United States: Legalized Marijuana Guidance Leaves Some Banks Dazed and Confused

Last Updated: February 22 2014
Article by Travis P. Nelson

Most Read Contributor in United States, October 2017

Last week, the Financial Crimes Enforcement Network ("FinCEN") issued new guidance in response to several states passing legislation to legalize marijuana for medical purposes, and in some states, for recreational purposes as well. This has left many financial institutions scratching their heads as to how to comply with the Bank Secrecy Act ("BSA"), which requires institutions to conduct due diligence on their customers (Customer Identification Programs), and to report suspicious activity that may be indicative of criminal activity (Suspicious Activity Reports). According to a recent USA Today online posting, 20 states plus the District of Columbia have enacted laws that allow people to use medical marijuana with a doctor's recommendation. Two states – Colorado and Washington – have legalized marijuana for recreational use as well.

Two key aspects of BSA compliance are the customer identification program ("CIP") and suspicious activity reporting ("SAR"). All banks must have a written CIP, see, e.g., 12 C.F.R. § 21.21 (for national banks), and are required to implement a written CIP that is appropriate for the institutions' size and type of business, and that includes certain minimum requirements. The CIP is intended to enable an institution to form a reasonable belief that it knows the true identity of each customer. The CIP must include account opening procedures, and reasonable and practical risk-based procedures for verifying the identity of each customer. If an institution cannot verify the identity of its customer, or concludes that its customer is attempting to open an account at the institution in order to further criminal activity, then the institution should decline to open the account.

The second key aspect of BSA compliance is SAR reporting. Banks are required by federal regulations to file a SAR report on: (a) criminal violations involving insider abuse in any amount; (b) criminal violations aggregating $5,000 or more when the suspect can be identified; (c) criminal violations aggregating $25,000 or more regardless of a potential suspect; and (d) transactions conducted or attempted by, at, or through the bank (or an affiliate) and aggregating $5,000 or more, if the bank or affiliate knows, suspects, or has reason to suspect that the transaction: (i) may involve potential money laundering or other illegal activity (e.g., terrorism financing), (ii) is designed to evade the BSA or its implementing regulations, or (iii) has no business or apparent lawful purpose, or is not the type of transaction that the particular customer would normally be expected to engage in, and the bank knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction. See, e.g., 12 C.F.R. § 21.11 (national banks).

Under federal law, narcotics and controlled substances are generally prosecuted under the Controlled Substances Act ("CSA"). 21 U.S.C. § 801 et seq. This provision makes it illegal to "manufacture, distribute or dispense, or possess with intent to manufacture, distribute or dispense, a controlled substance." 20 U.S.C. § 841(a)(1). Controlled substances include marijuana. 21 C.F.R. § 1308.11. Those engaged in a "continuing criminal enterprise" of drug-related activity can be subject to substantial fines and imprisonment. 21 U.S.C. § 848.

Despite the fact that the sale and distribution of marijuana is very clearly prohibited under federal law, with the passage of marijuana legalization legislation in several states, financial institutions are left with the question of how to treat marijuana businesses that are operating legally under state law, but in violation of federal criminal law. In order to address this potential confusion, FinCEN has issued BSA Expectations Regarding Marijuana-Related Businesses, FIN 2014-G001 (Feb. 14, 2014) (the "Guidance"). While acknowledging that the CSA "makes it illegal under federal law to manufacture, distribute, or dispense marijuana," and that Congress has made a "determination that marijuana is a dangerous drug," Guidance pg. 1, the Guidance provides a framework for institutions to adhere to their BSA responsibilities, while providing financial services to marijuana-related businesses. Rather than strict adherence to federal law, the Guidance advises institutions to take a risk- or policy-based approach to self-policing for customers engaged in marijuana-related activity.

The Guidance notes that "the decision to open, close, or refuse any particular account or relationship should be made by each financial institution based on a number of factors specific to that institution." Guidance pg. 2. FinCEN offers certain factors that institutions should consider in evaluating the risk of providing financial services to marijuana-related businesses as part of the institution's due diligence review: "(i) verifying with the appropriate state authorities whether the business is duly licensed and registered; (ii) reviewing the license application (and related documentation) submitted by the business for obtaining a state license to operate its marijuana-related business; (iii) requesting from state licensing and enforcement authorities available information about the business and related parties; (iv) developing 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 (e.g., medical versus recreational customers); (v) ongoing monitoring of publicly available sources for adverse information about the business and related parties; (vi) ongoing monitoring for suspicious activity, including for any of the red flags described in this guidance; and (vii) refreshing information obtained as part of customer due diligence on a periodic basis and commensurate with the risk." Guidance pg. 2.

Institutions are also advised to consider whether its customers' marijuana business activities implicate any of the enforcement policies set forth by the Justice Department in a memorandum issued by Deputy Attorney General James Cole August 29, 2013 ("Cole Memorandum"). See http://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf. These policy objectives direct U.S. Attorneys to target higher-priority marijuana activity, such as distribution to minors, use of profits from sales of marijuana to fund gang activity, preventing the use of firearms or other violence in the growth of marijuana, preventing "drugged driving."

With respect to SAR filing, the Guidance creates a three-tiered marijuana-specific reporting approach – "Marijuana Limited," "Marijuana Priority," and "Marijuana Termination." Under a Marijuana Limited filing, where none of the Cole Memorandum's enforcement priorities is implicated, and the institution does not find any other criminal activity, institutions are expected to file a SAR, but use the term "Marijuana Limited" in the narrative section in Part V of the SAR form. Where an institution determines that a marijuana business is engaging in activities that do implicate one of the Cole Memorandum's enforcement priorities, the institution is expected to file a complete SAR, with a detailed narrative that uses the term "Marijuana Priority" in Part V. Where an institution "deems it necessary to terminate a relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program," Guidance pg. 4, the institution is expected to file a standard SAR, with the term "Marijuana Termination" in the Part V narrative. In termination cases, where the financial institution becomes aware that the marijuana-related business seeks to move to a second financial institution, FinCEN urges the first institution to use Section 314(b) voluntary information-sharing (if it qualifies) to alert the second financial institution of potential illegal activity.

The Guidance also provides red flags for institutions to distinguish priority SARs, and notes that currency transaction reporting requirements apply to marijuana businesses just as they would in any other context.

Despite the above attempts to provide direction and clarity for financial institutions in states where the sale of marijuana has been legalized, some in the banking industry remain unconvinced. According to a recent Wall Street Journal report, some of the nation's largest banks have existing policies not to provide banking services to marijuana businesses. See "Banks to be Allowed to do Business With Marijuana Dispensaries," Andrew Grossman, Wall Street Journal (Feb. 14, 2014). Frank Keating, president of the American Bankers Association, has said that the Guidance "doesn't alter the underlying challenge for banks," and that: "As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions." Id. Sen. Charles Grassley of Iowa, the ranking Republican on the Senate Judiciary Committee, has called the Cole Memorandum "encouraging an improper use of prosecutorial discretion." Id.

The American Bankers Association has expressed further skepticism that mere guidance will give financial institutions the level of comfort required to open themselves up to marijuana businesses. According to the Association, "Because marijuana is illegal under federal statute, guidance alone isn't enough. There's a great deal of guidance that banks would want to see in terms of banking with these types of businesses but guidance alone doesn't change the fundamental prohibition. In order for banks to be comfortable banking marijuana businesses, the federal statute must be changed by Congress. It's also important to recognize that while guidance for marijuana businesses might help, guidance also can be changed overnight. Similarly, even though regulatory modifications would be less subject to change, regulations cannot overturn federal statute – only Congress can change the law. The only way to eliminate the risk of criminal prosecution for banks is if Congress changes federal statute."

One possible legislative remedy is currently pending in Congress – the Marijuana Businesses Access to Banking Act of 2013 (H.R. 2652) – sponsored by Rep. Perlmutter (CO – 7). This bill would do the following, among other things: (a) prohibit a federal banking regulator from terminating an institution's deposit insurance, or prohibiting, penalizing, or otherwise discouraging an institution, based on the institution's services to marijuana-related legitimate businesses; (b) prohibit a federal banking regulator from recommending, motivating, or encouraging a financial institution not to offer services to an operator of a marijuana-related legitimate businesses; (c) prohibit a federal banking regulator from taking any action on a loan to an owner or operator of a marijuana-related legitimate business or real estate related to such business; (d) grant immunity from federal prosecution or investigation to an institution providing services to marijuana-related legitimate businesses; and (e) prohibit the Treasury Department from requiring reporting (e.g., SARs) solely because the transaction involves a marijuana-related legitimate business. These provisions are designed to prevent federal regulators from interfering with marijuana-related legitimate businesses merely because they are in that industry. However, the bill would not prevent regulators from taking action based on such businesses' involvement in other criminal activity. Moreover, the bill would not prevent financial institutions from determining on their own that involvement with such businesses is too risky. The bill has 27 co sponsors, but has not made it out of committee.

In considering whether to provide financial services to marijuana-related businesses in states where it has been legalized, institutions must consider not only the policies and guidance outlined above, but also the substantial reputational risk management that involvement with such businesses carries. While there are strong opinions underlying the marijuana legalization debate, both sides would likely agree that providing banking services to such businesses carries heightened compliance and reputational risk. Moreover, while the Cole Memorandum and the FinCEN Guidance have attempted to provide direction for institutions in how to deal with marijuana-related businesses in a manner that comports with safety and soundness, and complies with the BSA, it also puts institutions in the potentially awkward and uncertain position of having to apply federal law enforcement policies and priorities to their customers' activities. Rather than the clarity provided by a policy that absolutely prohibits involvement with customers engaged in illegal drug activities, the FinCEN Guidance places on institutions the burden of having to make subjective judgment calls about the nature and risk of its customers' activities in a decidedly hazy area. While this sort of risk assessment function is nothing new to financial institutions, when such is being applied against the backdrop of clear anti-drug statutes – and a public that is increasingly scrutinizing financial institutions' activities and third-party relationships – many institutions may find any prospect of serving this new market simply go up in smoke.

Travis P. Nelson is a member of the Financial Industry Group, resident in the firm's Princeton and Washington, D.C. offices. Mr. Nelson is a former Enforcement Counsel with the Office of the Comptroller of the Currency, U.S. Treasury Department; a former Congressional staffer; and a frequent lecturer on financial services examination and enforcement issues. Mr. Nelson is a co-leader of the firm's Financial Institutions Enforcement and Investigations Task Force, and regularly advises banks and money transmitters on compliance with BSA/AML issues.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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