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Cannabis Watch: SEC makes second move in a week against a once-hyped pot-stock’s former executive

The Securities and Exchange Commission on Monday charged Canadian pot producer Cronos Group Inc. and a former executive with accounting fraud, accusing them of improperly booking sales and overstating revenue by millions of dollars.

Cronos Group
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and its former chief commerce officer — William Hilson, who left the company at the end of 2019 — agreed to settle the matter without admitting or denying the SEC’s findings, the agency said. Shares of the company fell 2.4% after hours.

The move by the regulator marks the second time in a week that it has filed charges related to a company that was swept up in a pot-stocks craze around the time that Canada became the first industrialized nation to legalize marijuana for recreational purposes. And it follows questions surrounding Cronos’s accounting protocols that cropped up more than two years ago.

See also: Former CEO of NewAge, a drink company that shot to pot-stock fame, accused by SEC of ‘multiyear fraud’

Cronos Chief Executive Mike Gorenstein, in a statement, said he was “pleased to have resolved these matters.” Tobacco giant Altria Group Inc.
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— which owns more than 40% of Cronos and is its biggest shareholder — referred inquiries to Cronos.

The SEC alleged that across three quarters between 2019 and 2021, Cronos “submitted financial statements with the SEC that contained material accounting errors related to, among other things, revenue recognition and goodwill impairment.”

The agency also found that Hilson, in one of those quarters, made an oral agreement to sell “cannabis raw material and to repurchase cannabis product in the following quarter” — a $2.3 million oversight that “was neither known nor accounted for by Cronos.”

However, the SEC said, Cronos quickly reported the alleged misconduct — the company restated its 2019 financial information in early 2020 after delaying its annual review for an internal inquiry. And the company cooperated with the agency’s investigation — which was first reported by MarketWatch — and took steps to improve its accounting protocols, the SEC said.

For more: Cronos paid $300 million for a small CBD company, and CEO’s private-equity firm stands to collect $120 million of it

“While today’s order finds that Cronos’s controls were not up to standards when it began filing financial statements with the SEC, Cronos avoided penalties by promptly self-reporting its accounting misconduct as it came to light within the company, cooperating with our investigation, and promptly taking effective remedial steps,” Mark Cave,  associate director in the SEC’s Enforcement Division, said in a statement.

The SEC said that Cronos agreed to cease and desist from future violations, and to retain a consultant to review and make recommendations surrounding its accounting controls, the SEC said.

Hilson, the agency said, agreed to a three-year ban from being an officer or director for any company with registered securities and reporting requirements under parts of the Exchange Act. He also agreed to a minimum three-year suspension from practicing before the SEC as an accountant.

Last week, the SEC accused former NewAge Inc.
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Chief Executive Brent David Willis of a “multiyear fraud” that included misleading public statements meant to promote the wellness beverage maker, which once pitched itself as primed to capitalize on CBD drinks.

Hilson was Cronos’s chief financial officer from October 2016 to April 2019. He then worked as its chief commerce officer from April 2019 to December 2019.

During part of that time in 2019, Cronos — which is much smaller than some of its Canadian rivals — was trying to aggressively expand into the vaping market, the SEC said. But its ambitions ran up against an insect infestation that sapped quality supply. They also ran into limited production resources and accounting inexperience as the company tried to work with third-party operators to use up the compromised crop, secure resin to make vapes and boost flagging sales.  

“During this time period, there were a limited number of third-party firms in Canada that either had the capacity to purchase Cronos’ lower-quality biomass and convert to other uses, or the ability to supply resin to Cronos for use in vaporizer cartridge production,” the SEC said. “Cronos considered its dealings with such third-party firms to be part of its wholesale channel.”

The accounting oversights, the SEC said, stemmed from whether sales should be recognized on transactions with two companies. One of those companies sold resin to Cronos or bought crops from it. Cronos and the other company agreed to source raw materials together, and that company would handle making vape cartridges and converting cannabis bud into resin, the SEC said.

The SEC also focused on an impairment surrounding Cronos’s acquisition of a U.S. company that makes CBD products under the name Lord Jones. That business, the SEC said, faced “an approximate 60% decrease in projected revenues in future years,” according to an internal forecast prepared in the second quarter of last year, amid competition and discounting from rivals. 

“As a result of such information, Cronos should have determined that it was required to perform an interim impairment test,” the SEC said. “However, Cronos’s internal accounting controls were insufficient to provide reasonable assurances that an appropriate impairment analysis was conducted in the second quarter of 2021.”     

Cronos Group bought Lord Jones for $300 million in 2019. MarketWatch at the time reported that the price of the deal was equal to 75 to 150 times Lord Jones’ 2018 sales. Gotham Green Partners, a private-equity fund co-founded by Gorenstein, paid $12.8 million for a 40% stake in Lord Jones, MarketWatch reported.

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