Legal? Illegal? Some players still work both sides of state marijuana industry

Technically, the marijuana shops in Santa Ana and Costa Mesa are on opposite sides of the law.

Santa Ana allows cannabis retailing, so the city welcomes and collects tax money from some 18 licensed cannabis stores in the city’s boundaries. Costa Mesa doesn’t, and it would like to shut down the eight rogue shops in town that are selling weed in defiance of state and local law.

But the distinction between many of these shops — and between legal and illegal marijuana shops throughout Southern California — is far from black and white.

Many illicit shops sell products also offered in legal shops, even though licensed cannabis farmers, manufacturers and distributors can’t legally peddle their goods in unlicensed shops.

Some of the underground shops are owned by people who also have stakes in legal stores, with the owners using a complex scheme of limited partnerships and proxy owners — sometimes called “go to jail guys” — to hide their dual roles.

And unlicensed business are promoted side by side with legal operators on the online directory Weedmaps, whose principals are also invested in the legal cannabis industry.

More than a dozen sources who spoke to the Southern California News Group on and off the record over the course of several months say the blurring of legal and illegal worlds is the cannabis industry’s most widely known yet difficult-to-prove secret.

All of the players who double dip — meaning they support unlicensed operations even as they hold licenses for other, legal operations — are taking a huge risk. If they’re caught, they face losing their legal businesses, could pay stiff fines and might face criminal penalties.

But California’s legal marijuana market, which started on Jan. 1, 2018, is still small and struggling. The state’s illicit market — which has its roots in the medical marijuana market California created 21 years ago — is thriving, more profitable and roughly eight times bigger than the legal world.

So, according to many in the industry, business owners are playing in both sides of the cannabis market.

“I resigned as a board member from Santa Ana Cannabis Association because half of the members are running rogue operations,” said Robert Taft Jr., who owns several licensed businesses and drove the ballot measure that brought marijuana manufacturing, testing and distribution — but not cannabis retailing — to Costa Mesa.

“They’re still living the lie,” Taft said, “and they’re going to mess it up for all of us.”

Publicly, many of those double dippers are joining other legal operators in calling for more enforcement against an illicit market that’s undercutting their prices, stealing their customers and robbing the state of hundreds of millions in tax dollars.

But behind closed doors, sources say a handful of people with stakes in the licensed industry also are backing dozens of illegal shops throughout Southern California.

Meanwhile, some manufacturers and distributors are diverting products that didn’t pass strict state testing requirements to California’s thousands of unlicensed shops.

“The black market that they’re complaining about is the black market that they’re creating,” said Gem Montes director of the Inland Empire chapter of the cannabis advocacy group NORML.

The strength of the unlicensed cannabis market is a key reason why the state reports that the industry generated just $1.5 billion in taxable sales in 2018. That was a fraction of the state’s estimated $8 billion marijuana market, meaning only one dollar changed hands legally for every seven that changed hands illegally.

And when state or local authorities do manage to shut down a rogue shop or manufacturer, they often don’t have the resources or hard evidence needed to nail the people behind the operation. In many cases, limited enforcement means an operator can use a legitimate business as a shield to make money in both sides of the cannabis industry.

Jett Nettekoven, a former cannabis shop manager who now works in one of Santa Ana’s licensed stores, described the problem this way: “Until you get the head of the snake, you’re never going to stop it.”

Addicted to profits

Given how challenging it is to get state and local marijuana licenses, the assumption a year ago was that business owners wouldn’t risk losing that legal status by double dipping in both markets. But Montes and others said those challenges are precisely the factors driving some folks to take the risk.

Insiders describe an economic cycle that’s tough to break.

Some cannabis business owners initially kept their underground operations going only as a way to sustain them financially until they got licenses to operate legally. But they soon learned that as long as the unlicensed market remains entrenched, legal businesses struggle to make a profit, paying taxes and other overhead to comply with state regulations while unlicensed competitors sell similar or even the same product without paying the same overhead.

That makes the illegal cannabis both cheaper for the customer and more profitable for the merchant or producer — an incentive to work both sides of the fence until the legal market stabilizes enough to generate profits.

Complicating it all is the fact that in a state where recreational weed is legal, many customers shop in unlicensed stores without any idea that they’re helping to break the law.

“Most (operators) are surviving off of their black market businesses even when they have a license,” Montes said.

But others who are double dipping, according to Taft and others, include growers and manufacturers who tried to get too big, too quickly.

These operators landed millions of dollars in investment to build massive grow and manufacturing operations as soon as the legal market emerged. But more than a year later, there are nearly 7,000 licenses for farms and more than 1,200 licensed manufacturers supplying just 700 licensed storefronts. Those operators can’t move their product fast enough on the legal market to meet their obligations to investors, so some have either remained in — or turned to — the illicit market.

“They had dreams of conquering and owning everything,” Taft said. “But if they scaled (up) too early, that’s their own fault.”

Then there’s a third group of operators who are double dipping simply because they aren’t interested in taking a pay cut.

Many in this group made a lot of money when recreational weed wasn’t legal (Nettekoven said illicit shops, pre-Prop. 64, could easily pull in $10,000 a day), and now they’re letting the violence, corruption and double-dealing leak into the legal market.

“There’s no way people who came out of running illegal stores, and came into the legal environment, can try to live the life they were living five years ago if they’re doing everything by the book,” Nettekoven said.

“All these guys… got addicted to the money back in the day,” he added. “There’s just no way they’re going to stop.”

Elaborate schemes protect owners

During the 21 years that California’s multibillion-dollar unregulated medical marijuana market thrived, cannabis operators learned to create elaborate schemes to disguise their connections to unlicensed shops. And now that some operators are also tied to valuable licensed businesses, Montes said, double dippers have become even more careful about burying their identities.

For example, “there’s not one illegal store that has the actual owner’s name on it,” said Nettekoven, who five years ago helped run a medical marijuana shop called The Q, in Corona, before California legalized the recreational side of the industry.

The true owners often will find a landlord willing to deal with getting warning notices from city authorities in exchange for a tenant willing to pay twice the going rate for rent, Nettekoven said. The operator then pays an individual to sign the lease as a proxy owner, perhaps cutting them in on 10 percent of the shop’s revenue, in exchange for that person accepting whatever punishment might come from running an illegal operation and keeping the majority owner’s name off all paperwork.

When the city’s code enforcement officers visit the shop, the workers don’t know who actually owns it so they can’t offer up that information. And when local authorities confront a property owner, the landlord typically will claim ignorance about their tenant’s operation and then spend weeks slow-walking the eviction process, according to Nettekoven and others.

Meanwhile, illicit operators often repeat this process at multiple locations in multiple cities. That way, when authorities eventually do shut down one location, they can send their customers to another spot.

“It’s your flock of sheep,” Nettekoven said. “You just guide them to the next pasture.”

That “next pasture” strategy was on display Wednesday, March 6 in Costa Mesa.

The Costa Mesa shop Holy Grail had been openly selling marijuana without a license since December. A day after the Southern California News Group contacted the building’s owner to ask about his tenant’s operation, a visitor to the shop was greeted in the parking lot by two young women who said Holy Grail was closing down. But those women also handed out fliers, directing customers to one of two other unlicensed dispensaries, Harbor Holy Fire in Costa Mesa or Newport Beach Church.

The building that housed Costa Mesa Holy Grail is owned by Jeffrey Theders’ Warner Holdings LLC. Theders also holds the state license for ShowGrow, a legal marijuana shop in Santa Ana. Theders declined to speak for this story, but his attorney, Marc Wasserman — who with his brother, Craig, runs the Stanton firm Pot Brothers at Law — said Theders’ tenants told him they intended to use the building to sell CBD, a cannabis compound that’s sold as a health supplement. As soon as Theders found out his tenant was illegally selling marijuana, Wasserman said, he started the eviction process.

For weeks, Costa Mesa Holy Grail was one of the most prominently advertised cannabis shops in Orange County on Weedmaps. The online directory even labeled Holy Grail with a “gold pin,” an advertising seal of approval that reportedly costs shops $50,000 a month. An hour after Southern California News Group mentioned the gold pin to Wasserman, the shop’s ad disappeared from Weedmaps.

Wasserman’s family owns West Coast Cure, which has made marijuana wax at a facility in Newport Beach since 2010 and is now a licensed cannabis manufacturing and distribution company.

State records show that Weedmaps co-founder and board chair Doug Francis also registered West Coast Cure LLC with the California Secretary of State in 2016, using the Weedmaps’ Irvine headquarters’ as the address for West Coast Cure. Francis also is a principal in DICA Distribution, a cannabis distribution company that last year received approval from officials in Sacramento to share a building with West Coast Cure.

The defunct Weedmaps page and an Instagram account for Costa Mesa Holy Grail showed it previously operated as a “church” in Newport Beach, with a comment on the first social media post that reads: “RIP NEWPORT HOLY GRAIL.”

Last year, Newport Beach used a court injunction to shut down The Church of the Holy Grail. Newport Beach City Attorney Aaron Harp said the city is focused on simply shuttering unlicensed cannabis storefronts, and that the problem hasn’t been big enough to justify stepping up enforcement to prosecute the operators. Harp also said he’s not aware of any attempts by neighboring cities to coordinate such a crackdown.

Tough to trace

Products that carry the West Coast Cure label are among many items made by licensed companies — and sold legally in sanctioned stores — that also pop up for sale at illicit pot shops and delivery services across the state.

“There is a major issue with products that are being carried at legal and illegal shops,” said Melahat Rafiei, a cannabis industry lobbyist and consultant who advocates for the Santa Ana Cannabis Association.

Frustrated over losing money to illegal operators, Taft and his business partner, Jeff Holcombe, say they hired a secret shopper, outfitted with a hidden camera, to expose the problem.

Footage provided to the Southern California News Group show what Taft and Holcombe say is their secret shopper walking into unlicensed shops, including Harbor Holy Fire, Beach Buds and The Spot in Costa Mesa, and buying what appear to be the same licensed products that Taft and Holcombe sell at their licensed Sana Ana shop, 420 Central. While the products sell for the same pre-tax price at the licensed and unlicensed stores, workers at the illicit shops boast that their customers don’t have to pay taxes.

Taft says he’s pulling these products from his shelves, filing complaints with state regulators and speaking out against the practice because every sale at an unlicensed shop is, in his view, an indirect form of theft from a licensed shop.

“I’m sorry, you can’t double dip in my city and have me just sit here and be walked on like a doormat,” he said.

There was talk about having all of the licensed Santa Ana stores boycott some brands by not selling products that are found at unlicensed shops, but Rafiei said they couldn’t convince all of the legal operators to agree.

One factor that makes it tough to regulate where licensed products are sold is the embryonic state of California’s track and trace program, a component of Prop. 64 that eventually will require licensed companies to digitally monitor all of their products, from seed to sale. Though some farms and other companies are starting to use the track and trace system, the current status of the technology makes it difficult to pin down whether manufacturers or distributors are knowingly diverting their products, or if licensed shop owners are buying products for their legal stores and shuffling them be sold tax-free in their underground shops.

Even manufacturers say they’re not sure how products with their branding are ending up with illicit retailers.

“The answer to this question is unclear,” said Allison Luvera, spokeswoman for Kurvana, which has long been a major player in the world of cannabis vape oils and cartridges.

“All we know is that Kurvana is not selling products directly to unlicensed operators.”

After the Southern California News Group emailed Kurvana photos of what appears to one of its vape pens that had been purchased at Harbor Holy Fire, an unlicensed store in Costa Mesa, Luvera said they started working with their attorneys to send a cease and desist notice to the shop.

Owners of Harbor Holy Fire did not respond to calls and messages seeking a comment.

Paul Jacobson with Rove, a Desert Hot Springs-based maker of vape cartridges, said he doesn’t believe licensed manufacturers are knowingly sending products to illicit shops.

“I think it would be crazy for companies to do that,” Jacobson said. “If you’re in existence in 2019, and you have a state license, I think your future is bright. And it would be very shortsighted to double dip.”

But multiple sources told the Southern California News Group they know of manufacturers that are doing just that.

Some counterfeit products are on the market, including international manufacturers knocking off brand-name vape cartridges and selling them online. And many companies — as well as state regulators and others — point to counterfeiting as a key reason why licensed brands wind up in unlicensed stores.

“There is a tremendous amount of counterfeit activity in the industry currently,” said Kevin Halloran, chief financial officer for Kushy Punch, which is best known for cannabis-infused gummy candies.

But Kevin Gardner, who manages 420 Central and vets products for the Santa Ana shop, said he’d testify in court that the branded products purchased in unlicensed stores by Taft’s secret shopper are the real deal.

Many West Coast Cure products that Weedmaps listed for sale — often found in illicit shops throughout Southern California — even included a distinct blue “verified seal” that’s supposed to help shoppers tell if they’re getting a legitimate product. Brands pay for those blue check marks, which Weedmaps’ website says “only appears on authentic products sold at brand authorized retailers.”

The Wassermans didn’t respond to questions about West Coast Cure products. But shortly after the Southern California News Group questioned their apparent verified sale at illicit shops, their authenticated products were pulled down from Weedmaps menus.

Officials with the California Department of Public Health, which regulates manufacturers, and the Bureau of Cannabis Control, which regulates shops and distributors, say they haven’t taken any action against licensed companies for maintaining apparent ties to the illicit market.

Given how tough it is to prove such connections, sources suspect many of these double dippers won’t quit until the FBI nails them for tax evasion.

“That’s how Al Capone went down,” Taft said. “History will repeat itself.”