Performance Audit of Marijuana Regulation in Nevada
A new audit released by the Nevada Legislative Commission examined the state’s regulation of the cannabis market and concluded that regulators and cannabis businesses are coming up short in several areas.
The audit is the first detailed look at cannabis regulation in Nevada since voters approved the legalization of adult-use marijuana in 2016. The audit compared the tax returns of 10 cultivators and five (5) dispensaries to METRC data for a 6-month period spanning from January to June 2018. Some of the audit’s conclusions include:
METRC data is incomplete and inaccurate
METRC is not being effectively used to regulate the cannabis industry
Additional guidance to license holders is necessary for consistency
The purpose of the audit was to determine if regulatory activities governing the cannabis industry were adequate and provide recommendations for areas of improvement to ensure the Department of Taxation Marijuana Regulation and Enforcement Division effectively monitor cannabis tax revenues and inventory. The full audit may be found here.
1. METRC DATA IS INCOMPLETE AND INACCURATE
The data reported in the Marijuana Enforcement Tracking Reporting and Compliance (METRC) information system was found to be incomplete and inaccurate. The audit concluded that license holders are not properly recording all marijuana cultivation, inventory, sales, and waste activity into the METRC system, and has occurred partly because effective monitoring and oversight of the system has not been performed by the Department.
Data in the METRC system did not compare to totals reported on cannabis tax returns for 72% of the returns investigated. These discrepancies are estimated to have cost the state more than $500,000 in uncollected tax revenue.
VARIANCES EXIST BETWEEN METRC AND TAX RETURNS
Of the 10 cultivators and five (5) dispensaries inspected, the audit found several discrepancies in their recordkeeping, including:
For wholesale marijuana tax returns filed by cultivators, METRC data did not agree about 70% of the time.
For retail marijuana tax returns filed by dispensaries, METRC data did not reasonably compare about 57% of the time.
For sales tax returns filed by dispensaries, METRC dada did not reasonably compare about 60% of the time.
Cannabis businesses are required to update METRC records daily and reconcile the physical records on a quarterly basis; however, the variances stated above reflect lower inventory sales and transfers which indicate licensees are not recording all appropriate transactions into the METRC system.
REQUIRED REPORTS ARE NOT OBTAINED
Cannabis license holders are required to submit monthly sales, purchases, production, and price information to the Department of Taxation at least quarterly, per NRS 372A.285. These reports, however, are not obtained from license holders.
These reports are beneficial in focusing on regulatory activities by validating and identifying inconsistent data in METRC. Additionally, the information in these reports would calculate fair market values and corroborate tax returns.
WASTE AND PACKAGE WEIGHT DATA NOT ALWAYS ENTERED IN METRC
Cultivators are required to enter waste data in METRC throughout the production cycle, including when plants are harvested and trimmed into a useable product. However, nine (9) of the 10 cultivators investigated did not enter the proper waste data, or entered meaningless information into the system that was neither identified or corrected by the Department. Out of the 1,085 harvests evaluated, the audit found the following:
Waste weights were not entered in for 15.6% of the investigated harvests.
Unreasonable waste weights were entered for 5.6% of harvests. Because other data is calculated automatically based on waste weights, corresponding amounts were inaccurate or incomplete.
Final product package weights were not entered for 1.5% of harvests. Package weights show a useable product that should be tracked until sold to the consumer.
Monitoring waste data is important for the prevention of cannabis products being diverted to the black market.
2. METRC IS NOT BEING EFFECTIVELY USED TO REGULATE THE CANNABIS INDUSTRY
Insufficient and inaccurate data prevents the Department from effectively regulating the industry, verifying the accuracy of tax collections, protecting consumers, and preventing diversion of cannabis to the black market.
According to the audit, METRC is not being used to track inventory for medical marijuana products and ensuring products are associated with the correct license type.
HIGH POTENCY PRODUCTS SOLD TO RECREATIONAL CUSTOMER
Medical marijuana products contain high THC levels compared to products allowed for recreational consumers. Products exceeding recreational THC limits should be tagged as medical inventory, associated with a medical license, and sold only to patients with a validated medical card.
However, the audit found many high-potency products meant for medical marijuana patients improperly sold to recreational customers in 42.9% of cases examined by auditors. Because THC content is not consistently reported in METRC, the Department did not identify or follow up with license holders regarding inappropriate sales to recreational consumers.
HIGH POTENCY INVENTORY NOT EFFECTIVELY TRACKED IN METRC
Dual-licensed facilities may operate as a combined marijuana establishment, provided its’ inventory is securely segregated. Regulations require operations to be segregated for each facility type, medical or recreational, including financial records; however, dispensaries that have recreational and medical marijuana licenses are not associating products or consumer sales to the correct license.
The auditor reviewed sales activity from 17 dual-licensed facilities and found:
For one (1) dispensary, all sales were recorded under the medical license even though 81% of the sales recorded were to recreational consumers.
For eight (8) dispensaries, all sales were recorded under the recreational license even though 18% of the sales were to medical patients. Medical cardholders can purchase recreational cannabis products. However, it is unlikely these eight (8) dual-licensed facilities are not stocking high potency products that should be accounted for and solder under a medical license.
The remaining eight (8) retailers examined had sales attributed to both licenses, as would be expected from a dual-licensed facility.
Likewise, some license holders reviewed accepted and accounted for medical inventory under a recreational license, meaning transfer were made from the medical license of a production facility to the recreational license for retailers.
Ineffective tracking of medical inventory in METRC makes it difficult to identify inappropriate sales to consumers. Procedures have not been developed to ensure medical marijuana products are accounted for under the proper license type in METRC.
METRC NOT USED EFFECTIVELY TO MONITOR PRODUCTION WASTE
Production waste and moisture loss depend on many factors including methods used, temperature and humidity, location, and product strain. Cannabis products are susceptible to loss and theft and misappropriations can be covered up through the waste process.
Majority of waste data reviewed was relatively consistent, however, the Department is not effectively using METRC to monitor production waste amounts, or isolate and review transactions that appear unreasonable. Additionally, the Department has not developed a process to isolate unreasonable activity and pursue further scrutiny or compliance.
METRC NOTIFICATIONS COULD ASSIST THE DEPARTMENT
METRC allows regulatory agencies to set up custom notifications based on a variety of parameters. However, these notifications which could assist the Department by flagging irregular transactions, have not been activated. When notifications are not active, errors and adjustments made by the licensees are not automatically brought to the attention of the Department.
3. ADDITIONAL GUIDANCE TO LICENSE HOLDERS IS NECESSARY FOR CONSISTENCY
The department needs to determine and provide appropriate instructions to license holders regarding how THC should be reported in METRC. Additional guidance is needed over revenue reporting on wholesale tax returns so month-end sales are reported in the same manner
IMPORTANT REGULATORY DATA NOT EASILY FOUND IN METRC
Lab results and related THC potency data is difficult to find in the METRC system. The department indicated THC information may be located in three areas in the system: the product title or description, lab result screen, or the item detail screen.
The audit reviewed 12 products and found the THC information was sporadically available in the stated locations. This occurs because the Department has not determined the most effective way to report THC content or provide licensees with guidance on how this information should be reported. Additionally, the unit of measure input for THC content in METRC is different than the unit of measure established to regulate most marijuana products. Both of which unnecessarily complicates efforts to monitor and track medical product sales.
REPORTING ON MONTH-END SALES TRANSACTIONS SHOULD BE CLARIFIED
The department has not provided sufficient guidance to licenses cultivators on how to report month-end transactions for tax purposes. Some cultivators report transactions based on the date the product was shipped while others report transactions based on the date the product was received.
The department indicated wholesale transactions should be recorded based on the date the product is received, however, this protocol was not included in the wholesale tax return instructions.
RECOMMENDATIONS TO IMPROVE CANNABIS REGULATION
Develop additional policies and procedures to verify the ongoing accuracy and completeness of METRC data. Procedures should address significant data elements.
Utilize METRC to identify licensees at risk for potential tax deficiencies and incorporate the use of METRC data into the audit selection process.
Obtain reports required by NRS 372A.285. Compare the reports to METRC and utilize information to regulate the industry.
Develop procedures to monitor data in METRC regarding harvest weights, waste, package weights, and moisture loss. Follow up on incomplete, erroneous, or irregular entries.
Establish additional procedures to regulate and identify inappropriate sales of high potency (medical) products.
Establish procedures to ensure marijuana products are accounted for and solder under the proper license.
Develop statistics and benchmarks for METRC data regarding regulatory activities.
Establish a program to monitor METRC data and identify and investigate irregular activity.
Identify and establish system notifications using METRC data. Review and follow up on notifications.
Revise how THC is reported in METRC and on lab reports. Ensure total product THC is identifiable and congruent with state law.
Provide licensees guidance regarding data input requirements for THC information and lab results. Monitor licensee compliance with data input.
Revise tax return instructions to provide appropriate guidance to licensees regarding how month-end wholesale transactions should be recorded on tax returns.
Evaluate and install additional security measures.
The Department of Taxation has accepted all 13 recommendations.
NEVADA CANNABIS INDUSTRY AIMS TO REFLECT GAMING GOLD STANDARD
Nevada’s comprehensive regulations for the gaming industry have in some ways served as a model for the younger recreational cannabis industry. Governor Steve Sisolak signed an executive order on January 25, 2019 to establish a marijuana advisory panel that would create guidelines for a proposed Cannabis Compliance Board, similar to the Nevada Gaming Control Board. “Nevada’s gaming industry is seen as the international gold standard and there is no reason we cannot take steps to ensure our marijuana industry is viewed the same way,” Sisolak said in a statement.
With cannabis poised to take its place as one of the most heavily regulated industries in the world, compliance is and will increasingly be the name of the game for cannabis companies.