Marijuana ETF Shifts Custody

September 18, 2018

ETF Managers Group, issuer of the ETFMG Alternative Harvest ETF (MJ), the market's only pure-play marijuana fund, has replaced the fund's custodian, U.S. Bank, effective yesterday, Sept. 17.

According to an update to MJ's Statement of Additional Information (SAI), the new custodian for MJ is Wedbush Securities, a broker-dealer based in Los Angeles.

In addition, ETFMG will now take the fund's administrator duties in-house. Transfer agent services, meanwhile, will be handled by Canton, Massachusetts-based Computershare Trust Company.

Formerly, the administrator and transfer agent roles were performed by U.S. Bancorp, parent company of U.S. Bank. has contacted ETFMG for comment without response.

No Rationale Given

No rationale was given in the SAI update as to why ETFMG and U.S. Bank decided to part ways, but the likeliest explanation has to do with ongoing risks of acting as custodian for the ETF.

For months, questions have swirled about whether U.S. Bank, a federally chartered and licensed bank, would be willing to continue shouldering the potential legal risk of being a custodian of a marijuana ETF.

For a while it seemed that no news was good news, and that the custodian issue may have been quietly resolved. That appears now to not be the case.

U.S. Bank declined to comment for this article.

What Is A Custodian?

A custodian plays a vital, but often-overlooked, role for any ETF by holding securities on behalf of the fund.

As has extensively reported, until recently, most big U.S. banks have refused to be a custodian for a marijuana ETF. That's because holding stocks involved with a drug still outlawed by the U.S government could potentially run a bank afoul of a Dept. of Justice newly recommitted to prosecuting federal marijuana-related crimes (read: "Promise & Peril Of Marijuana ETFs").

It's not that the underlying marijuana stocks themselves are verboten, since many custodians already hold these for other contexts. For example, Canopy Growth Corp., a Canadian medical marijuana producer, is both the largest holding in MJ and the second-largest holding in the nonmarijuana-related SPDR S&P International Small Cap ETF (GWX).

Instead, the problem is that custodian banks would be holding these stocks specifically for a marijuana ETF. When a federally chartered, licensed and insured bank declares that the primary reason it is holding marijuana companies is to provide exposure to a federally illegal substance, the bank invites additional scrutiny; it runs the risk of being denied FDIC insurance or even losing its banking license.

That's true even though the majority of investable marijuana stocks are domiciled in Canada, where marijuana is legal. Though those stocks may fall outside U.S. jurisdiction, the custodian bank does not.

ETFMG Circumvents US Bank

The custodian issue was brought to the forefront through the unusual way in which ETFMG brought MJ to launch.

Instead of the usual filing-to-launch process, ETFMG retrofitted one of its existing ETFs with a new index. Prior to Dec. 26, 2017, MJ tracked Latin America real estate and carried the ticker "LARE" (read: "When An ETF Changes Its Exposure").

In so doing, ETMFG circumvented the need to find a new custodian for the fund or get the SEC's green light for a de novo ETF. Despite the dramatic difference in indexes between LARE and MJ, the ETF had already been approved once and would not need to be reapproved. In fact, ETMFG didn't even need to get input from LARE's custodian, U.S. Bank, before making the change.

Prior to MJ's index switch, U.S. Bank had demonstrated little appetite for a marijuana ETF, turning down multiple proposals similar to the fund from other issuers.

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