Securities and Exchange Commission charges Canadian cannabis Nasdaq-listed company Cronos Group Inc. for improperly accounting for millions in revenue

The Securities and Exchange Commission today charged Cronos Group Inc., a Nasdaq-listed cannabis company based in Toronto, for improperly accounting for millions of dollars of revenue and for other accounting misconduct in multiple reporting periods. The SEC also charged Cronos’s former Chief Commercial Officer, William Hilson, with fraud and aiding and abetting the company’s violations. In agreeing to settle with Cronos, the Commission determined that the company should not incur a financial penalty, given its timely self-reporting, significant cooperation, and remediation.

At the start of 2019, Cronos’ business was primarily focused on the cultivation and
growth of cannabis flower (also called biomass), which Respondent in turn expected to sell under
various brands in the retail market. However, beginning in early 2019 and continuing throughout
that year, an insect infestation of certain biomass in the company’s vault storage facilities rendered
that biomass unsuitable for retail sales as originally expected. Cronos also lacked the
manufacturing ability to convert the biomass to other uses. As a result, Cronos was left with a large
supply of lower-quality biomass in its limited vault storage facilities. In response, Cronos was
motivated throughout 2019 to sell off its inventory of lower-quality biomass to free up space in its
storage facilities.Around the same time, in anticipation of forthcoming regulatory changes in Canada,
Cronos made a strategic decision to enter the cannabis vaporizer market. Cronos expected the
market for cannabis vaporizer products to eventually surpass the market for the sale of cannabis
flower. As part of its shift in business strategy, Cronos sought to procure a supply of cannabis resin,
a key input of vaporizer cartridges used in the production of vaporizer products. Cronos, however,
lacked the in-house manufacturing capability to convert biomass into resin, and, in any event, given
the lower quality of its biomass inventory, the company’s biomass product could not be used for
such purpose. As an alternative, Cronos looked to third-party manufacturers from which it could
purchase resin for use in the process of vaporizer production.

According to the SEC’s order, in three separate 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 order also found that, in one of the quarters, Hilson entered into an undisclosed oral agreement to sell cannabis raw material and to repurchase cannabis product in the following quarter. This agreement was neither known nor accounted for by Cronos, which discovered the $2.3 million accounting error during an internal investigation. After discovering the accounting errors, Cronos promptly reported the misconduct to the SEC and provided extensive cooperation that meaningfully advanced the Commission’s investigation. It also took effective remedial steps to enhance its internal accounting controls.

Here is what the Order says happened:

Between 2019 and 2021, Cronos furnished to and/or filed with the Commission,
financial statements in three separate quarters that contained material accounting errors. In two of
the three quarters—the first quarter of 2019 and the third quarter of 2019—Cronos improperly
recognized revenue in connection with certain transactions with the same counter-party where the
sale of cannabis raw materials (or cannabis flower) by Cronos occurred simultaneously with the
purchase by Cronos of processed cannabis product. Separately, in the third quarter of 2019, a sinceterminated senior executive of Cronos entered into an undisclosed oral agreement with a different
counter-party to sell cannabis raw material to the counter-party but then repurchase the cannabis
product, either as a derivative product or in some other form, in the following quarter. This oral
repurchase agreement made it inappropriate for Cronos to recognize revenue in connection with the
sale transaction. Finally, in the second quarter of 2021, Cronos failed to timely record impairment
charges in connection with goodwill and intangible assets associated with its U.S. reporting unit.
As a result of the foregoing accounting errors, Cronos furnished to and/or filed with the
Commission, periodic reports that contained materially inaccurate financial statements.

After discovering the accounting errors, Cronos filed restated financial statements for
the relevant quarters. In connection with the first and third quarters of 2019, Cronos disclosed that
it had materially overstated its revenue by $5.8 million. In connection with the second quarter of
2021, Cronos disclosed that it should have recorded approximately $234.9 million in impairment
charges in relation to its U.S. reporting unit. Concerning all three quarters, Cronos disclosed that it
had identified material weaknesses in its internal control over financial reporting

During the second quarter of 2021, certain Cronos personnel were aware ofinformation indicating the existence of impairment indicators related to goodwill and intangible assets held by the U.S. business. In particular, the U.S. business had underperformed relative to budget expectations as of the second quarter 2021; internal forecasts prepared during the second quarter of 2021 had shown an approximate 60% decrease in projected revenues in future years; and the U.S. business faced significant pricing pressures as a result of increased competition anddiscounting by other firms. As a result of such information, Cronos should have determined that itwas required to perform an interim impairment test.

The SEC’s order against Cronos finds that the company violated the antifraud, reporting, books and records, and internal controls provisions of the federal securities laws. The SEC’s order against Hilson finds that he violated the antifraud provisions of the federal securities laws and further aided and abetted and caused Cronos’s violations of the reporting, books and records, and internal controls provisions.

Without admitting or denying the SEC’s findings, Cronos and Hilson offered to settle the matter by agreeing to cease and desist from future violations of the charged provisions. In addition, Cronos agreed to retain an independent compliance consultant to review, assess, and make recommendations with respect to the firm’s financial reporting and accounting controls. Hilson agreed to a three-year officer and director bar and agreed to be suspended from appearing and practicing before the SEC as an accountant for at least three years. The Commission determined not to impose a financial penalty on Hilson in light of his consent to pay $70,000 (CAD), or approximately $54,000 (USD), to the Ontario Securities Commission for similar conduct.  

The SEC’s investigation was conducted by Kendra Kinnaird and John Higgins, with the assistance of Marlee Miller and Bonnie Kartzman in the Office of International Affairs. The investigation was supervised by Fuad Rana and Kristen Dieter. The SEC appreciates the assistance of the Ontario Securities Commission.

Jeffrey Newman is a whistleblower attorney with the firm Newman & Shapiro. He can be reached at Jnewman@NewmanShapiro.com