Here is a snapshot of Tuesday’s marijuana-related results:

(See Addendum listing all states that have legalized marijuana, and dates of legalization.)

As a result of Tuesday’s referenda, the percentage of Americans who live in states providing legal access to marijuana for recreational use rose from 5% to over 20%. The state-legalized marijuana industry, which is projected to generate about $7 billion this year, will now grow exponentially. It is estimated that California alone will triple the legal marijuana market in the United States. An industry that grew from $1.5 billion in 2013 will now be valued in excess of $25 billion by 2020. 

Business operators and investors appear to be lining up to enter the state-legalized marijuana market. One need look no further than the list of the primary backers of this year’s California recreational use referendum to see that marijuana companies as well as private equity and tech entrepreneurs are eager to tap the rapidly expanding market. Sean Parker, the founder of Napster and a former president of Facebook, was the biggest donor to the pro-recreational marijuana campaign in California, which raised about $23 million. Elsewhere significant private equity dollars have poured into legal marijuana initiatives. For instance, Tuatara Capital in New York has invested tens of millions of dollars in a marijuana-related partnership. Privateer Holdings, a cannabis-focused investment fund, with backing from Peter Thiel’s Founders Fund, has raised $100 million. And Casa Verde Capital is raising a $25 million fund to invest in the marijuana industry. 

Of course, investment in the legal marijuana business will not be risk free, especially given the current status of marijuana under federal law. Notwithstanding the passage in both red and blue states of laws that recognize marijuana as having medical benefits and as being a relatively benign recreational drug, marijuana is still listed as a “Schedule I” controlled substance along with heroin, LSD, Ecstasy and other dangerous drugs, under the federal Controlled Substances Act. This classification means marijuana is illegal under federal law, and is regarded federally as having a “high potential for abuse” and “no currently accepted medical use.” 

In light of marijuana’s Schedule I status, those entering or investing in a marijuana business that is legal under state law will face, at least theoretically, the prospect of federal criminal prosecution. Furthermore, if past is precedent legal marijuana businesses will continue to face resistance from banks and other financial institutions and payment processors, whose businesses have an interstate component, and which are, therefore, leery of “aiding and abetting” illegal federal enterprises, regardless of how legal those same enterprises may be under state law. In addition, there are significant adverse federal tax consequences for otherwise legal state marijuana businesses, as Section 280E of the Internal Revenue Code disallows any deduction or credit “for any amount paid or incurred during the taxable year in carrying on any trade or business . . . consist[ing] of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law.” Over the past 20 years, every marijuana business that is legal under state law and which has challenged the applicability of Section 280E to its business, has failed in its efforts with either the IRS, the courts, or both. 

Although the risks of venturing into the marijuana business are real, they can be mitigated. With the support and guidance of appropriate legal counsel, who understand the inconsistencies and interplay between state and federal marijuana laws, the risks can be navigated and reduced, if not entirely eliminated. In fact, the legal tension between federal and state law regarding marijuana has existed since 1996 when California passed the nation’s first medical marijuana law. During these past 20 years, there has not been a single successful federal prosecution of any marijuana business that was authorized and legal under state law. Furthermore, specific guidance from the Department of Justice (DOJ) with regard to the potential prosecution of marijuana businesses that are lawful under state law indicates that “enforcement of state law by state and local law enforcement and regulatory bodies should remain the primary means of addressing marijuana-related activity.” The DOJ notes that federal enforcement actions in the marijuana space will be restricted to priorities such as preventing the distribution of marijuana to minors, and preventing state-authorized marijuana activity from being used as a pretext for the trafficking of other illegal drugs or other illegal activity such as money laundering. In other words, absent a violation by a state-authorized marijuana business of some other federal law, the chance of the DOJ initiating a federal prosecution or enforcement action against a marijuana business that is lawful under state law has been extremely low, and in our view is unlikely to increase under President-elect Trump, who has expressed the view that marijuana should be decriminalized, and enforcement activities, if any, should be left to the states.

As for the impediments that banks and other financial institutions have erected to marijuana businesses, those have been alleviated by guidance issued in 2014 by the Financial Crimes Enforcement Network (FinCEN), which makes clear that banking institutions may provide services to legal marijuana-related businesses. Per FinCEN’s guidance, banks that take on legal marijuana businesses as customers, must file Suspicious Activity Reports (SARs) regarding those customers, but the SARs need only be what FinCEN calls “Marijuana Limited” SAR filings, which means that the SARs need do nothing more than identify the customer, and note that after appropriate customer due diligence the bank has found that the customer’s business is legal under state law, and does not run afoul of the DOJ’s guidance. Having done that, the bank is then free to provide financial services to the customer. 

With regard to the hurdle that Section 280E of the tax code has erected for marijuana businesses, the impediment will change if and when marijuana is “re-scheduled” and down-graded from a Schedule I controlled substance to either Schedule III or lower. The prospect of that happening sometime soon is speculative, but there is reason to believe it is possible. While Hillary Clinton and Donald Trump did not agree on much during the election, they both indicated a readiness to reschedule marijuana down to Schedule II and possibly lower. President-elect Trump noted that he is “in favor of medical marijuana 100%.” He has been more equivocal regarding recreational use of marijuana. While indicating that he believes marijuana should be decriminalized and regulated by the states, he has not suggested federal legalization.  Furthermore, more traditional Republican Party members have not expressed an interest in eliminating the tension between federal marijuana law and the laws of those states that have legalized marijuana whether for medical or recreational use or both.