CannTrust (TSX: TRST) executives involved in illegal growing coverup
In my initial comment on these pages, I said it was “unbelievable” that CannTrust (TSX: TRST) (NYSE: CTST) was found to have been growing cannabis illegally and selling its illegal output into the legally established distribution system and exporting it overseas. Next, I compared the TRST scandal with the Ascent Industries (CSE: ASNT) fiasco and drew the conclusion that there is more bad news to come and I thought investors would be well advised to sell TRST stock.
The news this week, if correct, leaves experienced market veterans like me scrambling to find a new word or phrase that doesn’t involve vulgarity and profanity. The press reported Tuesday that TRST Chair Eric Paul and Chief Executive Officer Peter Aceto have known since November 2018 that illegal growing was taking place at TRST’s grow facility. One can conclude that since the unapproved activity did not stop until recently, that Paul and Aceto were willing participants in the scam. In a series of e-mails reported by the press, the senior executives of TRST were not only informed, they appear to have been involved in the cover up. Here are some quotes from the most damaging e-mail and the players involved include Graham Lee, Director of Quality and Compliance, Ian Abramowitz, Chief Financial Officer at the time and Ilana Platt, Vice President of Innovation and Regulatory Affairs.
These are excerpts from an alleged e-mail dated November 16, 2018 sent by Lee to Aceto, Abramowitz and Platt and later forwarded to Paul in which Lee said: “We dodged some bullets. [Health Canada] did not ask about RG8E/W, which are unlicensed rooms currently full of plants.” This e-mail goes on to outline “current risks” including plants growing in unlicensed rooms, storage of cannabis in unlicensed rooms and a large number of lost bottles of cannabis not reported to Health Canada. Lee goes on to say, “Although serious, on their own, each of these can be talked through with [Health Canada]. The concern is that together they will paint a picture with the regulator of a company not in control. We have dodged observations for items 1 and 6 despite having HC in the building.” It seems to me based on these emails that not only did several TRST management members know about the illegal activity by November 16, 2018, they must have known about it sooner. The e-mail from Lee apparently did not set off a firestorm of questions among the group or reports to Health Canada of what they had just learned. In fact, when Paul received the email, he responds by advising the others how they and TRST should respond to Health Canada. Anyone surprised by this news would know the regulators had to be informed.
It also means that when Aceto said, “21 years a trusted banker of the people & 9 years the CEO. Then 9 months later a thief/fraud? Ah, doesn’t make sense. Let the dust settle” he was knowingly misleading people at best and outright lying at worst.
Here is what I would consider another very serious matter. In late April, 2019, TRST announced it was doing an offering of common shares. This was a contributing factor in TRST’s share price being weak. On May 2, 2019, TRST announced it planned to sell 36,363,636 shares at US $5.50 to raise US $200 million. This included a 5,454,545 share sale by “certain shareholders.” This unsettled the market because the offering was priced about US $1.00 per share lower than the market price and around a month before, the stock price was approximately $10.00 per share. Also a Secondary Offering is often viewed negatively by investors. The offering closed May 6, 2019 with the sale of 30,909,091 shares or 15% short of the original amount.
The first issue is that in the Prospectus Supplement to the Short Form Base Shelf Prospectus Dated March 18, 2019, New Issue and Secondary Offering May 1, 2019, the following information can be found.
What it shows is a company named Cannamed Financial Corp. sold 5,204,545 or 95.4% of the shares and 56.8% of Cannamed Financial is owned by the Paul Family Trust. I assume the Paul in the Paul Family Trust refers to Eric Paul, the Chair of the Board of Directors of CannTrust. I also note that although the size of the offering ended up 15% lower, the Secondary Offering remained unchanged. The seller of the other 250,000 shares was owned by Mitchell Sanders, a Director of TRST. At this point, I don’t know what Sanders knew or when he knew it.
We know for certain, if the e-mail information is correct, Paul and Aceto among others knew there had been illegal growing going on and this fact was not disclosed in the Prospectus. Let me reiterate, I am not a lawyer of any kind – securities, civil or criminal but I know enough to believe this is problematic on many levels, perhaps all three. To my way of thinking, the underwriting has to be reversed and the investors made whole. This creates another problem for institutions such as mutual funds that participated in the offering. If a fund shareholder redeems (sells) their mutual fund shares before this is sorted out, what happens to their financial interest in the outcome?
The lead runners of the underwriting were BofA Merrill Lynch, Citigroup, Credit Suisse and RBC Capital Markets. All the underwriters have egg on their face but the leads have more egg than the rest. And RBC Capital Markets is Royal Bank, the largest bank in Canada. This was the first time they stepped up to underwrite a company growing marijuana. No one likes it but RBC probably hates being made to look stupid more than the rest. Remember, on September 19, 2016 we reported here that Bruce Linton, then President of Canopy Growth confirmed that a year before that, Royal Bank closed Canopy Growth’s bank accounts. You can imagine, then, for Royal Bank to finally step forward and participate in this cannabis underwriting was probably a difficult internal decision and news of this outcome set the fur flying in the executive suite.
This means the group of lead underwriters and especially the Royal Bank will do anything in their considerable power to get the money back for their own investment clients and will probably make sure the individuals involved in this scam pay the price as well. Remember the $150 million TRST has in the bank? As the Godfather might say, “Fuggetaboutit!” To me, justice means somehow between the American and Canadian regulators, underwriters, institutional and individual investors, that money is going back.
I didn’t think there would be such damning evidence uncovered. For anyone who thought Eric Paul and Peter Aceto were going to escape this fiasco, you now know for certain that thinking was incorrect. Aceto was fired for cause and Paul was forced to resign. They are done like dinner. One question that arises is what will happen to Lee, Abramowitz and Platt? Consistent with my expectations last week, I believe they are as good as gone. And there may be others. For something like this to happen you a need corporate culture that facilitates it. To change that you have to change more than just the top two executives.
I said last week, “Bad news is like a cockroach. If you find one there are many more that haven’t been found. Yet.” Now we’ve found more cockroaches. But I doubt these are the last ones. My guess is there are still more, many more, yet to be uncovered. Imagine what a forensic auditor might find going through the financial records: false entries, altered entries and hidden entries. Think about what law enforcement or regulatory investigators will find reviewing six months of e-mails. If I was a member of the TRST board of directors, management team and employee group, I would be worried. Even before this information came to light, the cannabis stocks had been weak for six months and investors had lost money. There is even some question in my mind if the company made disclosures relating to the recent issues raised by Health Canada in a timely manner. Of course, after the news entered the public domain, the stock crashed. So there are hundreds of millions and perhaps more in stock losses investors have suffered that can be linked to this malfeasance.
TRST has approximately $150 million in cash. TRST has assets. Senior management and directors probably have deep pockets. This will appeal to the ambulance chasers, the 99% of lawyers who give the other 1% a bad name. So far we have only talked about regulatory issues which are serious enough. There are civil and criminal legal issues that will probably arise.
Here’s another thought. Peter Aceto joined TRST as CEO on October 3, 2018. On November 12, 2018, Brad Rogers, then president and Michael Ravensdale, the head of production left TRST “…to pursue other opportunities.” It was said these two executives were instrumental in building TRST’s production facilities and left “…as the company focuses on a country-wide supply shortage….” The only reason two production types would leave when the need for production was greatest is because their goal was to increase production legally. It also begs the question, “Who is the whistleblower?” Is it Rogers or Ravensdale or both? I have no special insight on these matters but the timing and motives are a fit.
The special committee formed by TRST (there was a similar committee struck by Ascent Industries (CSE: ASNT) as well) keeps bringing forward the same old statement that it will take "appropriate actions." There could be problems here. The committee is made up of independent directors but directors nonetheless. Nobody is without self-interest. Even me. TRST is a gift that keeps on giving to a cannabis news service.
Immediately after the report that Aceto was fired and Paul had forced to resign, CannTrust shares recovered around 15%. A similar thing happened in the early days of the Ascent Industries’ (CSE: ASNT) scandal. But the recoveries were temporary. I recall ASNT shares dropped over 75% from there. We are still closer to the beginning of the TRST fiasco than the end. In my opinion, there will be many more revelations that will shock investors and drive TRST stock lower. Shareholders should act accordingly.
So far, the bad news from TRST has generally driven the price of most cannabis stocks lower. That is because the news came as such a shock. It sucked the confidence out of the entire cannabis community in short order. The typical line of thought was, “If CannTrust was growing illegally, anyone might be.” But I think that will change gradually moving forward. Bad news on TRST will impact their share price more and more and the rest of the cannabis market less and less. Until this happens, TRST remains a market driver and unfortunately it is driving the market down.