California

How Sacramento failed to monitor its cannabis storefronts, as the FBI steps in

Sacramento’s legal marijuana business began as a loose-knit group of independently managed, nonprofit collectives dedicated to dispensing cannabis to patients with medical needs. Sacramento had a green future.

A decade later, the pot industry has transformed into a corporate affair dominated by a handful of investors, including a Ukrainian-born businessman indicted this month on campaign finance charges along with two close associates of Rudy Giuliani, the president’s lawyer.

Last week, the city learned that the FBI is investigating whether pot business owners in Sacramento have bribed local officials in exchange for favorable treatment. And Mayor Darrell Steinberg has called for an audit into cannabis licensing in Sacramento. The state of California is doing its own review.

How did this happen? A Sacramento Bee investigation has found that the city’s lax oversight has allowed the pot industry to consolidate far beyond what elected officials imagined when they gave their blessings to the city’s 30 pioneering marijuana dispensaries years ago.

Despite city regulations that explicitly prohibit buying and selling permits for storefront pot shops, dispensary owners have been allowed to trade their businesses with ease. City regulations require shop owners to surrender their permits if they want to exit the business and require a public lottery for transferring the license. But the city has never held one.

“These companies are being bought and sold like candy, and they’re going to select individuals,” said Richard Miller, director of education and outreach at the east Sacramento dispensary A Therapeutic Alternative. Miller’s also the state director of the American Alliance for Medical Cannabis. “That’s not a fair marketplace. That is a monopoly.”

This consolidation has occurred while a host of other problems have simmered around the management of Sacramento’s pot storefronts, which reported about $142 million in revenue in the last fiscal year.

The city’s Office of Cannabis Management, which employs five people, currently lacks a director. Its former chief, Joe Devlin, left the office in May and now works in the industry for Ikänik farms, which offers “handcrafted cannabis brands.” The new audit ordered by the mayor comes only two years after the same auditor released a critical report about the city’s oversight of the department. Several of the issues raised in 2017 remain unresolved.

Further, the city has failed on its promise to promote minority ownership of pot dispensaries, a critical demand of the black community that saw a disproportionate number of African American men imprisoned nationwide for possessing and selling marijuana. Instead of spreading the wealth, a handful of players now control almost half the city’s cannabis storefront shops in the now-legal industry.

There are no black owners of dispensaries in Sacramento, said Malaki Amen, president and CEO of the California Urban Partnership.

Amid this, dispensary owners are left fighting over ownership of the lucrative businesses in court. Two lawsuits name the city as a defendant. One cannabis entrepreneur claims his Sacramento dispensary was stolen from him while he was in prison on federal charges. The public oversight of that ownership transfer happened with a simple form filed with the city’s Office of Cannabis Management.

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Along the way, one successful investor, a Sacramento man named Garib Karapetyan, has amassed control of eight of the city’s 30 storefront dispensaries, and his business partners own a ninth under their Kolas brand.

At one of the Kolas dispensaries, Twelve Hour Care on Fruitridge Road, Karapetyan is the permit holder with a Ukrainian-born U.S. citizen from San Francisco named Andrey Kukushkin — one of four men indicted last week on charges of running a scheme to funnel foreign campaign dollars to U.S. politicians. State cannabis regulators say the two men are partners on 11 pot-related businesses in Sacramento, but Karapetyan’s attorney said those records are inaccurate.

The arrest of Kukushkin and his links to the Sacramento cannabis world has rocked the industry.

“It’s the Wild West out there,” said Joe Starr, chief operating officer of Vibe Bioscience, a Canadian firm that purchased a Sacramento dispensary in February.

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Andrey Kukushkin leaves federal court Oct. 17, 2019, in New York. Kukushkin and David Correia pleaded not guilty Thursday to conspiring with associates of Rudy Giuliani to make illegal campaign contributions. They are among four men charged with using straw donors to make illegal contributions to politicians they thought could help their political and business interests. Kevin Hagen AP

In addition to the storefronts run by Karapetyan, two other groups of investors control five other Sacramento dispensaries between them. Perfect Union owns two dispensaries and manages a third. A businessman named Justin Flanery has two more, Two Rivers Wellness and Green Solutions.

The new generation of players in Sacramento’s pot industry says they’ve done nothing improper. Perfect Union spokesman Matthew Z’berg said when his company comes in to manage a struggling dispensary, it’s providing a vital public service by preventing more vacant buildings and run-down storefronts in some of the city’s struggling neighborhoods.

“If you’re a good operator of a dispensary and your sales are really good, then it’s probably not a bad thing for failing or low-level dispensaries to take on a new management group to oversee the day-to-day function of a flailing dispensary,” Z’berg said.

That three investor groups own or operate 14 shops, or nearly half of Sacramento’s 30 dispensaries, troubles smaller players in the city’s cannabis industry who’ve been involved since the beginning. They say the city should have never let so much of the market be cornered by so few.

The rapid acceleration of Sacramento’s cannabis industry can be seen all over the city, particularly on the freeway billboards and alternative newspaper ads. This expansion has occurred as Sacramento, along with hundreds of other cities around the state, has attempted to manage the transformation of a once-criminal enterprise into legitimate businesses that pay taxes and follow the law.

City elected officials say it’s time to take a closer look at whether Sacramento has failed to do so.

“Obvious mismanagement has occurred in our permitting process,” said Councilwoman Angelique Ashby. “Several of us on the City Council have raised concerns many times about the lack of integrity and perceived equity in our marijuana permitting system.”

Loose rules on dispensary ownership

In 2009, the city asked its medical marijuana dispensaries to register with the city. Thirty of them eventually made it through the permitting process, and the city capped the number of dispensaries allowed in the city at that number.

The city’s code leaves no wiggle room for selling permits: “Cannabis business permits may not be transferred, sold, assigned or bequeathed expressly or by operation by law,” it reads. “Any attempt to directly or indirectly transfer a cannabis business permit shall be unlawful and void, and shall automatically revoke the permit.”

Each year, the 30 dispensaries must re-apply for their city permits, Assistant City Manager Leyne Milstein, who is acting as the city’s interim pot czar, told The Bee. When new applications come in, city staff make sure there is at least one name listed in the application from the previous year — a process it started in 2014 when it first started issuing medical dispensary permits, Milstein said.

“The system was created to ensure accountability while allowing businesses in this nascent industry the flexibility needed to survive and succeed in this evolving market,” city spokesman Tim Swanson said in a statement. “Cannabis businesses, like other legal businesses, should have the flexibility to make changes, bring on new officers, managers, etc.”

The city is nevertheless now reviewing its dispensary permit process, and earlier this month added more details to its annual forms.

It’s unclear whether the city staff always followed its “continuity” process, because the city no longer has in its possession all dispensary applications dating back to 2014, according to documents the city provided to The Bee in response to a request under the California Public Records Act.

In any event, the documents that are available clearly show that ownership of some dispensaries has changed over time.

Karapetyan’s business partners were listed on the applications for just two shops in 2011, according to city documents obtained by The Bee. In 2018 and 2019, various combinations of the five men were listed on nine permits.

In October 2018, the partners announced the shops would now be operating under the “Kolas” brand, which they called “the biggest thing to happen to Sacramento cannabis dispensaries as we know it.”

City documents for three of those shops list a former owner as “relinquishing” ownership or board membership, while Joe and Garib Karapetyan are written right underneath, each having 50 percent ownership in the business.

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A billboard in south Sacramento advertises six of the pot dispensaries controlled by businessman Garib Karapetyan. A man indicted in the campaign finance case linked to attorney Rudy Giuliani case is an officer of the THC dispensary. Dale Kasler dkasler@sacbee.com

An attorney for Karapetyan and four of his business partners said they were just following the rules.

“I can tell you that my clients haven’t done anything different than anything any of the other (dispensaries) have done in the city. Everything we did was above board and done with the blessing of the city,” said Brad Hirsch, a Roseville attorney.

The Perfect Union owners were listed on only one dispensary application in 2011 — River City Phoenix. They’re currently listed as permit holders on two — River City Phoenix and Hugs, which are now both rebranded as Perfect Union.

Justin Flanery was listed in paperwork for one shop in 2011. Now he is listed on two: Two Rivers Wellness and Green Solutions. The city in April issued administrative penalties to those two dispensaries after they could not produce business records within 24 hours, Swanson said. Flanery could not immediately be reached for comment.

The issue of dispensary consolidation has been on the City Council’s radar for years, yet little has been done to stop it. This, despite council members expressing outrage.

During a City Council meeting in October 2017, after the city’s auditor released a damning report of lax oversight, Ashby, Councilmen Allen Warren and Larry Carr said they were appalled. Warren said the city’s “continuity process” allowed the system to be manipulated. Carr called it a shell game.

In 2018, the city started requiring more detailed ownership paperwork, including forms laying out changes in ownership.

Devlin, the former head of the cannabis department, said that was his idea.

“The city’s policy of continuity predated my time in the cannabis office,” Devlin said. “I worked with the city manager and city attorney to create a process for documenting that policy.”

Yet no significant changes were made to the dispensary ownership permitting process following that council meeting.

The city is still not inspecting dispensaries to identify under-reporting of gross receipts, as recommended in the 2017 audit, a follow-up city audit released earlier this month found. The city also has not developed a “risk-based enforcement program” that identified high-risk violations to make sure problems were quickly fixed.

The city plans to seek bids from companies to complete those tasks, a follow-up document from the city auditor’s office said.

The city conducted the 2017 audit after Lanette Davies and other dispensary owners raised the red flag about permits appearing to be sold.

BEHIND OUR REPORTING

Why we did this story

Three years ago, California transformed a once-criminal enterprise, the sale and cultivation of marijuana, into a legal, regulated industry.

In Sacramento, that means city officials under the Office of Cannabis Management, have the responsibility to permit and monitor the 30 storefront shops allowed to operate here. This is a $142 million industry that has already had a huge impact on the city. The Sacramento Bee wanted to find out how these shops are regulated, and who is behind them.

The story took on new meaning when four men were indicted for allegedly funneling foreign money into U.S. campaigns and attempting to secure cannabis licenses in Nevada and “other States,” as the indictment said. It turned out, one of the men who was indicted was a Ukrainian-born businessman named Andrey Kukushkin who was co-owner of a pot dispensary in Sacramento.

Read more by clicking the arrow in the upper right.

How we did this story

This story is the result of several weeks of reporting by Bee staff, numerous public records requests and interviews with regulators and people associated with the cannabis industry.

We first began this story after hearing from sources that the City of Sacramento’s licensing system for pot dispensaries was only loosely regulated and effectively shut out people who were trying to obtain a permit to operate a storefront shop in the city.

The first and hardest task was dislodging the permit and ownership records from the city. That required multiple requests under the California Public Records Act and frequent negotiation and prodding. Once we obtained most of the records, we got a clearer picture of how ownership is transferred in Sacramento.

We scoured other public records as well, including state business documents, federal records, tax forms and court filings, and interviewed sources throughout the city. Those sources include current and former city officials, attorneys, cannabis dispensary owners, and many others connected to the industry. We also visited several of the storefront shops to obtain public business records, but in a few cases we were turned away by employees.

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Davies said she feels the city had retaliated against her for speaking out at council meetings against the rampant transfers of licenses. She eventually went to the auditor with her findings, and when that didn’t solve the problem, she sued the city.

Davies said the city refused to approve her permit when she moved locations last year, which she said has killed her business and nearly bankrupted her.

“All it got me was closed,” said Davies, a permit holder for Canna Care medical dispensary. “Literally they have taken everything from me. It cost my family everything.”

The city disputes Davies’ accusations, Swanson said. The case is headed toward trial in Sacramento County Superior Court.

Sharing the cannabis wealth

Jerard Johnson opened a cannabis delivery business about a year ago in north Sacramento. He wants to one day open a retail dispensary but doesn’t see a pathway for which that can happen.

“Unless you’re right next to me in Del Paso Heights, it’s gonna take me 20 to 30 minutes to get to you,” said Johnson, who is black. “If you’re a dispensary, in that 20 to 30 minutes, you can see five people.”

In 2018, the City Council adopted a much-lauded, two-year pilot initiative called the Cannabis Opportunity Reinvestment and Equity Program. The idea was to give people who were arrested for nonviolent marijuana crimes as part of the “War on Drugs,” which disproportionately affected African Americans, better access to what is now a lucrative legalized industry.

For those who meet certain zip code, income, and other requirements, the program waives thousands of dollars in fees for them to open a cannabis business and prioritizes them for permits.

But more than a year in, none of the city’s 30 storefront dispensaries are owned by African Americans. There is no pathway on the horizon for that to ever change.

“It’s disturbing to have this cap just hovering over our heads, particularly when the city has gone through this whole exercise of completing a study to measure who was arrested by police for marijuana-related charges,” said Amen of the California Urban Partnership, who advocated for the city to adopt the program.

That study found that black residents, who make up only 14.6 percent of the city’s population, accounted for nearly half of the cannabis-related arrests in 2010. Of the more than 250 people who showed up to a recent workshop to learn about the program, the vast majority wanted to open storefront dispensaries, Amen said.

“For the vast majority of them, that’s what they want to do,” he said. He wants to open a dispensary where multiple African American entrepreneurs can sell their products.

Storefront dispensaries are more lucrative than cultivation, distribution and delivery, Amen said. The only other pot business that can be as lucrative as storefront dispensaries are manufacturing businesses, he said.

The City Council in November discussed increasing the cap on storefront dispensaries to allow CORE participants a chance to open some, but ultimately decided against it for now.

In early August, a year after the program started, the city announced that the first CORE participant was able to get a city permit — a small cultivation site in an industrial area just north of downtown owned by Betty Mitchell, who is black. More CORE permits are in the pipeline, but none for dispensaries.

In addition to being a permit holder for eight dispensaries, Garib Karapetyan also has an open manufacturing business and a cultivation site set to open once city inspectors OK the building, Swanson said. He’s also a partner in three other city cultivation sites, state business records show. Perfect Union’s Spradlin also owns a cultivation site in the city.

Perfect Union aims to one day exclusively sell “flower” cannabis in its dispensary that it grows itself, Z’Berg said.

“We’re trying to get as vertically integrated as possible,” Z’Berg said.

Equity advocates say that puts the CORE participants who do get permits for cultivation or delivery at a disadvantage because it’s harder to find shops to sell products to.

“If they’re growing their own supply and putting that into the dispensary what room is there for equity participants?” Amen said. “Many of the cultivators who are entrepreneurs of color have a barrier to getting their product into a store because there is a good old boys club out there.”

Who owns the storefronts?

Earlier this year, a small sign that simply read “8112 Alpine,” perched in the grass outside of a dispensary on Alpine Avenue near Sacramento’s Colonial Village, was covered up by a sign that reads “Vibe by California.”

A Calgary company called Vibe Bioscience purchased the dispensary in February for $2.8 million, according to statements filed with the Canadian Securities Exchange.

Asked about the city ordinance prohibiting dispensary owners from selling their permits, Starr, the firm’s chief operating officer, said the purchase was “fully compliant with all state and local ordinances.”

“Our legal team worked with the city of Sacramento,” he added. “We obviously pay our taxes, we do everything to be a good corporate citizen in the city ... It’s a fantastic city to do business.”

The previous owner of the Alpine dispensary, Brian Pritchard, is still listed as permit holder. The permit was dated March 8, about three weeks after Vibe completed the purchase of the business. He is also listed as Vibe’s operations director on the company’s website. Starr said Pritchard is also a shareholder; the purchase was done with a combination of cash and Vibe stock.

The city was not aware of the reported $2.8 million deal before learning of it from The Bee, Swanson said. The city has not received any documentation noting changes to the Alpine dispensary permit, and is looking into the matter, Swanson said.

Billy Baker, one of the original owners of Hugs dispensary on Stockton Boulevard, told The Bee he sold his dispensary in 2017. He refused to disclose the sale price, and when asked if he knew that selling the permits was against city code, he hung up.

The 2018 city paperwork shows Perfect Union’s David Spradlin and Mark Pelter as the owners of the business, with 50 percent ownership each. On Tuesday, Caity Maple, a vice president of Perfect Union, said listing Spradlin and Pelter as co-owners was a paperwork error by the company.

She said Hugs is a mutual-benefit nonprofit corporation, which does not have owners but is instead overseen by a board of directors that include Pelter, Spradlin, and Cathy Roemer, one of the original owners. Those three are listed on the 2019 permit.

“In no way do we go around knocking on doors, saying, ‘Hey, how much for your permit?’” said Z’berg, Perfect Union’s spokesman. “You’re not supposed to do stuff like that.”

But Davies said she has received large proposals to buy her dispensary, including an offer of $3 million ($1.5 million in cash, the rest in stock) from a firm called Seven Leaf Ventures Corp., according to a January 18 letter she provided to the Bee. She declined the offer.

“Do you know how hard it is to say no to somebody who says ‘I have 3 million dollars, I’d like to give it to you to buy your company’ and we have to say no because we can’t sell? While we have no money?”

A lawsuit filed last year in Sacramento Superior Court sheds more light on how the permits could be transferred while circumventing the city code.

A Bay Area company Baystone Holdings bought 55 percent of Metro Health Systems dispensary (which is now managed by Perfect Union) for $800,000, according to the lawsuit. The original owner, Brian Galletta, remained a 10 percent owner, though, and his name stayed on the city paperwork, satisfying the city requirement. In the lawsuit, the Baystone investors accuse Galletta of locking them out of the business.

Galletta remains the 2019 permit holder. In court papers, he denied doing anything wrong and accused Baystone of embezzling $1 million from Metro Health.

Sacramento city officials say they’re intent on strengthening oversight of the young industry.

City Manager Howard Chan said that after cannabis was decriminalized in California, the city ”put into place rules and regulations to ensure accountability as well as flexibility for small businesses in this new industry.”

“As the cannabis market has continued to grow and evolve, so have the city’s policies and procedures,” he said. “The city welcomes any input that improves our processes and makes our communities safer and stronger.”

The Bee’s Phillip Reese and Sam Stanton contributed to this story.
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Theresa Clift covers Sacramento City Hall. Before joining The Bee in 2018, she worked as a local government reporter for the Pittsburgh Tribune-Review, the Daily Press in Virginia and the Wausau Daily Herald in Wisconsin. She grew up in Michigan and graduated from Central Michigan University.
Dale Kasler covers climate change, the environment, economics and the convoluted world of California water. He also covers major enterprise stories for McClatchy’s Western newspapers. He joined The Bee in 1996 from the Des Moines Register and graduated from Northwestern University.
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