A. Introduction: The great divide between State and Federal law.
As more States move towards the legalization of marijuana in various forms and to various degrees, marijuana is quickly becoming a growing and profitable industry. Despite changing state legislation, the federal government still lists marijuana as a Schedule I controlled substance under the Controlled Substances Act (“CSA”) 21 U.S.C. § 801 et seq. As a result, the possession, use, and distribution of marijuana in an state remain crimes under federal law. In addition, as described in a February 14, 2014 Department of Justice (“DOJ”) Memorandum by Deputy Attorney General James Cole entitled, Guidance Regarding Marijuana Related Financial Crimes: “The provisions of the money laundering statutes, 18 U.S.C. §§ 1956, 1957 the unlicensed money remitter statute, 18 U.S.C. § 1960, and the Bank Secrecy Act (“BSA”), 31 U.S.C. §§ 5311-5330, remain in effect with respect to marijuana-related conduct.” A copy of the February 14, 2014 DOJ Memo can be read here.
Moreover, the United States Supreme Court has found that the federal government has the power under the Commerce Clause to regulate, prohibit, and criminalize the possession, sale, and use of marijuana regardless of whether such activities are legal under State law. As explained by Justice Scalia in his concurrence in Gonzalez v. Raich:
Not only is it impossible to distinguish ‘controlled substances manufactured and distributed intrastate’ from ‘controlled substances manufactured and distributed interstate,’ but it hardly makes sense to speak in such terms. Drugs like marijuana are fungible commodities. As the Court explains, marijuana that is grown at home and possessed for personal use is never more than an instant from the interstate market and this is so whether or not the possession is for medicinal use or lawful use under the laws of a particular State.
545 U.S. 1 (2005). Thus, the Court held that even small amounts of home grown marijuana legally grown pursuant to State law triggered the CSA because there was a threat of unwanted commodity diversion that could disrupt Congress’s control over interstate commerce.
However, on August 29, 2013, Deputy Attorney General Cole issued a memorandum to federal prosecutors regarding the DOJ’s enforcement priorities with respect to marijuana. The Cole Memo lists eight priorities that guide DOJ in its enforcement of the CSA against marijuana-related conduct in light of the growing number of States which have legalized its sale and use. These priorities include:
Preventing the distribution of marijuana to minors;
Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
Preventing state-authorized marijuana activity from being used as a cover or pretext for trafficking of other illegal drugs or other illegal activity;
Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
Preventing marijuana possession or use on federal property.
A copy of the August 29, 2013 Cole Memo can be read here.
An example of DOJ’s exercise of prosecutorial discretion in CSA enforcement was the subject of an indictment recently unsealed in the Federal District Court in Denver. In November 2013, federal agents raided several Colorado medical marijuana dispensaries for alleged ties to international money laundering. The investigation has so far resulted in the indictment of four individuals on money laundering charges. According to the Indictment, the conspiracy centers around the defendants’ alleged creation of a shell corporation known as Colorado West Metal, LLC. The Indictment alleges that defendants opened a Wells Fargo bank account using the Colorado West Metal name to accept international money transfers from Columbia with the purpose of using that money to purchase marijuana warehouse facilities. The Indictment further alleges that the funds were then transferred out of the Colorado West Metal account and through the accounts and trusts of several other entities prior to the purchase of the dispensary property in an effort to conceal its source. The defendants also allegedly used the Colorado West Metal account to wire proceeds from the sale of marijuana in their dispensary internationally back to Columbia. As part of the ongoing criminal investigation, the defendants’ marijuana dispensary was again raided by federal agents on April 30, 2014. The Department of Justice press release detailing the indictment can be read here.
The Indictment is instructive in several respects. First, the Indictment highlights the difficultly banks face in establishing AML procedures for effectively complying with their responsibilities under the Bank Secrecy Act when dealing with the cash intensive business of marijuana as well as the ease with which criminally-derived funds can quickly become commingled with lawfully earned funds. The case also highlights how critical it is for the federal and state governments to resolve their marijuana-related differences.
B. Financial Institutions’ Responsibilities under the Bank Secrecy Act.
In addition to direct criminal penalties for drug trafficking and money laundering, marijuana-related businesses face additional legal barriers which make operation difficult. One such barrier is finding financial institutions to process the proceeds of marijuana sales due to the criminal status of marijuana sales under federal law.
Pursuant to the Bank Secrecy Act (“BSA”), financial institutions are required to create reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, federal law requires that financial institutions file Suspicious Activity Reports (“SAR”) if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320; see also 12 C.F.R. § 21.11; (more information on BSA requirements can be found on the Office of the Comptroller of the Currency’s website here).
Moreover, in addition to reporting requirements under the BSA, financial institutions also face the realistic possibility of federal criminal penalties for assisting in money laundering should they knowingly accept and process money received from dispensaries. Under a plain reading of the BSA and the money laundering statutes, banks cannot provide financial services to marijuana-related businesses without violating federal law. Consequently, financial institutions have been hesitant or have simply refused to allow marijuana dispensaries to maintain accounts or conduct business with them. Banks’ refusal to do business with marijuana-related businesses has been the subject of numerous articles including those by the New York Times and the Huffington Post.
As it applies to the proceeds derived from the sale of marijuana pursuant to state law, FinCEN has explained:
Because federal law prohibits the distribution and sale of marijuana, financial transactions involving a marijuana-related business would generally involve funds derived from illegal activity. Therefore, a financial institution is required to file a SAR on activity involving a marijuana-related business (including those duly licensed under state law), in accordance with this guidance and FinCEN’s suspicious activity reporting requirements and related thresholds.
(emphasis added). See FinCEN, FIN-2014-G001, BSA Expectations Regarding Marijuana-Related Businesses, (February 14, 2014), available here. Thus, because the sale of marijuana remains prohibited under federal law, financial institutions are placed in a position where, if they agree to service marijuana dispensaries, they would be required to report any transaction regardless of State law.
Financial institutions’ refusal to allow marijuana-related businesses to use their services and maintain bank accounts has made it extremely difficult for these businesses to operate. As a result, many legal marijuana businesses have resorted to all cash operations. Further, with the banking situation as it is, some marijuana-related businesses have sought “creative” solutions to their banking problems, including: 1) establishing shell companies to disguise marijuana proceeds; 2) funneling marijuana derived profits into accounts of other legitimate businesses; 3) placing marijuana derived profits into bank accounts of family members or personal accounts; and 4) flying cash out of country to locations such as the Cayman Islands. Our previous report regarding the potential criminal and civil liabilities associated with such activities can be read here. Kristen Wyatt of the Associated Press has highlighted several of these and other “creative” solutions on her Twitter feed which can be followed here.
However generally speaking, the use of shell companies or other accounts to mask the profits derived from the sale of marijuana could subject the owner of a marijuana-related business to a wide variety of federal criminal penalties, including bank fraud, 18 U.S.C. § 1344, wire fraud, 18 U.S.C. § 1343, and money laundering. Additionally, those who assist in such actions, for example the friend or family member who allowed for money to be transferred through his or her account, could also face similar criminal charges. Moreover, should such fraud occur, the financial institutions that process this money can still be held liable for money laundering and face criminal and civil fines and penalties, all of which are available regardless of whether marijuana is legal under State law. Regardless of whether marijuana is involved, if a company lies for the purpose of opening a bank account, the consequences can be incredibly severe.
C. The federal government’s attempt to create a compromise to allow for access to financial services: FinCEN’s “BSA Expectations” Guidance and the Department of Justice Cole Memorandums
FinCEN has made clear that a financial institution’s obligation to file a SAR is unaffected by any state law that legalizes marijuana-related activity. However, given the burgeoning marijuana industry, FinCEN recently undertook to explain how financial institutions can provide services to marijuana-related businesses while maintaining their responsibilities under the BSA by publishing its Guidance: BSA Expectations Regarding Marijuana-Related Businesses. FinCEN’s Guidance focuses on three areas: 1) increased due diligence; 2) new marijuana-related businesses SAR filing responsibilities; 3) “red flag” examples which may indicate a violation of state law or implicate a Cole Memo priority.
At the outset, it must be noted that FinCEN’s guidance should be read in conjunction with the August 29, 2013 and February 14, 2014 DOJ memorandums issued by Deputy Attorney General Cole to federal prosecutors regarding DOJ’s enforcement priorities with respect to marijuana. It is against this backdrop and with these priorities in mind that FinCEN drafted its guidance. FinCEN has explained that this Guidance furthers the objectives of the BSA “by assisting financial institutions in determining how to file a SAR that facilitates law enforcement’s access to information pertinent to a [enforcement] priority.”
1. Financial Institutions are required to engage in “thorough due diligence” prior to accepting marijuana-related businesses as clients.
FinCEN’s guidance makes clear that before providing financial services to a marijuana-related business, a financial institution must conduct a thorough customer due diligence. FinCEN noted that this due diligence should include: 1) verifying that the business is licensed and registered with state authorities; 2) a review of the state license application and supporting documents to operate as a marijuana business; 3) requesting available information about the prospective customer from state licensing and enforcement authorities; 4) obtaining an understanding of the nature of the business including the types of products sold and the customers to be served; 5) monitoring of publicly available sources for adverse information about the potential business customer; and 6) monitoring for suspicious activity, including whether the business implicates one of the DOJ enforcement priorities or violates state law. Further, financial institutions should continue their due diligence efforts and periodically refresh such information throughout the time they provide financial services to marijuana related businesses.
2. Financial Institutions New Marijuana-Related Businesses SAR filing responsibilities.
While the traditional filing of SARs has been limited to “suspicious” transactions, SARs for marijuana-related activity are more complex due to the conflict between state and federal law. Thus, while other businesses rarely trigger an SAR filing, every single marijuana-related business will trigger the filing of an SAR.
Towards that end, FinCEN has established three categories in describing a financial institution’s SAR filing responsibilities when engaging in services for marijuana-related businesses: 1) “Marijuana Limited” SAR filings; 2) “Marijuana Priority” SAR filings; and 3) “Marijuana Termination” SAR filings.
Regarding the first category, FinCEN explains that financial institutions should file a “Marijuana Limited” SAR when the institution reasonably believes, based on its due diligence, that the potential marijuana-related business customer does not implicate one of the DOJ Memo priorities or violate state law. It is important to note that this SAR filing should state “the fact that the filing institution is filing the SAR solely because the subject is engaged in a marijuana-related business,” and that no additional suspicious activity has been identified. Further, the financial institution must file continuing marijuana-related SARs which detail the amount of deposits, withdrawals, and transfers from the account since the previous SAR filing throughout the time that a financial institution provides services to a marijuana-related business. However, should a financial institution’s continued due diligence reveal a potential violation of state law or implicate a DOJ Memo priority, the financial institution should file a “Marijuana Priority” SAR.
A “Marijuana Priority” SAR is only to be filed when a violation of state law is suspected or when the activities of a marijuana-related business may implicate DOJ Memo enforcement priorities. A Marijuana Priority SAR will be substantially more detailed and should include: 1) identifying information of the subject and related parties; 2) addresses of the subject and related parties; 3) dates, amounts, and relevant details of the financial transactions involved; and 4) “details regarding the enforcement priorities that the financial institution believes have been implicated.”
Additionally, financial institutions must be aware that these filing obligations also apply when the institution provides “indirect services” to a marijuana-related business such as providing services to a another domestic financial institution which in turn services marijuana-related businesses or to a non-financial customer who provides goods or services to a marijuana-related business. (FinCEN uses the example of a commercial landlord who leases its property to a marijuana-related business). This naturally will require that financial institutions perform robust due diligence on all customers with potential indirect ties to marijuana-related businesses. However, FinCEN explains that “[i]n such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.”
The final category of SAR filings is the “Marijuana Termination” SAR. “If a financial institution deems it necessary to terminate a relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program, it should file a SAR and note in the narrative the basis for the termination.”
3. Red flag monitoring to indicate a violation of law or DOJ enforcement priority
In addition to making clear that prior to providing financial services to a marijuana-related business a financial institution must conduct a thorough customer due diligence, FinCEN has identified a series of red flags that would indicate that a marijuana-related business may be engaged in activity that implicates one of the Cole Memo priorities or violates state law. Such red flags include: that the business receives significantly more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates; that the business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law; a customer seeks to conceal or disguise involvement in a marijuana-related business activity; and that a business is unable to demonstrate the legitimate source of significant outside investments. The complete list of red flags can be found in FinCEN’s BSA Expectations Guidance.
However, FinCEN has also made clear that these red flags do not constitute an exhaustive list. As such, FinCEN has emphasized the importance of viewing any red flag(s) in the context of other indicators and facts, such as the financial institution’s knowledge about the underlying parties obtained through its customer due diligence.
D. Analysis of FinCEN’s new “protections” for financial institutions.
FinCEN’s guidance may in fact be a good faith attempt by the federal government to ease anxieties about providing financial services to marijuana-related businesses. However, the banking industry’s reaction has been lukewarm at best.
As explained by the Colorado Bankers Association:
Bankers had expected the guidance to relieve them of the threat of prosecution should the open accounts for marijuana businesses, but the guidance does not do that. Instead, it reiterates reasons for prosecution and is simply a modified reporting system for banks to use. It imposes a heavy burden on them to know and control their customers’ activities, and those of their customers. No bank can comply.
(emphasis added). The Colorado Bankers Association’s statement is available in full here.
Similar thoughts were echoed by the American Bankers Association: “While we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.” The American Bankers Association’s statement is available in full here.
The sentiments of the CBA and the ABA were recently echoed by the Colorado State Senate in Senate Resolution 14-003 entitled, “Concerning Congressional Action to Facilitate Legal Financial Services for the Marijuana Industry.” In its resolution the Colorado Senate noted that both the Controlled Substances Act and the Bank Secrecy Act prohibit banks from providing financial services to marijuana businesses. The Colorado Senate further noted, among other things, that “[d]irectives from federal regulatory agencies such as the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency also prohibit bankers from accepting deposits from marijuana or hemp businesses.” Thus, the Colorado Senate passed a resolution stating:
Be It Resolved by the Senate of the Sixty-ninth General Assembly of the State of Colorado:
(1) That the ability of the federal executive branch to facilitate a reasonable regulatory structure for the marijuana industry is limited as long as federal law categorizes marijuana as an illegal substance.
(2) That the best solution to the problem of a lack of financial services for the legal marijuana industry will be comprehensive federal legislation authorizing banks and credit unions to serve legal marijuana and hemp businesses.
Be It Further Resolved, That copies of this Resolution be sent to all members of the Colorado delegation to the United States Congress, the speaker of the United States House of Representatives, the United States Senate majority leader, the United States Senate majority leader pro tempore, and the president of the United States.
Here, a careful reading of FinCEN’s guidance reveals that FinCEN’s red flags go above and beyond the anti-money laundering programs banks are required to keep. Further, these red flags may present more of a problem than a solution to financial institutions looking to provide services to marijuana-related businesses and to marijuana-related businesses looking to benefit from basic banking services. Asking a financial institution to dig deep into whether the business is receiving substantially more revenue than may be reasonably expected given the relevant limitations imposed by the state, what its competitors are making or what it reported on its income tax returns is essentially asking financial institutions to audit businesses they know nothing about in the first place. In effect, these red flags are totally impractical for typical banks looking to provide basic services to marijuana-related businesses because they raise more questions than they provide answers.
To take on this new industry, banks must acquire new tools for their anti-money laundering programs to comply with FinCEN’s Guidance. Full compliance will require both a comprehensive understanding of a bank’s requirements under the BSA and the intricacies of any given State’s marijuana dispensary and use laws. Compliance with FinCEN’s Guidance is possible, but banks willing to take on the new business must be cautious, flexible, and elegant in their approach. Without new tools, lack of access to the banking and financial services industry presents a potentially disastrous situation to the legal marijuana industry.