For years, the cornerstone of a strong Bank Secrecy Act/anti-money laundering (BSA/AML) program was its ability to detect and prevent the sale of illicit narcotics by identifying revenues derived from criminal enterprise. With the legalization of retail marijuana in Colorado and Washington, a cautious experiment is currently underway with strong implications for law enforcement and the financial sector. Building upon the emergence of medical marijuana, available to varying degrees in 18 other states1 plus the District of Columbia, this evolution of the financial crimes landscape has created a transition period that contains potential for both risk and reward.
The Department of Justice's (DOJ) release of guidance2 regarding marijuana enforcement in August 29, 2013 signaled a shift in focus for federal law enforcement. Commonly referred to as the Cole Memo, the guidance asserts that in states where a strong and effective regulatory system exists, the DOJ will not prosecute unless there is a suspicion that one of the eight federal enforcement priorities has been violated. Effectively the DOJ has respected the right of the states to govern their internal affairs so long as their regulatory regimes do not interfere with federal mandates, which 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 the 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.
Following the lead of the DOJ, the Financial Crimes Enforcement Network (FinCEN) released guidance (FIN-2014-G001)3 on February 14, 2014 that takes this presumption of state independence one step further by explicitly calling to enhance the availability of financial services for, and the financial transparency of, marijuana-related businesses. While respecting the confines of the federal enforcement priorities, FinCEN provides its support for the banking of cash-intensive marijuana businesses and clarifies expectations regarding due diligence and suspicious activity reporting for this industry.
Financial institutions will still be required to file suspicious activity reports (SARs) for all marijuana businesses, but they will now be asked to distinguish between "Marijuana Limited" and "Marijuana Suspicious" businesses. This distinction will be based upon enhanced due diligence conducted by the financial institution to determine whether or not the business is engaged in any of the eight federal enforcement priorities. If the answer is yes, then the SAR filing will be considered suspicious. If the answer is no, then the SAR filing will be considered limited. "Marijuana Limited" SAR filings will be in theory less onerous because they only require the names and addresses of the subject and related parties, as well as an assertion that no additional suspicious activity has been found aside from their association with an authorized marijuana-related business. However, banks will still be on the hook for continuous SAR filings so long as the customer continues to conduct marijuana-related business.
Better the devil you know than the devil you do not
However convoluted the guidance may seem, there is clear intent to advance the incorporation of legal marijuana businesses into the financial system. This is based on a pragmatic assessment by the federal government that state legalization is outside of their control and unbanked cash-intensive businesses pose greater risk to financial stability than risky businesses backed by trusted financial providers. This is the same rationale that allows for the continuation of other industries at high risk for money laundering, such as casinos, money services businesses (MSBs), and private banking. An additional benefit to incorporating marijuana-related businesses into the financial system is that it provides FinCEN with actionable data on an industry that has long lacked transparency. Understanding their revenue streams allows the federal government to track industry trends and combat illicit narcotics sales in other jurisdictions. This information is invaluable for preventing threats to public safety, health, and other law enforcement concerns. In other words, better the devil you know than the devil you do not.
Skeptics point out that additional due diligence burdens and more nuanced SAR filing requirements are not effective carrots to entice banks to move marijuana businesses out of the financial shadows, particularly given the risks associated with this nascent industry. Colorado and Washington may be carefully laying the regulatory groundwork for an effective system of controls over the next year, but it remains to be seen how far and how fast support for retail marijuana will spread. Large, national banks are unlikely to explore the possibility of banking an industry that is currently constrained by state borders and fraught with legal dangers. The reality is that the retail and medical industries will be considered a high-risk investment so long as marijuana remains on the Controlled Substances Act (CSA).4
Agile banks with strong compliance programs stand to gain by providing services to this industry
While many financial institutions may view marijuana-related businesses as a risky endeavor beyond their appetite, others view it as an opportunity to achieve first-mover advantage in a high growth industry.5 With more than $14 million in revenues generated in January 2014 by a mere 59 newly licensed dispensaries in the state of Colorado, agile banks with strong compliance programs stand to gain by providing services to this industry. Even as sales taper off from the initial excitement, more dispensaries are coming online to meet demand. As of March 2014, nearly 150 retail dispensaries have been licensed in Colorado.6 It is unlikely that FinCEN expects all banks to participate, but the roadmap they have provided has sufficient detail to satisfy institutions who are less risk-averse. The recommended due diligence focuses on verifying the validity of the state license or application; establishing and maintaining a customer profile based on available information for the business and related parties; and ongoing monitoring and due diligence. Many of these requirements are no more burdensome than those required of MSBs or money transmitters. The enormous amount of scrutiny being placed on the groundbreaking regulatory process ensures that a significant amount of due diligence has already been conducted by the state prior to the issuance of a license.
The most problematic component of the requisite guidelines is not the increased administrative burden of SAR filings or implementation of standard enhanced due diligence, but rather the need to develop an understanding of the normal and expected activity for the business, including the types of products to be sold and the type of customers to be served. The Colorado Department of Revenue does not expect clear patterns to emerge before mid-year, at which point government officials will have some insight into the volume, if not the transactional composition, of the industry.7 Herein lays the Catch-22 of the FinCEN guidance — financial institutions will not be punished for banking "Marijuana Limited" businesses, but without first banking these businesses they will not have the baseline data needed to establish whether or not the activity is suspicious according to the criteria outlined in the Cole Memo.
Ultimately, the success or failure of this audacious experiment will be based upon a combination of regulatory finesse, legal clarity, and the collaborative exchange of information. Financial institutions with robust compliance programs and the proper risk appetite will benefit from approaching this with cautious optimism, while continuing to push for clear legal protections for banking marijuana-related businesses. Likewise, consumer advocates and cannabis trade associations will benefit from establishing member guidelines for AML, and promoting transparency on typical transaction patterns. Coordinated efforts and a commitment to responsible banking will encourage law enforcement to focus their resources on issues that pose a greater threat to the stability of the financial system.
- Alaska, Arizona, California, Connecticut, Delaware, Hawaii, Illinois, Maine, Massachusetts, Michigan,Montana, Nevada, New Hampshire, New Jersey, New Mexico, Oregon, Rhode Island, and Vermont.