Major Canadian pot companies facing proposed class-action lawsuits in the U.S.

Some of Canada's biggest cannabis producers are facing proposed class-action lawsuits in the United States after investors were hit with steep financial losses in the stock market.

At least nine U.S. law firms are pursuing cases against Canopy Growth, Aurora Cannabis and Hexo Corp. in American courts.

Although the allegations vary, each pot producer is accused of misleading investors or failing to disclose certain problems with their businesses. When those problems became publicly known, the lawsuits claim, share prices plunged and investors were stuck with losses.

"[Investors] are mad; they were taken by surprise," said Reed Kathrein, a lawyer at Hagens Berman Sobol Shapiro LLP, which is pursuing claims against all three producers.

None of the allegations have been proven in court.

Each of the companies declined to be interviewed for this story. Canopy and Aurora denied the allegations in brief statements, while Hexo said only its lawyers are reviewing the claims.

Producers ride green crush

These companies were among several Canadian cannabis firms that listed on U.S. stock exchanges, riding a wave of investor enthusiasm surrounding the industry before and after Canada legalized pot.

"But when they hit obstacles, the share prices declined," said Kevin LaCroix, a Cleveland-based lawyer who is not involved in any of the proposed class actions, but has followed the industry.

"It's pretty common in the United States, when a company experiences a significant decline in its share price, opportunistic plaintiff lawyers will try and seize on that as an opportunity to try and make some money."

Lawsuits could create uncertainty

Even if the lawsuits aren't successful, they could still pose challenges to companies that are trying to win over investors, said Brad Poulos, a lecturer at Ryerson University's Ted Rogers School of Management.

"Anytime there's uncertainty about the future of a company, that's going to create uncertainty in the minds of shareholders," Poulos said.

"As the market determines the likelihood of a suit being successful, that will start to get priced into the stock," he said.

The cases against these three companies have attracted the attention of at least nine legal firms because of a feature of U.S. law, Kathrein said. After an investor's lawyer files an initial securities lawsuit, they publish a notice, which gives other investors 60 days to apply to the court to become lead plaintiff in the case.

'A beauty contest'

Law firms then issue press releases seeking investors in the hopes that they can attract a client who becomes the lead plaintiff. One of the qualifications to become lead plaintiff is they suffered the greatest amount of alleged losses.

"It's a beauty contest," Kathrein said. "These press releases are basically saying, 'Hey, I'm part of the beauty contest; select me.'"

Hexo, based in Gatineau, Que., is accused of failing to tell investors that it was inflating its revenue figures through a process called channel-stuffing, which involves sending retailers more products than they are able to sell. A court filing alleges Hexo didn't tell investors its reported cannabis inventory was misstated and that it was growing pot in an Ontario facility not properly licensed by Health Canada.

A class-action complaint filed with a New York court says when Hexo announced in March 2019 it was buying rival Newstrike Brands, the company said it was acquiring Newstrike's four production facilities. It also said it was "committing to achieving over $400 million in net revenue in 2020."

But by October, the company withdrew that commitment after projecting its net revenue for 2019 would hit between $46.5 million and $48.5 million. It blamed a slow rollout of retail stores across Canada, a delay in government approvals for edibles and vapes and early signs of falling prices. Two weeks later, Hexo announced 200 layoffs.

In November, the company revealed one of the facilities it acquired from Newstrike was growing cannabis without the proper federal approvals. A press release said the firm learned about the problem in July, shut down production and notified Health Canada.

"All told, Hexo has lost hundreds of millions of dollars in market capitalization as a result of these disclosures," the complaint says. "As a result of defendants' wrongful acts and omissions, and the precipitous decline in the market value of the company's securities, plaintiff and other class members have suffered significant losses and damages."

According to the filing, anyone who bought Hexo shares on U.S. stock exchanges between Jan. 25 and Nov. 15, 2019 can join the proposed class action. During that period, Hexo's shares plunged by 65 per cent on the New York Stock Exchange.

In a brief email to CBC News, Hexo said it does not comment on litigation issues, but that its legal team is actively handling the matter.

A high bar for lawsuits

LaCroix, the Cleveland lawyer not involved in any of these claims, says law firms pursuing the cannabis class actions have to meet a high bar. It's not enough to argue that investors lost money. Their lawyers have to prove the defendant companies and executives intended to mislead shareholders when they made the allegedly false or misleading statements, a concept called scienter, he said.

"Scienter is meant to encompass not only actual intent to deceive but reckless indifference or just total indifference to whether or not investors are misled," LaCroix said.

"That's often where shareholder claimants fall short, is they don't sufficiently plead scienter."

Kathrein, one of the lawyers pursuing the class actions, said he wouldn't be involved in the cases unless he was convinced he could meet the scienter test.

"We don't just rely on public facts," he said. "We have investigators that get out there and try and find witnesses who can tie the information that was allegedly known to them, tie that information to the senior executives."

Edmonton-based Aurora Cannabis is facing claims the company exaggerated or over-estimated the demand for its pot and produced too much, leading to oversupply. In November, Aurora said it was halting or deferring construction at production facilities in Denmark and Medicine Hat, Alta. It also reported disappointing financial results, including a 24 per cent drop in quarterly net revenues.

A couple of months later, the company told media it was selling a greenhouse in Exeter, Ont.

Another allegation is that Aurora was not up front with investors that it didn't secure necessary approvals from German authorities to use a certain growing method in that country. After a Marijuana Business Daily report revealed German pharmacists were ordered to stop selling Aurora's medical pot until there was a review, the lawsuit says, the company's share price dropped.

"As a result of defendants' wrongful acts and omissions, and the precipitous decline in the market value of the company's securities, plaintiffs and other class members have suffered significant losses and damages," states the complaint, filed a week ago in a New York court.

Aurora shares plunge

The filing says anyone who bought Aurora shares on U.S. stock exchanges between Oct. 23, 2018 and Jan 6, 2020 can join the proposed class action. During that period, Aurora's shares plunged by 75 per cent on the New York Stock Exchange, from $7.51 per share to $1.90.

Aurora denies the allegations.

"The company believes it has conducted itself in accordance with all relevant securities laws, and refutes these claims," it said in a brief statement. "The company intends to pursue a full defence against these suits."

Canopy shares were 'artificially inflated,' suit claims

Canopy Growth, Canada's largest pot producer, is facing allegations it exaggerated or overestimated the potential market for its products in Canadian retail stores, leading to inventory writeoffs and restructuring charges. 

One class-action complaint says the Smiths Falls, Ont.-based company issued press releases leading up to legalization that it was expanding its production capacity to meet projections of growing demand for cannabis in Canada and around the world. 

"As a result of the dissemination of the aforementioned false and misleading reports, releases and public statements, the market price of Canopy securities was artificially inflated," the complaint states.

In November 2019, the company reported lower-than-expected revenues and a $374.6-million loss. 

Then-CEO Mark Zekulin told analysts at the time the disappointing results were the result in part of a slow rollout of retail stores in Ontario, which cut its potential Canadian market in half. He said some provinces had slowed their purchases of cannabis because of high inventories, though Canopy's shipments were up in its most recent quarter.

Canopy's stock fell on the news.

Between Sept. 8, 2017 and Nov. 13, 2019 — the period that the proposed class action covers — Canopy's share price on the New York exchange fell by more than a third, from $28.26 per share to $18.50.

When asked for comment on the allegations, Canopy referred to a November 2019 press release, in which the company said it believes it has acted "in accordance with all relevant securities laws, and that the claims are without merit.

"The company intends to vigorously defend itself against any such suits."

Lawsuits could drag on

Kathrein, whose law firm is seeking the class actions, said the cases will start to move ahead after deadlines to select lead plaintiffs elapse, starting Monday. Ultimately, he believes the cases will likely be collapsed into one proposed class action for each of the three companies. 

The defendant companies will likely file motions to dismiss the cases against them, Kathrein said. It could take months to debate those motions, which means they may not be resolved until the end of the year, if not later, he said.

If the lawsuits survive that stage, it could take years to reach a resolution through the courts, though both sides could negotiate a settlement.