To serve your community or sit in jail: is there any reward to this banking risk?

March 2018 | SPECIAL REPORT: MANAGING RISK

Financier Worldwide Magazine

March 2018 Issue

US banks exist to provide financial services to the community they serve, be it local, statewide, regional or national. Bank charters are granted and continuously monitored by regulators to ensure that banks fulfil the needs of their communities. What happens when an industry has a desperate need for financial services but the local bank shuts its doors to providing help, even though that industry is operating legally and in compliance with all state and local laws? Does the bank provide services to that industry at the risk of being subject to regulatory enforcement actions or even subjecting management to potential criminal indictments? Such is the conundrum facing bank financing of the cannabis industry.

State participation in the cannabis industry

As of 1 February 2018, the National Council of State Legislators determined that “a total of 29 states, the District of Columbia, Guam and Puerto Rico now allow for comprehensive public medical marijuana and cannabis programmes”. Of these states, nine of them allow the use of cannabis for adult recreational purposes. An additional “17 states allow use of ‘low THC, high cannabidiol (CBD)’ products for medical reasons in limited situations or as a legal defence”. Of the 50 states and territories, 46 states allow the use of some product derived from the cannabis plant.

While state laws have allowed the use of cannabis products in various forms, federal law provides that marijuana remains classified as a Schedule I substance under the Controlled Substances Act (CSA), where Schedule I substances are considered to have a high potential for dependency and no accepted medical use, making distribution of marijuana a federal offence. While the manufacturing, dispensing and use of these products are federally prohibited, the number of states that have enacted laws governing the use, dispensing and growing of cannabis products within their borders has increased. Consequently, the Department of Justice (DOJ) has issued policy statements over the years providing guidance to federal law enforcement officers as to how they should proceed in enforcing the CSA.

DOJ position

The DOJ issued guidance to US attorneys in 2013, and updated it in 2014, wherein it instructed department attorneys and law enforcement to focus on the eight priorities listed below in enforcing the CSA against marijuana-related conduct.

First, preventing the distribution of marijuana to minors. Second, preventing revenue from the sale of marijuana from going to criminal enterprises, gangs and cartels. Third, preventing the diversion of marijuana from states where it is legal under state law in some form to other states. Fourth, preventing state-authorised marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity. Fifth, preventing violence and the use of firearms in the cultivation and distribution of marijuana. Sixth, preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use. Seventh, preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands. Finally, preventing marijuana possession or use on federal property.

In implementing the DOJ policy in enforcing the CSA, no safe harbour was given to anyone associated with the cannabis industry. However, if none of the DOJ stated priorities existed in a state’s implementation of its cannabis programme, a US attorney had discretion to use its resources to enforce other more pressing criminal laws.

FinCEN position

On the same day the DOJ issued its updated guidance, in a coordinated effort, the Financial Crimes Enforcement Network (FinCEN) issued its “guidance to clarify Bank Secrecy Act (BSA) expectations for financial institutions seeking to provide services to marijuana-related businesses”. It clarified “how financial institutions can provide services to marijuana-related businesses consistent with their BSA obligations, and aligns the information provided by financial institutions in BSA reports with federal and state law enforcement priorities”.

Prudential regulators position

On 13 August 2014, the four federal banking regulators responded to a request from the governor of Washington to provide guidance to examiners, banks and credit unions regarding policies enunciated by the DOJ and FinCEN. The regulators stated that they “incorporate guidance issued by FinCEN concerning the BSA into our supervisory process, and are currently reviewing the recent FinCEN guidance, as well as the DOJ guidance, for inclusion” in their examination manuals. They also responded that further clarity from Congress would provide greater legal certainty for both marijuana-related businesses and banks and credit unions. The regulators’ position has not changed to this date.

Notwithstanding these policy pronouncements of the DOJ and FinCEN or the position of the regulators, no safe harbour was given to financial institutions that chose to finance one or more elements of the cannabis industry. Nonetheless, it has been reported that approximately 400 banks and credit unions have decided that it was in the best interest of their communities to assume this risk and provide financing to the cannabis industry that was legal in their state, even though it was prohibited under federal law.

DOJ change

For those financial institutions assisting the industry and for others who were considering engaging in financing the cannabis industry, the risk of undertaking this activity must now be reassessed. On 4 January 2018, attorney general Jeff Sessions issued a Memorandum (Sessions Memorandum) that rescinded the DOJ guidance on enforcing the CSA against marijuana-related conduct.

In doing so, Mr Sessions stated in a press release: “The Department of Justice today issued a memo on federal marijuana enforcement policy announcing a return to the rule of law and the rescission of previous guidance documents”. The Sessions Memorandum states that the principles that guide federal prosecution “require federal prosecutors deciding which cases to prosecute to weigh all relevant considerations, including federal law enforcement priorities set by the attorney general, the seriousness of the crime, the deterrent effect of criminal prosecution, and the cumulative impact of particular crimes on the community”. It further states that prosecutorial discretion still exists in that “this memorandum is intended solely as a guide to the exercise of investigative and prosecutorial discretion in accordance with all applicable laws, regulations, and appropriations”.

As a result of the Sessions Memorandum, will US attorneys pursue violations of the CSA? Will they use prosecutorial discretion in enforcing any CSA violations by continuing to follow the principles enunciated in the earlier DOJ guidance? Some US attorneys already have stated that their prosecutorial decisions on cannabis-related industry activities will not change in light of the Sessions Memorandum. The Sessions Memorandum appears to have created more confusion than clarity regarding bringing either civil or criminal actions against banks and credit unions that provide financial services to the cannabis industry.

Problem and solutions

How can financial institutions serve their community by providing financial services to an industry that is legally authorised to exist under state law? The issue is that if banks and credit unions do not provide financial services to the cannabis industry, resulting in it being a cash only business, the probability of increased state and federal criminal behaviour exists. Some estimate that North American sales of cannabis products will exceed $20bn by 2021. A study by the California Treasurer projects sales of $7.6bn in California alone by 2020, producing $1bn in new tax revenue.

The cannabis industry authorised by new state laws will only grow. The danger of it being a cash-only business is obvious. Billions of dollars in cash transactions cannot be the answer to financing the growing cannabis industry. Organised crime, money laundering, illegal sales and tax evasion are only a few of the expected outcomes if financial institutions do not provide financial services to this industry, including access to the payment system.

What can be done so that financial institutions can reduce and eliminate the risks currently associated with serving this industry? The attorney general has the power to propose a rule that would remove cannabis products from Schedule I under the CSA, but it is unlikely that this attorney general would do so given his current view of the industry. The Treasury Department has a vested interest in preventing money laundering, fraud and tax evasion that would result from a cash-only cannabis industry, but it has no prosecutorial authority to enforce violations of the CSA.

In testimony before the Congress on 6 February 2018, treasury secretary Mnuchin stated that he was not consulted prior to the issuance of the Sessions Memorandum, but Treasury now is working with the DOJ. The FinCEN guidance still is effective, but is under review. He further stated that "I assure you that we don't want bags of cash. We want to make sure that we can collect our necessary taxes and other things".

In response to a question about the problem of a cash only cannabis industry, secretary Mnuchin stated “We are looking at what Justice has done. And again, as I said, we're sensitive to the issue of dealing with the public safety issue and also making sure that the IRS and others have ways of collecting taxes without taking in cash".

Some states are exploring the creation of a state-owned financial entity that could make loans to businesses within the state, which could include participants in the cannabis industry, but payment system issues would have to be resolved. Financial institutions also could continue to assume the risks of financing the industry, by adhering to the principles articulated in prior DOJ guidance with the hope that federal prosecutors would use their discretion and not prosecute for violations of the CSA.

The best solution to eliminate the risk of providing financial services to the cannabis industry was suggested by the prudential regulators a few years ago. They suggested that further clarity from Congress would provide greater legal certainty for both marijuana-related businesses and banks and credit unions. The current problem stems from a conflict with the provisions of the Controlled Substances Act and newly enacted state laws allowing the use of cannabis products. The 46 states that currently allow some use of cannabis products are not going to repeal those laws.

The most practical solution is to amend the CSA to eliminate the risks involved. A precedent already has been established by enacting federal laws that prohibit the DOJ from using any appropriated funds to prevent states from implementing its own laws that authorise the use, distribution, possession or cultivation of medical marijuana. Congress can provide greater clarity regarding the role that financial institutions can play in providing services to the cannabis industry.

A legislative fix to the problem has been introduced in Congress and currently has 78 House co-sponsors and 14 Senate co-sponsors. Secretary Mnuchin has pledged to work with OMB director Mulvaney (who sponsored a similar bill when he was in Congress) to develop the Administration’s position on the proposed legislation.

As 46 states already are invested to some degree in allowing cannabis products to be used, the number of votes in Congress exist that would allow changes to be made. As with all legislative actions, however, is there the will in Congress to make the change necessary to eliminate the risks currently inhibiting financial institutions from fully serving their communities?

Thomas Brooks is of counsel to Clark Hill PLC. He can be contacted on +1 (202) 552 2356 or by email: tbrooks@clarkhill.com.

Thomas Brooks

Clark Hill PLC

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