How Arizona’s ‘Non-Profit’ Medical Marijuana Industry Makes Millions

Photo Credit: David Wallace

Arizona’s surging medical marijuana industry includes a 40-acre greenhouse in Snowflake, stock traded on the Canadian market, an 800,000-square-foot factory turned indoor farm in west Phoenix, and home delivery for customers.

Sales of medical marijuana here soared nearly 50 percent in 2017 with an estimated value of $387 million. A small army of attorneys and high-end Scottsdale public relations professionals work on its behalf.

The size and scope of these operations belies the “non-profit” description voters heard when they approved medical marijuana in 2010. They also highlight an open secret within the industry: Non-profit doesn’t mean non-lucrative.

“When we created the program it was clear the vast majority of people interested in it were interested for financial reasons,” said Will Humble, former Department of Health Services who was in charge of creating the state’s oversight of medical marijuana after voters approved the program, although he opposed legalizing the drug.

“They’ll tell you it’s about patients. But they saw it as a golden ticket.”

Profitability in the pot industry has attracted attention from federal prosecutors as recently as 2012 in California, but even with a renewed focus on marijuana from U.S. Attorney General Jeff Sessions, Arizona operators see little risk in their profits.

Only the Department of Health Services knows how much any of the state’s 130 licensed dispensaries earns, but the Medical Marijuana Act that voters approved states that all dispensaries must run as “non-profits.”

While regulators can audit dispensaries, they have never sanctioned a dispensary for violating that stipulation.

That’s because even though the ballot initiative approved by voters used the word “non-profit” 125 times, it did not require dispensaries to register for tax-exempt non-profit status with the IRS or with the state.

Dispensaries must only abide by the vague requirement of having bylaws for their operation “to establish and maintain its non-profit character.”

What it means to be non-profit

Registering as a non-profit with the IRS doesn’t mean an organization can’t make a lot of money. Some of the biggest charitable organizations in the U.S., such as the YMCA and Salvation Army, take in more than $1 billion annually.

But operating as a traditional non-profit would require public reporting of revenues, expenses and profits that will be reinvested into the organization. Salaries of key employees also would be disclosed. Arizona dispensaries don’t report that to anyone but DHS.

Traditional non-profits also usually have a charitable mission. Dispensaries do not, other than selling medicine to customers.

Traditional non-profits often solicit donations to further charitable work, which donors can write off on their taxes. No such luck for money spent on medical marijuana.

“The biggest missed opportunity in the statute’s language is not holding them accountable to the IRS non-profit regulations,” Humble said.

The IRS rules for non-profits are designed to prevent any surplus revenues, or profits, from being distributed to the shareholders. Instead, non-profits must reinvest any profits into the business.

Many Arizona medical marijuana dispensaries have separate management companies that are paid to run the operations. The dispensaries may truly have no profits at the end of the year, but the management companies, which may include some of the same people involved in the dispensary, can be profitable.

DHS spokeswoman Nicole Capone said the agency is tracking the dispensaries’ cash via audits.

“This financial information, signed off by a CPA, should show that the dispensary is operating on a not-for-profit basis,” Capone said.

DHS officials could not answer more specific questions, such as whether there are any limits on what they can pay their executives or affiliated management companies.

“Some of those questions can only be answered by looking at everything, which a CPA is required to do in the form of an audit,” Capone said. “If there are some ADHS concerns with the results of that audit, ADHS may also do an audit, with help from our contracted CPA.”

After voters approved the program, Humble said it was apparent that the dispensary owners would make big money. When licenses were given out through a lottery system, there were investors in the parking lot offering money on the spot to purchase licenses from the winners.

Some of the state rules prevent dispensaries from, for example, using their revenue to purchase property from dispensary executives for an excessive price, thus preventing them from transferring wealth to that individual.

But there are no limits on the amount of marijuana license holders can sell or grow.

Dispensaries are allowed to grow their own marijuana and purchase it from farms run by other dispensaries, some of which supply dozens of retail outlets.

Millions invested in Arizona pot

The state’s program has attracted big-money interests.

For example, in early 2017, a publicly traded Canadian company now called MPX Bioceutical Corp. announced it was buying a stake in two Health For Life dispensaries in Mesa, as well as an affiliated marijuana extract company, for $25 million.

The relationship is detailed in reports to Canadian regulators  and provides a window into how non-profit Arizona dispensaries can generate profits for their management companies.

The company, then called Canadian Bioceutical Corp., reported that the dispensaries became “profitable” about a year after opening in 2014, with almost $20 million in annual revenue when they were acquired a year ago. The company didn’t report how much of that was profit.

The Health For Life dispensaries were owned by a New Jersey woman named Beth Stavola, who has made a name for herself nationally for investing in marijuana operations in multiple states.

The deal gave the Canadian company influence over the licensed Arizona dispensaries by managing them, staffing them and overseeing other logistics under a 20-year agreement. MPX does not directly own the dispensaries or Health for Life Inc.

Stavola joined the Canadian company, and regulatory reports indicate she was paid $125,000 and options to purchase 10.5 million shares of company stock at various prices in her first year. Her best options were to buy company shares at 20 cents each, and they were worth about $2.5 million based on recent prices for MPX shares.

A traditional non-profit can’t issue ownership shares.

“The licensee has to be non-profit, but from a business perspective, the relationships you form with management companies, there are many ways to be successful in Arizona and not run afoul of the non-profit formula,” said Laura Bianchi, a partner at the Rose Law Group and director of the firm’s cannabis department.

“Look, there are non-profits all over in all sorts of different industries where people make money.”

Humble said the Department of Health Services didn’t contemplate that type of international investment in Arizona dispensaries, but that it’s not surprising considering the money involved.

“I guess the (Department of Health Services) agency has decided that is an OK arrangement according to the bylaws,” Humble said.

MPX officials did not respond to requests for comment.

Industry expansion underway

In a sprawling west Phoenix building that formerly operated as a Revlon makeup factory, workers crowd into a room with piles of marijuana spread across long tables.

The workers are preparing the plant for packaging at the True Harvest indoor growing facility. Revlon once employed 900 workers at the 880,000-square-foot factory before closing in 2001. The facility was sold the year it closed for more than $5 million but has mostly sat unused — until True Harvest stepped in.

The ample electricity supplied to the building once used to run machinery is more than adequate for the intense lighting used to grow plants indoors and ventilate the building, while the water system used for makeup also proves useful for agriculture, managing partner Caleb Miller said.

True Harvest even hired some of the former Revlon workers who ran the plant to keep the marijuana operation running smooth, he said.

The facility could eventually employ more than 100 people and is in the middle of a series of expansions that will bring its capacity to 100,000 square feet and eight “clean rooms” used to grow as much as 1,000 pounds of marijuana a month.

A facility that size would produce about 14 percent of the 43 tons sold in Arizona last year.

“Yeah, the demand is there,” Miller said, citing state figures that show the number of patients with state-issued cards allowing them to purchase marijuana increasing rapidly.

“You can do the math,” he said.

Miller declined to say how much investors were spending on the expansion, but said he has no concerns with state regulations stipulating dispensaries operate as non-profits or with increased attention from federal prosecutors.

“Everything we do the state can look into at any time,” Miller said, noting the Department of Health Services paid the facility a visit in December.

Attorneys say profits allowed

Bianchi and other attorneys representing the industry in Arizona say the operations are on solid legal ground, but the profitability of medical marijuana operations has drawn attention in other states.

Since 1996, 29 states and Washington, D.C. have passed laws allowing for limited use of medical marijuana. Nine states allow adult recreational use.

Starting in 2011, U.S. Attorneys in California began a crackdown on the industry, often targeting the largest operations in the state with seizures of their marijuana, all based on the rationale that they were not complying with the spirit of the law.

Often the news of the seizures included figures from law enforcement regarding how much cash dispensary owners had on hand.

The raids stopped after the Justice Department issued the “Cole Memo” in August 2013, which said U.S. Attorneys should avoid enforcing marijuana laws in cases that don’t involve issues such as growing the plant on federal land, diverting the drug to minors or other issues, such as impaired driving.

Even the Cole memo indicated large, profitable operations could attract federal attention.

“A marijuana operation’s large scale or for-profit nature may be a relevant consideration for assessing the extent to which it undermines a particular federal enforcement priority,” the memo said.

A return to federal marijuana enforcement?

A return to the days of federal prosecutors singling out the marijuana industry could be at hand, though.

On Jan. 4, Sessions reversed the Cole memo.

With the new directive from the Justice Department, large, profitable medical marijuana operations could provide the same opportunity for U.S. Attorneys seeking to crack down on the drug.

Bianchi said her dispensary clients are unconcerned.

For one, dispensaries can still presume they are safe from prosecution thanks to an amendment first passed with the 2014 federal budget that prevents resources from being used to prosecute marijuana violations in states that have legal medical marijuana programs.

However, that amendment, called the Rohrabacher-Blumenauer Amendment, expires Feb. 8, absent an extension along with the budget.

But even without it, she sees a crackdown on medical marijuana in Arizona as unlikely.

“Even today and yesterday I was on the phone with investment groups out of the East Coast funding an expansion project,” she said. “We’ve talked about (Sessions’ move). They see it the same way I did, as a political maneuver.”

She said California’s medical marijuana program didn’t have as well-defined rules as Arizona’s, which would make prosecution more difficult here.

In the northern Arizona town of Snowflake, a 40-acre former tomato greenhouse has turned into what could be one of the largest legal marijuana farms in the world, though only a portion of the Copperstate Farms facility is in operation today.

Copperstate Farms, like other Arizona operations, is unfazed by the possibility of federal prosecution.

“The Rohrabacher amendment is still in place,” Copperstate attorney Ryan Hurley said. “Whether we expand or not is more linked to demand or the increased size of the medical marijuana program, or legalization for adult use. Those factors would drive expansion more than anything.”

That would change if Sessions moved into actual enforcement rather than issuing memos, he said.

“An actual enforcement would be different,” he said.