On November 3rd, voters in Arizona, New Jersey, South Dakota, Montana, and Mississippi passed ballot measures to bring legal cannabis to each of their states. It’s not every year that we see states from opposite ends of the political spectrum agree on something with such vigor. In fact, loosening the laws surrounding cannabis—be it medical use, recreational use, or farming of hemp products—has consistently been one of the only areas receiving bipartisan support in a country divided on almost everything else.
The passage of these ballot measures means that the cannabis industry will generate even more revenue. Despite the massive dollar amounts currently associated with the cannabis industry, reliable banking services remain elusive, due to federal drug and money laundering laws and the Bank Secrecy Act (“BSA”). This post will summarize the recent cannabis legislation, and recap the main roadblocks facing the industry (and financial institutions) from a financial compliance perspective.
Growing Support Among States
Arizona passed Proposition 207, legalizing cannabis for recreational use and allowing individuals to grow up to six cannabis plants in their homes. Likewise, Montana approved two ballot initiatives, which together will legalize recreational cannabis for adults over the age of 21. Mississippi passed Initiative 65, legalizing medical cannabis for patients with qualifying medical conditions.
New Jersey, which already had a medical program, voted to approve Question 1—allowing for an amendment to the state constitution that would enable recreational cannabis legalization. The next step will be for the state to adopt a cannabis bill, which could happen as soon as January 1, 2021.
South Dakota became the first state to simultaneously approve both medical and recreational cannabis. Some commentators have predicted that this dual effort will make implementing the new regulations much easier and more efficiently than states that have taken a sequential approach. This is especially groundbreaking as, prior to this ballot measure, South Dakota had one of the most restrictive views on all things cannabis.
These states join eleven others where marijuana is legal for all adults, and 34 others where medical marijuana is legal. While these ballot initiatives will take some time before they are fully enacted, many other states have, over the past few years, showcased the positive impact of legal cannabis on the state’s economy. In 2019, Colorado surpassed $1 billion in total state revenue from its marijuana industry (marijuana became fully legal in the state in 2014). Illinois, which legalized marijuana in January of this year, brought in over $100 million in tax revenue in the first ten months of its legal marijuana industry. Most states tax marijuana on multiple levels and at relatively high rates, making this a lucrative business for both the private and public sector. However, as much as the states have positioned themselves to reap the rewards of legitimate cannabis, we have repeatedly blogged on the serious barriers to entering this industry. Specifically, financial institutions that seek to service marijuana related business (MRBs) will need to do some heavy lifting on the compliance side.
Federal Law Poses Serious Restrictions, and Some Opportunities
Despite the majority of states having passed laws that decriminalize or legalize cannabis in some form, federal law has not budged: Marijuana remains a Scheduled I controlled narcotic under the federal Controlled Substances Act (“CSA”). Federal money laundering statutes likewise treat marijuana as an illegal substance. Under 18 U.S.C. §§ 1956 and 1957, the production and distribution of marijuana is a specified unlawful activity (“SUA”) that could give rise to a violation of federal law, if the proceeds of the SUA are used in a financial transaction. A financial transaction is defined broadly, and includes a deposit into or withdrawal from a bank account. This has serious implications for financial institutions intending to service MRBs, as the mere act by an MRB of depositing the proceeds of its marijuana sales into a bank account could constitute a federal money laundering offense.
So, how do financial institutions and the MRBs they service navigate these murky waters? In essence, they don’t—they trust that the federal government will not seek prosecution, so long as they are in compliance with state law. This concept began in August 2013, when then-Deputy Attorney General James Cole issued a memo (the “Cole Memo”) regarding marijuana enforcement in states that had passed some form of marijuana reform legislation. The Cole Memo, though not a legally binding document, was successful in instructing the DOJ and other federal agencies on the types of marijuana-related cases that were worth bringing, as well as the types that were not. Though federal law will always preempt state law, the Cole Memo posits that the two can coexist, giving us the present-day culture of federal deference to state decisions in this space. Although former Attorney General Jeff Sessions rescinded the Cole Memo, its legacy lives on, in the form of still-existing guidance on the banking of cannabis that the Financial Crimes Enforcement Network (“FinCEN”) issued in the wake of the Cole Memo.
FinCEN’s framework for its expectations of BSA/AML compliance and cannabis banking breaks down into three main elements: 1) customer due diligence, 2) mandatory filing of three types of marijuana-specific SARs, and 3) ongoing monitoring of “red flags”.
First, for customer due diligence (CDD), FinCEN provides a checklist of action items for financial institutions to undertake, in order to assess the risk of servicing a MRB. These items include:
- Verification with appropriate state authorities that business is licensed and registered
- Review of the submitted license application and related document
- Request for information about the business and related parties from state licensing and enforcement authorities
- FinCEN makes it clear that there is no one size fits all approach to CDD in relation to serving MRBs. Financial institutions must tailor their AML programs to suit their MRB customer’s individual risk profile, and conducting comprehensive CDD will enable them to do so.
Second, FinCEN has delineated three types of suspicious activity reports (SARs) that must be filed when a financial institution engages with a MRB. The obligation to file these SARs is unaffected by any state law on the legality of marijuana.
- Financial institution should file “Marijuana Limited” SAR if, based on its CDD, it has determined that marijuana-related business neither implicates Cole Memo priority nor violates state law.
- Financial institution should file “Marijuana Priority” SAR if, based on its CDD, it holds reasonable belief that business implicates a Cole Memo priority or violates state law in some way.
- Financial institution should file “Marijuana Termination” SAR if it deems it necessary to terminate relationship to comply with its AML program.
Finally, FinCEN provides a non-exhaustive list of “red flags” that should be used to determine whether an MRB has implicated a Cole Memo priority or possibly violated state law. Deciding which type of SAR to file and whether additional CDD is required may be influenced by presence of one or more of the following:
- Various indicia of use of the business as a front to launder money
- Inability to produce satisfactory documentation of license and conformance with state law
- Inability to demonstrate a legitimate source of outside investments
- Negative information in public records (criminal records or other connections to illicit activity) about owners or managers
- Engagement in international or interstate activity
- Excessive payments to managers or employees
Big picture, FinCEN expects financial institutions to tailor their AML programs to suit each MRB’s individual risk profile. If they follow FinCEN’s guidance and comply with every state law in which they do business, FinCEN in effect has implied that financial institutions may service MRBs. Despite the FinCEN guidance, banks and other financial institutions still must face the expectations of their direct regulators, such as the Office of the Comptroller of the Currency or the FDIC, which can range from neutral at best to overtly hostile to cannabis banking. For example, in June, 2020, the Chair of the FDIC conducted an interview where she explained the challenge of threading the needle between state and federal policies. However, at least one direct regulator, the National Credit Union Administration (NCUA), has stated that it will not sanction federally-chartered credit unions for working with state-legal marijuana-related businesses.
Each financial institution therefore must decide for itself whether to engage in this risky business. As of June 30, 2020, FinCEN estimated in the chart provided below that 695 depository institutions, including 185 credit unions, were providing banking services to MRBs. Although this number has been increasing over time, it may be artificially high because it could include institutions that ultimately rejected potential cannabis customers after filing a SAR.
There has been a slow but steady increase in financial institutions that engage with MRBs. That said, with thousands of banks and credit unions in the U.S., it is apparent that only a small percentage are willing to engage with MRBs—showing serious reticence among financial institutions overall. Given the serious regulatory burden that any financial institution must undertake to lawfully enter this space, this should come as no surprise.
It is no secret that federal black letter law is at odds with the state and local legislation that has sought to legalize and legitimize the marijuana industry. As such, this ongoing federal-state interplay is the source of a great deal of confusion from industry stakeholders, and corresponding congressional efforts to clarify it. In 2019, the Secure and Fair Enforcement (SAFE) Banking Act was introduced to align federal and state laws concerning MRBs and to ease their access to banking services. While the SAFE Banking Act had a great deal of bipartisan momentum in the House, it failed to pass through the Senate. This year, the Health and Economic Recovery Omnibus Emergency Solutions Act (HEROES Act), passed by the House on May 15, incorporated the SAFE Banking Act. However, the HEROES Act was “dead on arrival” in the Senate. With a new administration, we will likely see continued efforts at creating a sensible marijuana policy on the federal level. What remains unclear is whether any of those efforts will finally succeed.