WSLCB - Executive Management Team
(August 14, 2024) - Prohibited Practices

Leadership heard from the Education Program Manager about how notices to correct prohibited practices on promotions, discounts, and management agreements were impacting markets.

Here are some observations from the Wednesday August 14th Washington State Liquor and Cannabis Board (WSLCB) Executive Management Team (EMT) public meeting.

My top 3 takeaways:

• Director of Enforcement and Education Chandra Wax explained how prohibited practices in cannabis came to the board’s attention (audio - 1m,  video - TVW, video - WSLCB).
  • During the June 12th EMT, Wax noted an increase in compliance education related to “engaging in non retail conditional sales,” and “specifically about some producers/processors and the prices at which they were offering things to their retail clients.” The “very specific investigation looking into those” had involved several different “entities,” she’d said (audio - 5m, video - TVW, video - WSLCB).
    • Board Chair David Postman wanted a better sense of what prohibited practices meant, with Wax answering that employees consuming on the job would count, along with circumstances such as “after hours service” (audio - <1m, video - TVW, video - WSLCB).
  • In the meeting, Wax introduced Education Program Manager Matthew McCallum to talk about “a trend we saw last month in data, and the board asked some questions, so we brought a little bit more detail back.”

• Education Program Manager Matthew McCallum discussed a troubling spike in reported prohibited practices by cannabis licensees such as conditional sales of product, or the expectation of “kickbacks” from some retail staff (audio - 17m, video - TVW, video - WSLCB, presentation).
  • McCallum began by saying, “based off of some…recent numbers, some questions came up related to spikes in education we[’re] providing on prohibited practices, specifically in cannabis.” Postman had asked for a better understanding of the spike, commented McCallum, which involved RCW 69.50.328, a statute which constrained cannabis producers or processors from having a financial stake in a licensed retail operation, also called vertical integration. The policy was “based off of how liquor works,” and he noted it was codified in WSLCB rules related to cannabis licensing in WAC 314-55-018. He remarked the rules were “primarily designed…to keep the integrity of the tiered system in place, where one tier does not have too much influence or undue influence over another, and protecting…the financial, direct or indirect, interest between those tiers.”
    • McCallum noted, “relatively recently [laws which] govern cannabis, there's been [an] exception written in for some free…swag…T-shirts and hats and things like that, as well as specific services or treats. And those are outlined in [WAC] 69.50.585 but for the purposes of this, those exceptions aren't really what we're talking about.” He insisted their focus was on “relatively egregious or very clear prohibited practice issues.”
  • Comparing the complaints on the topic between 2023 and 2024, McCallum’s presentation showed two topics which had more than tripled so far compared to the prior year: “prohibited practices, or a combination of conditional sales with their prohibited practices…like extending credit,” which experienced a “drastic jump” in complaints, from three in 2023 to 49 so far in 2024. He explained that for the number of notices to correct (NTC), “it's important to understand how complaints come in.”
    • McCallum said almost all inquiries fielded by Education and Enforcement staff related to prohibited practices were “complaint driven.” McCallum acknowledged that there was “proactive” education on the violations, “but because of the nature of prohibited practices being…back end business deals between retailers and processors, it's not something that you can readily see just in passing, or in an annual inspection.”
    • A “relatively new or more advanced partnership with Finance, specifically the audit team,” could turn up such practices as part of other financial violations, said McCallum, who reviewed WSLCB Audit Team reports in order to “go out and try to provide education…on the things that they found.” He suggested this partnership was “primarily” the reason for the spike in prohibited practice NTCs on “illegal compensation…being provided between tiers.”
    • Additionally, there could also be complaints from licensees or their employees, McCallum added, which “typically shows up in the form of processors who are complaining that retailers are requiring them to provide discounts or kickbacks on sales.” He contrasted this with liquor sales, where “we typically see…the suggested influence coming from the manufacturer side to the retailers, [but with] cannabis, it's a lot more prevalent to see retailers suggesting that processors provide that money's worth.” McCallum described complaints lodged by some processors claiming they “can't compete with some of these bigger groups because they have deals with retailers,” or alleging “‘hey, this retailer is reaching out and saying they won't buy from me unless I fund a 20% discount on my product to the customer.’” He shared that oftentimes when bringing the issue to that retailer they “will then tack on and go, ‘well, licensee A, B and C are doing this.’ Also, here's a bunch of emails and stuff proving it, and so that'll generate new complaints to go out so that we're being equitable with how we address those amongst licensees.”
      • The imbalance between retailers and producer/processors may be exacerbated, in part, because the latter can only sell to licensed retailers, whereas Washington law and WSLCB policy allow alcohol manufacturers options like on-site sales and event-based sales, in addition to federal laws allowing interstate sale for the alcohol sector.
      • Previous legislative efforts to allow limited direct sales rights to producers and processors include HB 1995 in 2019, HB 2279 in 2020, and HB 1855 in 2022.
    • The last complaint group was from current or former retail staff McCallum labeled “disgruntled,” and who emailed WSLCB and said, “‘here's a shopping list,’ or…’here's a menu that either our license, our retail location, would send out to processors,’ or ‘here's a bunch of information about processors that are offering money's worth contracts that are not allowed.’”
  • Delving into greater detail around how such prohibited practices were being organized and executed, McCallum remarked that they “typically see producer/processor, lending or giving money to a retailer, or a lot of times we'll see like a payback program, where…they're splitting, essentially, a discount at the till.” In liquor, this practice was called an “instant rebate,” he said, and was similarly prohibited. Extensions of credit involving retailers were also a problem, he indicated, though “credit between processors and processors, or producers and processors” occurred less frequently, staff had identified some instances.
    • A regular problem was volume discounts, which McCallum said were “retail licensees that are either demanding that if I buy X amount, you're going to discount it. Or vice versa, processors that are coming with…a physical menu: Buy this amount, get this discount, buy more, get more of a discount.” He relayed how “my staff have had retail licenses flat out [say]: ‘My goal is to run my competitors out of business.’”
    • Volume discounts “across a brand or a series of licensees” amounted to exclusivity contracts where a retailer argued “I'm only going to buy from you if you agree to only sell to my five retail locations or the five locations that I own,” McCallum pointed out.
    • Prohibited practices included “more in depth ones where licensees create secondary companies to give away items….places that'll have sort of a shell store next door. You come in, and then the employees from the cannabis location will walk you next door to give you the items that the license location isn't allowed to give, but they're still acting…as the employee.”
    • McCallum clarified that some promotions were allowed, highlighting WAC 69.50.585 again, saying producers and processors were “allowed to give items of nominal value,” which he typified as “swag,” like “a shirt for a budtender to wear, or here's a hat…small things, lighters, pencils, things like that.” However, “they can't give them directly to the customer, and they can't give them to the retailer for the purpose of forwarding on to the customer, but they are allowed to give those to the staff of retail locations,” he said. This frequently meant they “will try to elicit those free items as a condition of doing business, and that isn't permitted.”
    • Retailers hosting producers or processors during “vendor days at a location is super common,” McCallum told the group, which involved a “processor licensee, who's who's selling the product, [talking] about their product with customers, and that's permitted…probably the biggest issue we have with that is they tend to try to give away swag to customers when they're doing that, which isn't allowed.”
    • Another prohibited incentive McCallum mentioned was when retailers told producers or processors “if you sell only to us, then we'll advertise…for your business” on their website. 
  • Turning to the information his team provided licensees when issuing NTCs around these practices, McCallum insisted their education was highly consistent, and included an update in a 2023 Enforcement bulletin, because “once we created the Education program, Kelly Hallows, who's the Education Specialist, has been going back through some of the old education and trying to update it.” This included mentioning the new statute on acceptable promotions and “specified [prohibited practices] a little better based off of what we're seeing.” There would also be an agency newsletter with content on prohibited practices sent out “this fall.”
  • McCallum qualified that the spike in NTCs might not represent that the practice is on the rise, but could be staff “doing a better job of identifying what's already happening.”
    • He found it unlikely all the practices had just become common, and thought the increasing NTCs were emblematic of how compliance had “grow[n] as a program, we're able to identify and address them better.” McCallum also indicated that in person education tended to be the most common practice for WSLCB, “and we're consistent with our language, and we make sure that all the resources that the licensee needs, like the bulletins, like the WACs and RCWs, are included in the education.” Corresponding statute and rule references were included on NTC forms as well, he stated, “so they don't have to search for it, and we give that to them, either physically and digitally, or digitally again after meeting with them.
    • McCallum added that addressing complaints in-person at the location had also prompted Education staff to check if a licensee had an annual inspection “in the last six months to a year, so that while we're out there, we're going to go ahead and cover proactive education.”
    • As external complaints came in, he noted Education staff had to “determine if the complaint has enough information to write an NTC or not,” which they often didn’t unless the complainant could show communications that supported an allegation such as an emailed list of volume discounts. More often, Education staff would visit and speak with the alleged violator about the complaint, “if they say, ‘Yeah, we're doing that,’ then we're going to issue an NTC. If they say, ‘No,’ we're giving them the exact same education that would be in an NTC. We just can't write them the formal NTC because we…haven't determined…100%, the violation actually exists.” Internal complaints were far more likely to include documentation which supported a NTC, McCallum said, and “90% of those, if not more, are coming from those audit reports or are coming from places where we have…a definitive violation that's been identified.” In both cases, any repeated complaints following education “may be escalated to [Enforcement officers], especially if…we've shown that there's a violation, we have evidence that there's a violation, and they continue to do it.”

• Board members posed several questions to staff about the agency response to prohibited practices in cannabis, covering aspects such as industry trust, wholesale competition, potential rule changes, the interplay with public safety, and the influence of management agreements.
  • Board Member Ollie Garrett asked how long McCallum had been managing licensee education. McCallum responded that he’d helped design the consultant program for Enforcement and Education, and saw that it was “moved out from under commissioned lieutenants, and became a separate program within Enforcement.” He stressed they don’t “do anything punitive.” Garrett mentioned an “enforcement reform” law passed in 2019, and McCallum acknowledged that compliance staff had started out as a division within Enforcement, “and then we moved them a year, about a year and a half ago under their own program” (audio - 1m,  video - TVW, video - WSLCB).
  • Garrett’s curiosity was broader, as she wondered if McCallum’s team was seeing evidence the “industry has overcome the fear of being able to say, ‘Yes…that did occur,’ and work with you all, or is there still a fear of…‘I'm gonna lose my license if I say yes,’ and things like that? Are you seeing more of a trust in the industry?” McCallum doubted prohibited practices were the best example of this, but “overall, yes…and we get a lot of positive feedback from our licensees about this program…and they are very open to discussing issues” (audio - 4m, video - TVW, video - WSLCB).
    • He felt the attitude of his staff was, “if it's not public safety, or if it's not something…real imminent, or severe to the public, we're going to try to utilize the education program,” and that licensees respected that. However, licensees were less likely to be transparent about prohibited practices since “most of them, when we're dealing with it, they know they're not supposed to do it, so they're not going to admit to us that they are.” Moreover, most licensed staff understood that while McCallum’s team didn’t enforce some violations they would share what they learned with WSLCB investigators, yet following up on complaints meant an “in depth financial investigation that takes a significant amount of time.” He observed, “occasionally, we'll get ones where they go, ‘Oh, I didn't know I wasn't supposed to do that. I'll stop,’ “but most of the time, they're aware of it.” Education was only effective when a business intended to stop a prohibited discount or promotion, “if they know what they're doing isn't allowed, it's pretty hard to catch them.”
    • Garrett replied that she was more concerned about licensees who genuinely “didn’t know…in the past and through litigation, we would see things like a store that just opened up and had signage advertising, and they didn't know it was illegal, and it was reported to us, and…then they ended up with a AVN.” McCallum insisted that as an original advertising coordinator for cannabis, agency officials had always gone “above and beyond to exhaust every opportunity to work with them and correct on it.” In addition to in-person education and issuing NTCs, he argued, when “they need an extension to fix the signs, we always provide them the extension if they ask.” McCallum continued, finding “recently, when we go out to provide them education, it's much more in the line of ‘we disagree that the LCB has the authority to regulate this, and we're going to take this as far as we can.’”
    • Garrett wondered with additional producer licenses to be issued related to the social equity program at the agency, how these businesses’ representatives would distinguish themselves from other companies when participating in vendor days. He answered they could use advertising materials and talk to retail staff and consumers directly, “actually, they can have retail licensees come out to their facility and see how they make it. Those are all things that are allowed.”
  • Thinking about social equity producers who would be coming to the market, Garrett had heard the argument that new producers were destined to struggle in a competitive market. She felt such businesses could argue, “maybe what we grow is going to be better than what's already out there. So who are you to say there's not a need for more of the product, if our product could be better than what's out there” (audio - 3m, video - TVW, video - WSLCB).
    • McCallum said with regard to increasing the number of producer or processor licenses, prohibited practices represented a threat to the smallest operators. He specified, “what the concern is, is that the large players in the industry, the bigger processor licensees, are able to leverage retailers or provide retailers with more…money's worth, things that aren't allowed, but they do that, and that would essentially push out somebody smaller.” With retail options being more limited for cannabis manufacturers than their alcohol counterparts, “that's one of the most common things that people complain about to my staff,” McCallum commented, “how hard it is to compete with the larger businesses.”
    • As the study by Whitney Economics indicated the number of producers and amount of canopy far outpaced projected demand; and over 1,100 producer/processors were licensed compared to fewer than 600 stores statewide; any new producers would face significant challenges achieving profitability.
  • Board Member Jim Vollendroff reflected that he wasn’t familiar with the specifics of prohibited practices, seeking clarification whether most situations were violations of law, or rule. McCallum suggested most were rule violations, and that cannabis and alcohol had separately listed restrictions which represented a “pillar of maintaining the tiered separation” with no financial interest between licensed retailers and producers/processors (audio - 2m, video - TVW, video - WSLCB).
  • Vollendroff also thought there was value in telling licensees about their right to petition for rule changes. McCallum agreed, “I've been working sending stuff to Justin's team more regularly if we come to an impasse with a licensee where we're no longer talking about whether or not they're violating the current WAC or RCW, but a disagreement with what the WAC should be, or something that they want to see added.” He emphasized that this had been a long time practice, along with advising licensees to file public record requests if they felt WSLCB officials were “singling [them] out.” McCallum pointed out that Enforcement and Education staff “took all of the AVNs [Administrative Violation Notices] and hearings…and we post those online now as well. So that's all very transparent, so people can go and see that process” (audio - 2m, video - TVW, video - WSLCB).
  • Postman checked whether prohibited practices were considered a public safety-related violation. McCallum answered that they weren’t classified as such. “It used to be a little more serious, because a lot of times it was an indication of hidden ownership,” McCallum stated, “but they're not public safety violations…it's relatively low on the the penalty list” (audio - 4m, video - TVW, video - WSLCB).
    • Postman mused that the lower priority “belies the fact of how important this is to our system…we've got separate producer, processor, and retail that can't be crossed. We have [three] different tiers of producers…to Member Garrett's question about over saturation of the market [there were some] people in the industry today who think this practice is making it as hard as anything to be competitive.” He wondered if it was unreasonable to say “these are anti-competitive behaviors.”
    • McCallum concurred that many licensees were explicitly trying to get one up on their competitors, and the vast majority of external complaints his team fielded were licensees "at each other's throats.” With fewer retailers than producers, he was unsurprised “those with, with money or means or who are willing to cross into the prohibited practices…would make it harder for someone who's trying to be compliant, or maybe doesn't have the resources to give both discounts and things like that.”
    • Postman guessed that the difference in capacity between tier 3 producers who could grow on up to 30,000 feet of canopy compared to tier 1 growers who could only have up to 4,000 feet of canopy. McCallum said processors in particular raised the concern “how am I going to compete when everybody's doing this…I can't compete if, if you're not going to stop them from doing it, too.” He added, “when we see it, we deal with it. But this is a very hard one to see, because we can really only spot it ourselves through, like audit reports.” Postman voiced appreciation for their efforts, as prohibited practice violations had “a pretty direct impact on on some of these” licenses, including one “who said to me, ‘I know it's not allowed, I know it's terrible, but if I don't start doing it, I'm out of business.’ I think it's fairly dire for some of the growers.”
  • Postman wondered about looking at NTCs for prohibited practices in relation to “franchise or management agreements” which could connect multi-license holders making it harder to do business without engaging in prohibited promotions since, “you've got the buying power for a dozen stores.” McCallum reported that the biggest problem there was the under-reporting of management contracts, and their complicated nature. “More and more we're running into processors that are engaging in contract” growing by hiring small struggling producers to grow specific cultivars, he indicated, because they “pay you up front” to be an “exclusive grower for [a] processing business.” One suspicious sign of this would be when a processor was recruiting employees for “three or four grows” at once. He noted that an investigative unit which had looked into those kinds of violations until they were “downgraded…historically, that was one of the issues we ran into…feedback we'd gotten related to how serious of a penalty hidden ownership” should be. Postman felt that might have been true, yet “if you can be buying on behalf of a dozen plus stores, it is more of a financial situation. There's more money to be made or lost in that” (audio - 3m, video - TVW, video - WSLCB).
  • Postman called for another meeting to “follow up and talk about management agreements too, and see what we can do to get them to submit those, make sure we're looking at them carefully.” He thanked McCallum and his staff “for your work with finance…It's really impressive and I really like what your team is doing.” McCallum welcomed questions or suggestions on useful data his team could produce, as well as inviting the board to ride along on a compliance visit: “we will accommodate whatever you need and take you out and show you whatever you want to see, or whatever we want you to see” (audio - 2m, video - TVW, video - WSLCB).

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