The Cannabis Conundrum

Ten years ago, who would have thought that more than half of U.S. states would legalize medical marijuana, and nine would legalize recreational use? More than $8 billion of legalized North American sales in 2017 likely will blossom in the coming years, as Nevada, Massachusetts and the most populous state, California, recently passed laws allowing recreational sales, according to The Arcview Group.

The growth of cannabis commerce has left one critical party out of the picture: the federal government, which regulates the banking industry, and still considers marijuana a Schedule I drug under the Controlled Substances Act. Making matters worse for the industry, Attorney General Jeff Sessions in January rescinded former Attorney General James M. Cole’s prosecutorial guidance, known as the Cole memos. The memos, both in 2013 and 2014, had guided federal prosecutors away from prosecuting marijuana in states that had legalized the drug as long as individuals and organizations met certain parameters, such as not selling to minors.

Banks are responsible for complying with know-your-customer rules, for reporting suspicious activity to the federal government, and complying with the Bank Secrecy Act, which forbids money laundering. Not doing so results in hefty fines for the bank and possible criminal prosecution. But a few hardy souls in the financial sector have continued to bank the industry, unfazed by the attorney general’s action.

“With the amount of revenue and cash that’s generated with that type of business, it makes no sense to not put them in the banking system,” says Neil Zick, president and CEO of Twin City Bank, a $55 million asset bank in Longview, Washington, which has been banking cannabis businesses for about four years. He says a lot of management teams and boards don’t want to serve the industry because it’s a moral issue for them, or they don’t want the hassles of the compliance. Still, there’s evidence that a growing number of banks are providing banking services to the industry, whether knowingly or not.

The Financial Crimes Enforcement Network, or FinCEN, a division of the U.S. Treasury charged with combating money laundering and the illicit use of the U.S. financial system, has reported that 400 financial institutions as of September 2017 were actively banking the industry, up from 318 in October 2016. The agency gets this information from required filings called Suspicious Activity Reports, or SARs. Banks and credit unions sent some 39,000 of these filings since the second quarter of 2014 related to marijuana, the majority of them labeled “marijuana limited,” meaning the financial institutions believed the business “does not raise any red flags as defined in the Cole Memo,” and is compliant with state regulations. Since the attorney general’s rescission of the Cole memo, FinCEN has said that it continues to refer financial institutions to its 2014 guidance, which references the Cole memo.

Steven Kemmerling, founder and CEO of MRB Monitor, which tracks the marijuana industry, says he thinks 400 is a high number, and he only knows about two dozen financial institutions that are intentionally banking marijuana businesses. “I also think all banks bank marijuana, but they don’t know it,” he says. An investigation he did based on state licensing records found that some of the biggest banks in the country bank the beneficial owners of cannabis businesses, whether the banks knew about the marijuana businesses or not. Providing banking services to beneficial owners, or even landlords, electricians, CPAs or attorneys who service marijuana-related businesses could require SARs under federal law. One landlord had a marijuana retailer paying him $30,000 per month in rent, and after a few times hauling a bag of $30,000 in cash to the bank, his bank turned him away, according to Kenneth Berke, cofounder of PayQwick, a cannabis compliance company and licensed money transmitter, who was able to solve the landlord’s cash problem.

Not everyone volunteers their connection to the cannabis trade, making it possible that some banks are missing them. Some retailers, for example, disguise the nature of their business, with names such as “alternative health solutions,” says Michelle Rutter, government relations manager for the National Cannabis Industry Association. Access to banking services, she says, is “definitely still a struggle.” Even Rutter’s trade organization had trouble getting basic financial services, such as a 401(k) plan for employees. Don Childears, the president and CEO of the Colorado Bankers Association, says he’s aware of 20 banks in the state knowingly banking marijuana businesses, but that the rescission of the Cole memo may make bankers more nervous, especially if they were just thinking about setting up a compliance program to actively bank the industry. “I can’t name a lawyer who would tell a bank: Just go do this,” he says.

Alan Abel, the global anti-money laundering practice leader for Crowe Horwath LLP, says he doesn’t know of any bank that would willingly bank growers or retailers. Banks have to set up elaborate ways to monitor and report possibly suspicious activity within all their business units, and independently test the effectiveness of that program. Although risk management systems have become more sophisticated with the help of technology, there’s also the strategic risks to consider. What’s the sustainability of this business? Will the Justice Department be lenient for a year or two, and then change gears in year three?

Some banks and credit unions have decided that they can take on the risk, and make a profit from it. Zick said his board approved the bank’s program with the initial limit of 10 marijuana-related banking customers, and the bank now has 50 of them. It only provides deposit services, not wanting the risk of lending to a space where collateral could be seized by the federal government. Twin City uses the company Banker’s Toolbox and its software to monitor activity for BSA compliance, so the biggest additional workload is the filing of SARs. Each of the 50 cannabis customers necessitate a new SAR quarterly. Twin City Bank is state chartered, but it also is examined by the Federal Deposit Insurance Corp. So far, regulatory exams haven’t brought up any major problems, and the bank’s flat fee of $500 per month per account is helping make the banking of marijuana profitable, Zick says.

Salal Credit Union in Seattle also services the cannabis industry, but charges fees to customers based on the number of transactions and the type of business. Its lowest fee is $50 per month for an ancillary business account, such as one for an electrician or a CPA with marijuana-related clients.

The fees help pay for the significant level of due diligence and monitoring required for each account, says Carmella Houston, vice president of business services at Salal. Large amounts of cash transactions must be reported to the federal government as well, and “cash is still the primary source for selling to end consumers,” she says. Visa and Mastercard won’t serve the marijuana industry. Her advice to financial institutions thinking about banking this business is to make sure they work closely with state and federal regulators, get to know their customers or members, understand the regulations and monitor customers closely. Also, set up a clear exit strategy in case they need to shut down accounts, put concentration limits in place and make sure they have a strong compliance program. “It’s not an industry that you want to dabble in,” she says. “You really need to understand it well.”

The state of Washington makes it easier for institutions such as Salal. “[The Washington State Department of Financial Institutions] went out to their banks and said, ‘We want banks to bank this industry,” says Berke. Applications on licensed enterprises is public information. “The licensee’s information can easily be obtained,” he says. The state also tracks all sales using barcodes, from seed to sale to a consumer, in an attempt to tax the business but also ensure that marijuana grown in the state isn’t shipped out. PayQwick and banks can use this information to monitor compliance with state law and FinCEN guidance.

Not all states have the same system or availability of licensee information, leading to disparate access to banking services in the different states. For instance, Oregon and Colorado have more privacy protections written into their laws, so access to state sales records on marijuana businesses is more cumbersome. California prior to January had county-by-county rules regarding the sale of medical marijuana, but no centralized state licensing and sales data. The California Cannabis Authority, a group formed under the auspices of the California State Association of Counties, is working to develop such a database now that recreational sales are legal statewide. The group wants financial institutions to tap into the data without making the information available for the public, to protect proprietary and competitive information, says Cara Martinson, the state association’s federal affairs manager.

For now, it’s primarily state chartered banks and credit unions such as Salal who feel most comfortable about banking the marijuana industry, not federally chartered banks. Banks are naturally risk-averse, and federal regulators make sure they stay that way. For the banking industry to become more comfortable with marijuana clients as business customers, there probably needs to be legislation from the federal government. “Everyone is pretty much resolved that only Congress can solve this,” says Childears.