Part One of a Three-Part Series
We begin this week with a three-part series on banking and the marijuana industry. States continue to pass medical and recreational use marijuana legislation despite that the fact that the substance remains classified as a Schedule I drug subject to the federal Controlled Substances Act. Thus, the medical and recreational marijuana industries continue to struggle with access to banking and credit, and those who attempt to serve these industries find themselves subject to the Bank Secrecy Act (“BSA”) and the criminal money laundering provisions. As we will detail this week, the struggle for financial institutions attempting to service the marijuana industry comes not only from the BSA and AML provisions, but in other forms. We start this week with an overview of the guidance documents issued by the federal government which identify the enforcement priorities and also potential windows for financial institutions to service the marijuana industry. We will follow up with a discussion of a recent federal court decision illustrating the practical difficulties of squaring the prohibitions of the federal drug laws with permissive state laws and the federal guidance documents. We will conclude with an exploration of how federal agencies beyond the Department of Justice (“DOJ”) and the Financial Crimes Enforcement Network (“FinCEN”), such as the Securities and Exchange Commission (“SEC”), can further muddy these waters by staking out their own regulatory and enforcement priorities. –Priya Roy
The DOJ Cole Memo
The future of federal enforcement is difficult to predict. Specifically, it is unclear whether and to what extent the Trump Administration will uphold recommendations previously issued by the DOJ in the “Cole Memo,” detailed below, regarding state-legalized marijuana activity. Attorney General Sessions, during his tenure in the Senate, is on record as saying that “the Department of Justice needs to be clear . . . [that] marijuana is not the kind of thing that ought to be legalized.” By contrast, the President himself, at several points during the 2016 campaign, endorsed a “states’ rights” approach to marijuana legalization. In the past six months, the Attorney General’s statements on marijuana policy have reflected an uneasy truce between these two conflicting views. For instance, in late February, Attorney General Sessions referred to the inefficacy of state regulatory schemes and the need for a comprehensive review as a basis for federal adoption of “responsible policies.” In mid-March, however, he described the Cole Memo enforcement priorities as mostly “valid,” and acknowledged that financial and logistical constraints meant that the DOJ could not “go into a state and pick up the [enforcement] work” that state and local authorities have traditionally done.
First, some basics on non-binding federal policy regarding enforcement against State-authorized marijuana businesses: The Cole Memo is a memorandum issued by Deputy Attorney General James M. Cole on August 29, 2013, that describes DOJ’s enforcement priorities “in light of the trend of state ballot initiatives” legalizing medical and recreational marijuana possession and create regulatory schemes for its sale, production, and processing. The Cole Memo updated guidance (previously provided by the Department of Justice in October 2009 and June 2011) by explaining enforcement priorities by which to guide federal prosecutorial decisions. These eight “enforcement priorities” serve as a checklist for federal prosecutors in deciding whether and how to deal with marijuana-related activity:
- prevention of the distribution of marijuana to minors
- prevention of marijuana sales revenue from going to criminal organizations
- prevention of diversion of marijuana from “legalized” states to others
- prevention of legal marijuana activity as cover/pretext for illegal drug dealing or other crimes
- prevention of violence and firearms use associated with marijuana production and distribution
- prevention of “drugged driving” and other negative public health impacts
- prevention of marijuana production on public lands
- prevention of marijuana possession or use on federal property
Fundamentally, the DOJ notes, the guidance is based on an assumption that the state and local governments enacting marijuana legalization have robust regulatory and enforcement schemes in place. The federal government “may seek to challenge the regulatory structure itself” if it determines that state enforcement efforts are insufficient to protect against the harms addressed by the federal enforcement priorities.
The Memo also modified previous DOJ guidance regarding using the size of a marijuana-related operation as a reasonable proxy for assessment of whether federal enforcement priorities are implicated. The new guidance indicated that size alone should no longer serve as a proxy, but could be a relevant consideration in a case-by-case analysis in which all information and evidence is weighed, including “whether the operation is demonstrably in compliance with a strong and effective state regulatory system”.
Soon after the issuance of the Cole Memo, FinCEN, which exercises regulatory authority primarily under the legislative framework collectively referred to as the BSA, issued a memorandum entitled “BSA Expectations Regarding Marijuana-Related Businesses” (the “FinCEN Memo“). As a bureau of the Treasury Department, FinCEN is responsible for analyzing financial transactions and data in an effort to combat money laundering and other illicit uses of the financial system. This guidance was issued to clarify how financial institutions can provide services to marijuana-related businesses consistent with their BSA obligations.
Customer Due Diligence
The first key element of the FinCEN Memo is a checklist of the “customer due diligence” that financial institutions should engage in to assess the risk of providing services to such businesses:
- verification with appropriate state authorities that the 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
- comprehension of normal and expected activity of the business – products, types of customers, etc.
- ongoing monitoring of public sources for adverse information re: business and related parties
- ongoing monitoring for suspicious activity and “red flags”
- periodic updates of this information (with frequency to be “commensurate with the risk”)
- consideration of whether the marijuana-related business either implicates a Cole Memo priority or violates state law
Mandatory Filing of Suspicious Activity Reports
Because financial transactions involving a marijuana-related business generally would involve funds derived from activity prohibited under federal law, financial institutions working with such businesses are required to file a Suspicious Activity Reports (“SAR”). The FinCEN Memo provides guidance on which of three types of SARs to fill out so as to ensure that the reports are useful in enforcement of federal priorities:
- The financial institution should file a “Marijuana Limited” SAR if, based on its customer due diligence, it has determined that the business neither implicates a Cole Memo priority nor violates state law. The report should contain identifying information (names and addresses) of the subject and related parties, as well as a narrative section specifying that the sole reason for filing is the marijuana-related nature of the business and that no additional suspicious activity has been observed. The institution’s responsibilities do not stop there; it must also file continuing activity reports with the same information, as well as details about all deposits, withdrawals, and transfers connected to the account since the previous filing.
- The financial institution should file a “Marijuana Priority” SAR if, based on its customer due diligence, it holds the reasonable belief that the business implicates a Cole Memo priority or violates state law. The report should contain “comprehensive detail” about the subject and account: identifying information (names and addresses), details regarding the implicated enforcement priorities, and detailed financial records of the transactions involved in the suspicious activity.
- The financial institution should file a “Marijuana Termination” SAR if it deems it necessary to terminate the relationship with the marijuana-related business in order to be in compliance with its anti-money laundering program. The institution must provide a narrative noting the basis for the termination, and if possible is urged to use Section 314(b) voluntary information sharing to alert the business’ new financial service provider of potential illegal activity.
Ongoing Monitoring of “Red Flags”
A financial institution’s determination of which type of SAR to fill out and whether additional customer due diligence is required maybe influenced by the presence of one or more “red flags”. The FinCEN Memo provides a non-exhaustive list of “red flag” scenarios that indicate possible implication of a Cole Memo priority or violation of state law by a marijuana-related business. These include:
- various indicia of use of the business as a front to launder money
- an inability to produce satisfactory documentation of a license and other conformance with state law
- an inability to demonstrate a legitimate source of outside investments
- engagement in international or interstate activity
- excessive payments to managers or employees
- negative information in public records (criminal records or other connections to illicit activity) about owners or managers
Mandatory Filing of Currency Transaction Reports
The FinCEN Memo closes by affirming that financial institutions have to report currency transactions connected to marijuana-related businesses in the same manner as they would in any other context. Marijuana-related activity is not eligible for consideration for an exemption of currency transaction report obligations under 31 C.F.R. § 1020.315(b)(6), as it may not be treated as a non-listed business under 31 C.F.R. § 1020.315(e)(8).
The Regime in Action
Last month, FinCEN issued an update on Marijuana-Related Business with data from 2017 Q1. The report indicates that the number of depository institutions (banks and credit unions) actively providing banking services for marijuana-related businesses has increased from 285 in January 2016 to 368 in March 2017. Since the 2014 FinCEN memo outlining mandatory filings of SARs for such businesses, FinCEN has received over 28,000 such reports. In the first quarter of 2017, specifically, filings of “Marijuana Limited” SARs increased significantly, while “Marijuana Priority” and “Marijuana Termination” filings stayed relatively static. This suggests that, while more banks are taking on marijuana-related businesses as customers, there is not a corresponding increase in the amount of (observed) suspicious activity.
In our next post, we will discuss the practical effects of these DOJ and FinCEN guidance documents on industries attempting to serve marijuana-related businesses (“MRBs”), and how real-world “de-risking” activity by financial institutions and the involvement of other actors can overwhelm the general purpose of the guidance to enable MRBs to engage in traditional banking activity under certain circumstances.