Small-scale liquor distributors who were excited about the possibility of getting in on Nevada’s new recreational marijuana business say they’re now being pushed out by the Department of Taxation’s proposed regulations.
Nevadans voted in November to legalize recreational marijuana through Question 2, which was backed by a group called the Coalition to Regulate Marijuana Like Alcohol. But the model in draft regulations that will head for a Tax Commission vote on May 8 doesn’t create a system like the three-tiered one that governs alcohol.
In the liquor world, producers sell to distributors who then sell to retailers, with strict rules preventing businesses from participating in more than one of those three tiers. Draft regulations on recreational marijuana in Nevada allow marijuana enterprises to get distribution licenses and transfer recreational marijuana to themselves in a vertically integrated format — more in line with the model governing medical marijuana than the one governing alcohol.
About a dozen smaller distributors — who have formed a new group called the Independent Alcohol Distributors of Nevada — take issue with how the regulations came about and argue the model goes against voters’ intentions. They enlisted a legal team this week and are considering their options for challenging the proposed rules.
Some fear a potential lawsuit could hamper plans to get recreational marijuana sales up and running by July through an “early start” program, which will allow medical marijuana dispensaries to tap into the much larger, more lucrative recreational market six months earlier than the ballot measure required.
“My only concern is I don’t want this to hold up the implementation of Question 2 and the early start program,” said Democratic Sen. Tick Segerblom, sponsor of numerous marijuana bills this session. “So I just beg everyone to work together to make sure this doesn’t stop us.”
A deal, and then the regulations
Alcohol distributors donated some $87,500 in the early stages of the Question 2 campaign as part of a deal aimed at ensuring the newcomer marijuana industry wasn’t making enemies with Nevada’s formidable liquor industry.
The campaign — which sought to emphasize the similarity between alcohol and marijuana rather than paint one as better or safer — was a success. Nevada voters approved the measure 54 to 46 percent.
As part of the agreement, the initiative language specified that in the first 18 months, only liquor distributors would be allowed to get a marijuana distributor license. But it contained a significant caveat — that if the department determined the arrangement would lead to an insufficient number of distributors, it could be opened up to other applicants.
Department of Taxation officials said they inquired of liquor distributors in November about their interest in being involved in the recreational market, and about 15 of the 67 responded affirmatively, according to department spokeswoman Stephanie Klapstein. The department then unveiled draft regulations March 16 that said they’d determined there were an insufficient number of distributors to supply the market during the early start period, and distribution would be open to marijuana establishments too.
“We were concerned that with the low number who responded to us, combined with the extensive process they'd have to go through … combined with the fact that they're regulated by the TTB (Alcohol and Tobacco Tax and Trade Bureau) federally — we were just concerned that with those factors combined, for the temporary program, we wouldn't have enough distributors who would be able to serve the market.” Klapstein said, pointing out that the federal government still classifies marijuana as an illegal controlled substance.
Liquor distributors disagree that there’s an insufficient number of them, pointing out that more than a dozen of them are interested in serving. There’s currently only one entity doing distribution for more than 160 medical marijuana establishments (including 55 dispensaries) — a company called Blackbird Logistics. Members of the liquor distribution group have been screened by federal officials to get their alcohol licenses and are regulated by the Department of Taxation; they serve an average of more than 200 businesses each.
"The alcoholic beverage industry has more experience in the legal business than the marijuana industry has experience in the legal business," said Kurt Brown of Capital Beverages in Carson City, which has been operating for 65 years.
They question whether it was proper for the department to unilaterally declare there weren’t enough distributors absent more public input. The move is expected give a foothold to the medical marijuana businesses who have already gone through extensive, marijuana-specific Nevada hurdles liquor companies still have to clear.
In an explanation letter, taxation officials said the groups expressed interest but didn’t follow up with the department with a plan for being ready to start on July 1. Taxation officials also think they’re in the clear because the initiative language says the liquor distributors’ exclusive right to distributor licenses is only effective “unless the Department determines that an insufficient number of marijuana distributors will result from this limitation.”
“It was an agency decision,” Klapstein said. “If you read the text of Question 2 … it does give us the authority to do that.”
The distributors say they weren’t told after the initial phone call in November how to follow through. As for concerns that a state marijuana license would put them afoul of permission they get from the federal TTB, they say they could have gotten around that by filing for a distributor license under a different corporate entity.
And they think there’s a case to be made that a move as substantial as determining sufficiency should be made in an outward-facing process, perhaps involving the appointed members of the tax commission, rather than an internal one from agency staff.
As it stands, the liquor distributors have a short timeframe to prepare their extensive applications for marijuana distribution. If regulations are approved May 8, they’d have to submit their applications by May 31.
Is the three-tier system relevant?
The dispute has raised questions about the importance of the three-tier system, which was established in the wake of Prohibition as a way to avoid business arrangements that policymakers believed led to aggressive sales and excessive alcohol consumption. Prior to Prohibition, manufacturers could operate restaurants that exclusively sold their liquor in an arrangement called a tied house, but policymakers thought it would encourage temperance to add distance between the tiers.
Distributors argue that voters intended to set up a system closer to the one that governed liquor as a way to ensure integrity in the tax collection process. They say the vertically integrated marijuana system is a case of the fox guarding the henhouse.
“The reason the alcohol distributors were included in the distribution chain to begin with in Question 2 was to provide a check and balance so the Department could make sure that we would validate what was being picked up at the supply side was exactly what was being delivered at the retail side,” said Allan Nassau of the Independent Alcohol Distributors of Nevada. “This would assure that the Department would have another link in the supply chain to verify what was being sold so they could collect the proper amount of excise tax and no impropriety would occur.”
Question 2 campaign spokesman Joe Brezny argues that the integrity check comes from a “seed to sale” tracking system, and that vertical integration is an effective system for marijuana because it allows retailers to maintain tight quality control over their products. He said the streamlined model also helped lower prices.
Brezny pointed out that sometimes, marijuana cultivation and production are on the same site as a retail store, so distribution would involve moving a package from one room or floor to the next in the same building.
“What happens if you put an independent distributor in the middle of that? That's the definition of a bottleneck,” he said. “Other than the three-tier system in alcohol where that has a historical reference from ending alcohol prohibition, I don’t know any other product in the product chain where that is a requirement.”
Besides, he argues, even the three-tier system for liquor has deteriorated in recent years. Microbreweries brew and sell their product at the same site without distributors, and wine tasting rooms at vineyards do the same.
“It's a dinosaur,” he said. “Microbreweries and craft vineyards with tasting rooms are the proof that the three-tier system is a relic of the past.”