

In almost all other circumstances, the 90-day deadline failed to meet its objectives. For example, the 90-day window assumed that local jurisdictions could process applications sooner. It turns out that local requirements can take longer especially when local agencies require land use (zoning) or environmental reviews. If it is a new applicant, there are often further delays getting approval when local jurisdictions require inspections and hearings for fire safety, ADA, new construction, or the addition of closed loop extraction systems. In Colorado, the state made licensing decisions on all of the applicants that applied for adult use in 2013, but only about a dozen were able to obtain all of the local approvals in time for the start of commercial sales on January 1, 2014.

State agencies in Colorado also faced challenges after the initial round of adult use applications. For the first nine months of legalization, only medical cannabis licensees were allowed to be licensed for adult use. After this initial period expired, new applicants who were not previously licensed as medical businesses began to apply for adult-use cannabis licenses. The scope of that application processing was significantly more resource intensive that transitioning a medical license into the adult- use system. Because the repercussions for non-complianceof the 90-day requirement were significant, state regulators always had to make those new applications a priority, which came at the expense of processing other licensing functions in a timely manner. For example, anytime a licensee wantedto change ownership of the licensed business, it had to get those modifications approved prior to consummating thetransaction. In the early days of legalization, a state should expect licensed businesses to have dynamic ownershipsstructures, and if most of the state resources are focused on new applications, then licensing decisions, such as changeof ownerships and renewal applications, may experience significant delays in processing. This problem became

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so severe in Colorado that the industry lobbied the state legislature to increase the regulators’ appropriation for more staff to process the backlog of applications.

Bottom line: licensing deadlines are a slippery slope. They may be useful early on when transitioning medical businesses into adult use. Beyond that, it may prove to be more problematic than it is worth, when you consider the unintended consequences these deadlines generate for regulators and industry actors.

Inventory Deadlines: Almost every state that has implemented adult-use programs have utilized existing medical business licensees to supply the initial inventory. There are a number of issues to consider when transitioning medical product into an adult-use program, not the least of which is limiting when and how often the medical companies can transfer product that is compliant with adult-use requirements (edible potency, testing, labeling, etc.). Some states allowed for a one-time transfer of medical inventory to get the adult-use system started (Colorado) while other states allowed for multiple or ongoing transfers (California and Massachusetts). Because this can be a complex issue, it may be best to delegate decision making over inventory transfers to regulatory authorities who are better equipped to understand how to account for these transfers in way that ensures the product came from regulated businesses, that supply is as sufficient as possible, and that all tax consequences are considered.

Testing: Required testing is existent in every adult-useprogram, and often, the testing requirements are more exhaustive compared to medicl programs. This topic is discussed in more detail belowbut rolling out a comprehensive testing program early in implementation (i.e. mandated startdates) could cause significant disruptions to supply from licensed cannabis businesses. In most cases, the demand for testing can outpace laboratory capacity if the comprehensive set of tests require implementation in a short period of time.

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AGENCY OR AGENCIES (CENTRALIZED OR DECENTRALIZED AGENCY AUTHORITY/DECISION MAKING)

States have taken various approaches to implementing adult-use (and even medical) cannabis. Those approaches generally fall into two categories. One category employs a centralized agency where most, if not all, of the licensing, monitoring, and enforcement occurs. States like Colorado, Washington, Alaska, and Oregon all have a point agency that is assigned the primary duties of licensing, monitoring, and enforcing cannabis laws and regulations. In Colorado’s case, the Executive Director of the Department of Revenue was authorized as the licensing authority and the department’s Marijuana Enforcement Division was created as the administrative arm. In Washington, Alaska and Oregon, their respective liquor control commissions were assigned the licensing authority duties and the commission’s staff serve as the administrative arms. Massachusetts took another approach and created an entirely new agency with a commission structure. The Cannabis Control Commission (CCC) is the licensing authority and its staff, led by the Executive Director, serves as the administrative arm. The CCC is still the primary authority for licensing, monitoring, and enforcement of all license types.

The second approach has been to decentralize rulemaking, licensing, monitoring, and enforcement authorities among multiple agencies. In California, the state created three different licensing authorities in existing departments. Each department created its own program or sub-agency to house the licensing authority and the administrative functions for rulemaking, licensing, monitoring and enforcement. The Bureau of Cannabis Control is responsible for storefronts, distributors and testing facilities; the Department of Agriculture is responsible for cultivations, and the Department of Health is responsible for manufacturers. In Ohio, its medical program follows a similar structure where multiple agencies engage in rulemaking, licensing, monitoring and enforcement.

Each approach has its advantages and disadvantages. For example, it is difficult, at least early on, for any one agency to incorporate successfully all of the resources needed to take on the volume of work and expertise necessary to stand up a cannabis legalization framework. At the very least, lead agencies need the help of other government agencies to draft regulations; mobilize the right resources; and coordinate licensing, monitoring, and enforcement.

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Even though challenges exist for implementation within a single agency, spreading out the authority among several agencies does not necessarily solve those problems and can, in fact, compound them. Even if all of the agencies are agreeable to working together, it may be difficult to do so due to conflicting statutes, challenges in mobilizing and coordinating resources, varied interpretations of cannabis legislation, hard-wired internal processes, professional priorities, minimal experience working in a multi-agency environment, and different personal or political positions regarding legalization among employees and/or stakeholders. Any or all of these can make cooperation challenging even when the collective intent is to do so. Decentralized frameworks have become challenging in other states as they seek to harmonize regulations, standardize processes, and utilize shared information technology systems. In these situations, having some form of central governance or decision making could make the difference between having product on the shelves on day one or not.

INTERAGENCY COMMITTEE

Cannabis legalization requires state governments to mobilize numerous agencies from multiple jurisdictions and areas of expertise in order to bring the right amount of resources to bear to meet the demands of implementation. These tasks are not easy. Cannabis legalization, directly and indirectly, incorporates a large number of regulatory frameworks and government activities, that otherwise need not be coordinated. Cannabis is an agricultural commodity; its manufacturing processes produce consumable/edible products; laboratory testing is required to make the product safe for consumption; certain activities involving the plant and its products constitute criminal acts; the plant faces direct taxation in addition to point-of-sale taxation. To wit, the licensed businesses, and every step of the supply chain, have to be monitored for compliance.

In an optimal setting, interagency committees can be a vital part of a working governance system. In a problematic setting, these committees become a hinderance or unproductive if they do not have the proper decision-making authority or influence. An interagency committee or workgroup can be

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helpful managing these complexities, whether the final bill chooses a centralized, decentralized, or hybrid approach to coordinating rulemaking, licensing, monitoring, and enforcement. These types of committees need to have direction beyond the frequency of meetings and makeup of the team to ensure decisions and coordination can occur when the agencies meet. To optimize the ability of the interagency committee to coordinate effectively among agencies, we offer the following policy approaches for consideration. Each of these approaches can stand alone or be combined for a more comprehensive governance structure.

Policy Approach #1: Articulate expected results.1

Here is some suggested language for articulating expected results:

The interagency committee shall perform strategic planning, coordination of regulations, educational content planning and implementation, community engagement, budget coordination, data collection, data sharing, and any other duties deemed necessary. To do so, the committee shall:

1. Coordinate with the executive directors of each state agency regarding the agency’s promulgation of rules on retail (adult-use) and medical cannabis that reduce negative economic, public safety, and health consequences for the state;

2. Align all policy suggestions and the promulgation of rules across state agencies to increase efficiency and eliminate unintended negative impacts on the state;

3. Create a universal budget that tracks the direct costs of cannabis regulation across all agencies;

4. Create a tax revenue plan that articulates how cannabis tax revenue will be spent, tracked, and monitored for efficacy.

1 Language drawn from CO Rev Stat § 24-38.3-101 (2016) and CO Rev Stat § 24-38.3-102 (2016)

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5. Communicate with other states related to the economic, health, and safety implications of retail cannabis legalization and regulation;

6. Identify and address gaps in data necessary to measure the impact of cannabis legalization on public health, safety, economics, or other areas of public concern across the state;

7. Anticipate, prioritize, and respond to emerging issues with the legalization of retail cannabis; and

8. Designate a staff member to serve as the contact person across all efforts managed by a state agency.

Policy Approach #2: Create a temporary position within the governor’s office to chair the committee.

As articulated above, the committee will have a great deal of work to accomplish over the first few years. We suggest that this committee be staffed and chaired by a fulltime position who can coordinate among agencies and communicate directly to the governor where needed. We suggest a three-year sunset to this position. At the end of that time, the work will be considerably less, and the chair position can revert to the relevant state authority which will be responsible for maintaining and refining the structures and processes established in the first three years. This will also create the time constraint and sense of urgency necessary for effective coordination.

Policy Approach #3: Provide tools and authority to aid in coordination.

Given that multiple agencies are tasked with significant rulemaking obligations, we suggest providing the interagency committee with some powers to align these rules. The interagency committee should direct the agencies to coordinate rulemaking activities and give some authority to the relevant state authority to create templates or otherwise ensure there is uniformity to definitions, application

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procedures, and licensing and operational requirements that have the potential of being the same regardless of the license type. If these activities are not coordinated, it can lead to duplication of effort and/or significant confusion during implementation—each of which generates inefficiencies in the licensing of compliant businesses.

Second, consider giving decision making authority to the relevant state authority to adopt regulations that clearly outline how and when inventory is going to be populated among adult-use licensees. In the absence of clear direction and decision making, different agencies licensing different license types could take different approaches to these activities, and there could be significant inconsistencies.

Policy Approach #4: Prioritize the creation of a functional governance structure so that there is clear delegation of decision rights, roles, and timing.

Such a legalization framework is complicated by necessity. The expertise and capacity to perform all the tasks necessary for a safe and efficient system is spread across many agencies. The interagency committee should prioritize creating and maintaining a functional governance system, but the authority to do so has to be clear in legislation.

For example, the shared approach to having multiple agencies licensing different business types could create some undefined overlap where it is difficult to know where one agency’s responsibilities end, and another’s begin. Licensing may happen with one agency, while another may have the responsibility for enforcement. This creates two potential challenges if the legislation does not provide for a clear delegation of decision-making authority. First, any vague requirements in legislation could lead to multiple interpretations and discretionary administrative activities that can cause dysfunction in the system. Clarifying that language in advance of passage is an essential step toward a stronger regulatory system. Second, multiple agencies may have a need to have shared information technology systems, and the legislature should be sensitive to the resource needs for such systems among multiple agencies—particularly in advance of cannabis tax revenue entering government coffers. It would be helpful for the legislature to direct an interagency

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committee to establish a governance structure that specifically outlines how the various departments will handle each of the challenges detailed above along with a number of others that may not be discovered until well into implementation.

Policy Approach #5: Allow for the participation of other agencies in the committee at the discretion of the chair.

The potential impacts of legalization may impact agencies not articulated in the draft. Policy changes, regulations, or budget considerations may impact driving while high, mental health and addiction services, cannabis in schools, water rights, banking, and many other issues. We suggest allowing the chair to bring in other agency heads when needed to discuss these issues.

Legalization incorporates so many di�erent policy areas that it could be costly, ine�cient, and time consuming to create one agency that would house all of the regulatory functions that make up a comprehensive regulatory framework for commercialized cannabis. Similar challenges could existif the structure were to decentralize the regulatory functions among several regulatory agencies in di�erent departments, especially if there was no guidance on how they were expected to interact, make decisions, and coordinate e�orts. Because there are advantages and disadvantages to bothapproaches, considering any combination of the policy alternatives above may help to mitigate those challenges.Moreover, in a decentralized system, a limited number of agencies can reduce coordination and communication costs and limit the amount of confusion surrounding legislative interpretation and mandates. Carefully weighing the value and importance of each agency involved is critical to establishing a system that is both comprehensive and functional.

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STATE LICENSING

Getting to this point can be hampered if the legislation is not crafted in a thoughtful manner. In fact, no state has pulled this off flawlessly. States have faced challenges when the licensing authorities are compelled to be reliant on other governmental bodies to complete a portion of the license application process. Other challenges have occurred because the legislation did not fully contemplate the timing of licensing with respect to the amount of time it takes the business to ready itself for opening after licensing. This section will discuss these types of challenges in more detail.

One of the first indications of successful implementation occurs when the state licensing authorities start issuing licenses to businesses that are prepared to operate in compliance with the regulations. This moment is usually an exciting time because it signals that lawful adult-use sales are imminent and that implementation e�orts have been successful in bringing safer, more regulated product toconsumers.

Harmonized Regulations: This topic was briefly discussed earlier and must be revisited because of its importance. The initial push to implement adult-use cannabis reform cannot be done well without the cooperation of multiple state agencies (even if a regulatory system is centralized), but as more agencies are tasked with legislative and/or regulatoryobjectives, the amount of time it takes to implement could be increased. This outcome is especially possible if each agency’s work needs to be coordinated with other state agenciesand if there is no governance structure or decision-making authority in place to coordinate the e�orts. This situation is particularly problematic for the initial rounds of rulemaking. For Illinois, there could be as many as four agencies scrambling to put out initial sets of regulations for di�erent types of licenses. In previous states that have legalized, agencies have struggled to harmonize components of the rules as basic as creating a shared, cohesive set of defined terms for the regulations or standardized application procedures. Many cannabis businesses will apply for multiple license types. If they have to go to several agencies to apply, it would be helpful for those processes to be as similar as possible to streamline the process for both the business and the regulator. It can

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also be confusing for these applicants if the defined terms are different for each agency’s rules. Providing the right macro-framework such that agencies have a firm decision-making structure is important to limit confusion and increase compliance among industry actors.

Scope of Due Diligence on Applicants: Many states have adopted best practices for conducting background checks on applicants from gaming and liquor regulations. Categories of checks range from criminal history to in-depth financial and ownership investigations involving bank statements, tax returns, liquidity, partnership agreements, and reviews of business and operational plans. All of these components have merit, but those practices could also increase the amount of time it takes for regulators to approve applications. As mentioned previously, the scope of background investigations of current medical businesses may be less if the requirements for licensing in the medical program were similar to the ones adopted in the adult-use program. In approving applications for adult use, regulators could utilize previous due diligence conducted on those entitles during the medical process, cross-reference that information with existing compliance/enforcement information, ensure that information remains valid and up to date, and approve those applications in a fraction of the time.

Fingerprint Checks: Another important consideration for state licensing is to ensure that the legislation has the proper wording necessary to authorize state agencies to conduct fingerprint checks on natural persons making up the

Application Volume: One of the challenges states face is an influx of applications when agencies are still trying to onboard resources to process them. Illinois will be positioned well at the onset if it elects to streamline the state licensing process for applicants that are currently licensed as medical cannabis businesses. If the law allows other applicationsfrom non-medical businesses, then it would be helpful to the implementation e�ort to create an initial window in which only applications from existing medical businesses be considered. After a set period of time, non-medical “new applicants” could then submit license applications to the relevant agency.

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Phasing in License Types and Privileges: Many states that have implemented adult-use cannabis laws include dates by which cannabis businesses are expected to be licensed and operational. If these types of start dates are incorporated into Illinois legislation, it would be important to include additional points in time by which licensees can exercise certain privileges of the license (i.e., cultivation, processing, transporting, wholesaling, etc.) in advance of the anticipated start date.

In order to illustrate this concept, let’s assume that the Illinois legislature expects all of the interested medical cannabis licensees to be licensed for adult use and operational no sooner than January 1, 2020. The wording and structure of this section of the legislation has to be crafted so this expectation can be met by regulators and the prospective licensees. The structure of the statute should allow for regulators to license a business in advance of the start, but also give regulators the ability to phase in the licensee’s ability to exercise all of the privileges granted by the license. For example, the regulators might license a storefront In November 2019 and explicitly prohibit the licensee from opening to the public for sales until January 1, 2020, while allowing the licensee to receive shipments of inventory and stock shelves in anticipation of the start date.

ownership structure of the cannabis businesses. If fingerprint checks are required before licenses can be issued, then it isvitally important to ensure that state licensing authorities get the proper authorizations from the relevant Federal and State authorities.

Earlier licensing of cultivations, processors and transportersis important because those licensees need evenmore time to grow and process product in order to supply storefronts with inventory. A lot of attention has been paid in this document to giving first priority to medical businesses interested in transitioning into the adult-use regulatoryframework. A concern with this approach is that the demand for medical cannabis still be met. It is not out of the realm of possibility that those medical businesses might end up moving too much cannabis over to the adult-use market creating shortages for patients. Giving cultivations and processors the ability to ramp up production above what is currently being produced in the medical program before any start date is anecessity.

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LOCAL APPROVALS AND LICENSING

This delay can be a major factor in implementing adult-use programs. It is not necessarily something that can be corrected through legislation, but it can be mitigated if local authorities are included in the legislative and rulemaking processes. Some of the most common complaints local jurisdictions voice during implementation is that state policies keep changing. This problem is enhanced when the state

Timing state licensing to coincide with local licensing has proven to be challenging for a variety of reasons. For example, early on during the implementation of the medical cannabis program in Colorado, the state was not allowed to license until the local jurisdiction approved and licensed the business. This situation created a number of issues for state regulators because the local processes often took considerably longer to approve than the state process. Since there were delays in final licensing, the businesses would change ownership in the middle of processing, and it ultimately created a budget shortfall for the state because it could not collect licensing fees. This issue was eventually fixed by allowing the state to proceed with licensing while the applicant continued to move through the local processes for land use, etc. However, in the interim, administrative dysfunction generated confusion among prospective licensees. Ultimately, the state issued licenses when its processes were concluded, but license validity was contingent on local approval. It was made clear to all state licensees that they could not begin operating unless and until all approvals were received.

Even though it is possible for the state to proceed with licensing under this scenario, it does not completely assuage the concern over having enough licenses on start dates outlined in legislation. Often, local jurisdictions’ processes for approving cannabis businesses do not begin until the state has established what its processes are going to look like. The longer the state takes passing legislation and promulgatingregulations, the longer it takes for local jurisdictions to start contemplating what their approach to licensing cannabis businesses will be. Given this scenario, the state could already be accepting and processing applications for state licensure before the local jurisdictions have evaluated the state policy and implemented their own ordinances/processes.

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Many of these issues may have been addressed during the local approval process for medical businesses, but local jurisdictions often want to hear from impacted communities when the planned use changes. It is common for local jurisdictions to view the addition of adult use privileges as a change in use needing additional approval. Every local

fails to communicate how specific policies are progressing and when state policy changes result in unfunded mandates or subsequent local changes. Proactively including local jurisdictions could provide the right resources and information they need to help inform state policy during deliberative stages and to get started on local approval processes moree�ciently. As important as it is to ensure that state agencies are communicating and coordinating properly, it is equally important to have effective communication between state and local governments.

The length of local approvals can also be mitigated if medical businesses are the first to get licensed. Both state and local governments are cognizant of receiving a large portion ofapplications, many of which would be starting the process from the beginning. Allowing medical businesses to makethe transition first into adult use can create a number ofe�ciencies and licensing is one of those areas. Navigating the transition to adult use can be less of a burden if local jurisdictions are only processing adult use applications from an existing population that is familiar with the approval processes. This course of action reduces the e�ort to a known number of potential licensees and prevents an influx of new applications that tend to consume more resources.

Allowing medical businesses’ transition first does not guarantee that local applications will be approved at the same rate as state licenses because many local jurisdictions will want to analyze the impact adult-use licenses may haveon communities. For example, the City of Denver required new hearings for existing medical businesses to evaluatethe impact adult-use sales would have in the neighborhoods where licensed premises were located. There were concerns over increased tra�c, access by minors, proximity to parks and schools, and crime related to the addition of adult-usestorefronts.

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jurisdiction is different; so, some will be comfortable looking at the adult-use program as being similar to medical. Others are likely to take a completely different look because it views the impact as something altogether different. If Illinois decides to allow for more licensees than it has in medical, there will likely be variation in extent that local jurisdictions look to manage the impact of adult-use cannabis businesses.

LABORATORY TESTING

The commitment to legalization includes an assurance that cannabis inventories will be properly tested before being sold to consumers. The expectation is that properly-tested cannabis will be available on day one of legalization. On the surface, this is a reasonable goal, but providing tested cannabis on day one of legalization can further limit the amount of supply in the early days—a time during which a multitude of factors contribute to a limited supply of cannabis.

Types of tests, testing standards, and testing frequency all combine to determine how extensive the testing processes will be to ensure that cannabis is safe and consistent at the onset of legalization. We discuss each of these in more detail below, but for now it is important to note that these policy decisions will determine how elaborate, time consuming, and costly testing will be for the various cannabis products. The aggregate number of required tests is important because there is often limited laboratory bandwidth to conduct all of the tests. It is not uncommon for the initial testing demand to outpace the ability of laboratories to complete testing.

NUMBER OF APPROVED TESTING LABORATORIES

To date, many established, non-cannabis testing laboratories that serve other industries have elected not to engage with the cannabis industry. This outcome may stem from a reluctance to get involved with a product that is illegal under federal law, but it may also have to do with rigid (or even conflicting) state and local requirements. In many cases,

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cannabis testing laboratories have to meet the same standards for licensing as other cannabis businesses (i.e., cultivations, manufacturers, and dispensaries). These requirements may include time consuming and expensive licensing processes—some of which may be subject to the same local approval processes noted above. The regulations also include significant investment in surveillance systems, alarms, construction, and other requirements. Bottom line, the additional requirements and general apprehension about testing cannabis may limit the viability of adding cannabis testing to an established laboratory, resulting in the need for a cottage industry of laboratory testing specifically for the cannabis industry.

Often, these new testing laboratories are formed for the exclusive purpose of testing cannabis. These laboratories endure the same requirements noted above. Often, they need to obtain a certification that evaluates the testing methodologies and instrumentation used to test cannabis. They typically cannot operate until every approval is issued. These laboratories require significant startup capital, and even when such capital is available, there can be a significant amount of time before revenue can be realized from testing cannabis.

These new entrants into the market strategically invest in instrumentation based on a business model not borne from entrepreneurial innovation, but from a hard-wired set of requirements from the regulatory system. Early testing requirements may not reflect the broad scope of testing contained in final rules issued later. This scenario has played out in several legal states already. In this case, testing laboratories purchase equipment needed to meet the requirements under the initial rules, and then add additional equipment later when new testing rules are promulgated. This raises costs to testing laboratories—costs which will ultimately be passed on to the consumer.

Existing medical programs, like the one in Illinois, include testing facilities that have already been approved to conduct testing on medical cannabis. This system can be advantageous when incorporating adult use in the state’s public policy. However, it may be important to expand the requirements for the adult-use market if the medical program has limited accountability, it is voluntary, it has permissive

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testing requirements, or there exist differences in the availability of products between the two markets (i.e., there are additional types of products available in the adult-use market that are unavailable in the medical market). Developed medical cannabis testing laboratories may have to undergo some significant changes to incorporate the more rigid standards frequently seen in mandatory testing frameworks for adult use.

All of the issues noted above combine to limit the number of qualified laboratories or limit existing laboratories’ ability to perform all of the test types required. It is not uncommon for states to begin legalized sales with a handful or fewer of qualified labs. As a result, lab capacity can be limited, and product can be on hold, waiting for tests to be completed.

NUMBER OF REQUIRED TESTS

Limited testing laboratories or a limited number of those laboratories leads to problems that are amplified if the number of tests is high or there is a high rate of test failures stemming from product not meeting requirements. If the regulated system is either unable to provide enough product in the early days of legalization or if unsafe product makes its way to market, then the regulatory framework could be perceived as failing right out of the chute—a failure that legalization opponents and media are likely to spotlight. This section highlights some of the particular issues the state must consider when developing a cannabis testing program.

Testing types: Testing types or categories of testing are fairly standard, regardless of the state. Potency, cannabinoidprofiles, terpene profiles, consistency of edibles, residualsolvents, microbials, and pesticides are some of the typical categories that laboratories are charged with evaluating,but there can more. Of those listed above, pesticides have proven to be the hardest to navigate. If pesticide testing is not properly designed in statute or regulation, there may be some discrepancies in what is required in regulation and what testing facilities can actually test for in practice. This policy balance is di�cult to achieve; so, it may be helpful to extend

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more precise rulemaking authority to the relevant agencies to refine such processes. That authority should be flexible enough for regulators to consider the complex nature of pesticide regulation when promulgating rules in this space. If pesticide testing standards do not hit the mark, there could be large amounts of cannabis placed on hold—a result that could be important to protect consumer awareness and public safety or could be a stumbling block that damages the credibility of the system based on minor differences between testing results and overly strict regulatory standards.

Testing standards: Standards are another complicated issue, and there is a significant debate around what the standards should be for approval or failure. Clearly, the standards have to focus on protecting public health. A balance must be struck so that public health is protected but without requirements being overly restrictive and arbitrary. Unfortunately, that tipping point has not been scientifically verified, and for cannabis products, federal government guidance is often unavailable. Knowing this, there needs to be some discretion given to regulators to craft regulations to allow reasonable testing requirements. For example, it makes sense to have variance or margins of error for most of the potency tests. There are also standard thresholds for certain types of microbials and pesticides from other, non-cannabis product markets. Even though there is a tendency to incorporate zero tolerance in some testing standards, the practical application tends to result in thresholds that far exceed the threat to public health. As was the case with testing types, deciphering the particulars of testing standards is something best left for a deliberative rulemaking process that crowdsources information from experts to determine proper rules, rather than these determinations being made by a legislative body.

Testing frequency: Some of the original testing frameworks in legal states required testing at various points in the production chain, even though well-established internal processes continued to produce nearly identical testing results at each step. As licensed cannabis businesses establish processes for cultivation and manufacturing, there may be an opportunity to reduce the frequency of testing and to reduce costs to licensees without compromising public health concerns or the integrity of test results.

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Illinois could allow licensees to process validate in order to reduce testing burdens. Process validation is when a company has established and documented procedures for cultivation and manufacturing processes that yield similar testing results every time the process is followed. Best practices for laboratory testing allow for the regulated industry to process validate specific types of tests to reduce the frequency of testing, provided certain requirements have been met. For example, process validation for potency testing may alleviate the need for continued potency testing, so long as test results were consistent over a period of time. Process validation should have some limitations. For example, process validation should expire after a certain time and compel a licensee to be recertified. Also, process validation should be withdrawn and reestablished after a significant change to the process is made. Some of these allowances may or may not be included in existing medical programs.

All told, these challenges stemming from mandatory testing for adult-use cannabis can have a material impact on the state’s ability to have safe, regulated cannabis available to consumers on day one. With that in mind, there are a few opportunities noted below that the state could consider when trying to protect public health in a reasonable way and provide safe product to consumers. These policy approaches can be considered individually or in any combination.

POLICY APPROACH NUMBER 1: Streamline processes to approve laboratories and laboratory testing standards from the existing medical marijuana system.

POLICY APPROACH NUMBER 2: Adopt the current medical program testing standards and testing types initially with a directive to regulatory agencies that allows flexibility and implementation of the program in a way that protects public health and improves testing requirements over time.

POLICY APPROACH NUMBER 4: Allow enough rulemaking authority and flexibility for regulators to implement key aspects of the testing framework when there is adequate laboratory capacity to conduct the mandatory testing.

POLICY APPROACH NUMBER 3: Direct regulatory agencies to promulgate updated testing rules for pesticides after careful deliberation with a broad base of impacted stakeholders.

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Test Sampling: Test sampling is not included in the equation for determining the total number of tests, but it plays a significant role in how efficiently and effectively the collection and transfer of testing samples occur. In order for the mandatory testing program to protect public health effectively, the test results have to meet scientific standards for reliability and validity. This presents a tremendous logistical issue. What are the standards for test sample collection? Who should collect the test samples? Who is authorized to transfer those test samples to the laboratory?

The typical mandatory cannabis testing framework requires that inventory be held at the licensed premises while waiting for the test results from a cannabis testing laboratory. If the process of collecting samples, transferring them to the laboratory, and performing the tests is inefficient, then this can and has led to supply problems. The tension between ensuring valid and reliable testing and creating efficiencies in the testing framework has been the subject of a lot of debate.

The most efficient way to deal with this problem is for government to provide a set of best practices to licensees and to allow licensees to collect their own samples and transfer them to the laboratory. Even though this is efficient, this approach relies on trusting licensees to collect samples from the product to be tested. In other words, it gives licensees some leeway to get the most favorable results for a given test. For example, licensees could learn sampling techniques that circumvent the purpose of testing in order to get passing results. This is a valid concern for regulators, but as licensed businesses become more established, they also have a vested interest in ensuring their inventories are safe and meet the testing standards. In the meantime, regulators could alleviate some of the weaknesses to the licensee sampling approach by conducting random testing of licensee inventory to ensure testing is being performed properly.

If the most efficient route creates too many concerns surrounding trust in licensees, then the state could consider allowing third-party samplers to collect samples from licensees and transport them to laboratories. The state could also require the laboratories to collect the samples, too. In both cases, the design of the legislation and regulatory processes can create too many regulatory barriers that third- party samplers and laboratories will not be able to e�ciently collect and deliver samples to the testing facility.

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It has been our experience that laboratories do not prefer to collect the samples because it requires them to invest more in employees and vehicles. They also argue that it puts more liability on them to collect and test the samples. As was the case with third party samplers, it is advisable not to require that testing laboratories collect samples and leave the details of these decisions to the rulemaking process.

There are other challenges, too. Third party samplers may have a hard time making a business model work if collecting and transferring testing samples are the only functions they can perform. Because business solvency in the cannabis space is an issue, we recommend that the state not exclusively require third-party sampling in legislation because there will undoubtedly be too few in the early days of implementation, compounding concerns about e�cient testing and proper levels of inventory on day one and beyond. We think Illinois could see similar problems to Nevada’s rollout when alcohol distributors were the only entities allowed, under the law,to distribute cannabis—and none was approved to do so as Nevada’s day one approached. Many are monitoring California closely to see if their distributor model will be able to move testing samples to laboratories in an e�cient way.

Even with the most e�ective regulatory allowances in place for third party and laboratories, it is not clear whether or not it is an e�cient way in which to collect samples. All that beingsaid, it most likely would improve testing reliability and validity. Illinois could overcome some of these challenges by allowing for licensees, third party samplers and laboratories all to collect samples while also giving the regulator the authority to further regulate and conduct random testing of inventories.

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CONCLUSION

This second portion of the report provides a set of lessons learned for Illinois to consider when crafting its policy for the legalization of adult-use cannabis. It includes public policy considerations that will give the state a viable path forward to implement the regulated framework in a way that protects public health and safety, efficiently governs the agencies tasked with implementation, provides an adequate amount of regulated cannabis in the early months of legalized sales, and thoughtfully prepares for challenges that will come beyond the initial launch.

[email protected]

@FreedmanKoski

FREEDMAN & KOSKI, INC. WORKS WITH GOVERNMENT, RESEARCH INSTITUTIONS, COMMUNITIES AND PRIVATE BUSINESSES TO GET CANNABIS LEGALIZATION RIGHT.

FOR MORE INFORMATION, PLEASE VISIT OUR WEBSITE AT WWW.FREEDMANKOSKI.COM.

Date post:	20-Jun-2020
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