ICT Views


Legalised marijuana prompts financial haze in the US

by: (Research and Development Manager) on

While the world’s attention was focused on Donald Trump winning the US election, seven American states were voting on matters that have dramatically changed the law in those regions.

What I’m talking about here is the legalisation of medical and recreational marijuana.

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As of the US election on November 8th, marijuana has been legalised for medical use in 28 states, with 8 of those states having legalised recreational marijuana. However, due to the Controlled Substances Act, marijuana is classed as a Schedule I drug.

This means that it either is considered to have a high potential for abuse, it isn’t currently accepted for medical use in the US and/or there is a lack of accepted safety for use. Marijuana’s classification as a Schedule I means it is illegal to possess, manufacture, distribute or dispense.

This is where the issue starts for the financial community. State law in those 28 states stipulates that marijuana is a legal substance and there are now hundreds of ‘marijuana related businesses’ (MRBs) in these states. MRBs are involved in anything from selling paraphernalia to growing marijuana and dispensing it.

MRBs operating in those states are conducting legitimate business and like any legitimate businesses, they need somewhere to deposit their earnings, accept credit/debit card transactions and make business payments (for instance paying wages or taxes). However, as the banking system in the US is under federal jurisdiction, banks cannot – technically – enable transactions for activity that subverts federal law. This is why hundreds of MRBs don’t have a bank account and are forced to deal solely in cash – which of course raises the spectre of additional risks around financial crime.

FinCEN Guidance

Given the growing amount of states legalising medical marijuana, the US Department of the Treasury Financial Crimes Enforcement Network (FinCEN) issued guidance in February 2014 on Bank Secrecy Act (BSA) expectations for financial institutions (FIs) wishing to provide services to MRBs. Specifically, FinCEN offered insight into how FIs can offer their services consistent with their Banking Secrecy Act (BSA) obligations.

LmusaarticleThis guidance advises that the decision to open, close or refuse any individual account/relationship should be made on a number of factors specific to that institution, which may include its individual business objectives, an assessment of the risks associated with offering a specific product/service, and its ability to manage this risk effectively.

In-depth customer due diligence (CDD) must be carried out when making this assessment. In other words, use a risk-based approach.

The FinCEN guidance was issued alongside a memorandum from the U.S. Department of Justice Deputy Attorney General James M. Cole (named the ‘Cole Memo’) which provided guidance to federal prosecutors regarding marijuana enforcement under the Controlled Substances Act.

The FinCEN guidance requires any FI that provides services to an MRB to file a suspicious activity report (SAR). This is because, in any circumstance, if an FI has knowledge or suspects that a transaction either involves funds derived from illegal activity under federal law, is designed to evade regulations under the BSA and/or lacks a lawful or business purpose, a SAR must be filed. Technically, under federal law, MRBs are doing at least one of these, therefore a SAR must be raised.  However there are three categories of SAR:

  • ‘Marijuana Limited’ – for MRBs that haven’t violated state law or any of the priorities from the Cole Memo
  • ‘Marijuana Priority’ – filed when a FI reasonably believes that an MRB has violated state law or any priority from the Cole Memo
  • ‘Marijuana Termination’ – this SAR is filed if an FI finds it necessary to terminate a relationship with an MRB to uphold an effective AML program.

FinCEN also advised on possible red flags that might result in an FI filing a ‘Priority’ SAR.

This guidance is useful, but in practice not only does such advice make dealing with MRBs expensive and time consuming for FIs, but it also does little to accommodate the fact such guidelines are not actual laws or legislation (banking MRBs is still technically federally illegal). The Cole Memo in particular, which suggested regulators and law enforcement have the opportunity to allow some discretion in their supervision - indicating that prosecuting banks serving MRBs isn’t a priority, and that law enforcement won’t likely pursue compliant FIs if they adhere to a very strict set of rules.

 What remains however, is the fact that there is no best practise on the burgeoning legal marijuana industry. This has led to a lot of FIs concluding that the risk of dealing with MRBs is simply not worth the reward.

Is there a solution?

With the likes of IBM and the Bank of America experimenting with finance inspired by Bitcoin, blockchain start-ups are looking to do the same thing for the legal marijuana industry. Tokken, a payment solution system in Colorado, has been developed specifically for the emerging legal marijuana industry which, according to their website, delivers ‘safe payment methods to consumers, and a robust compliance platform to partner banks. ’Tokken states that it will eradicate financial crime risks by ‘creating a virtual barrier to cash transactions’.

It uses a Blockchain ledger to guarantee data integrity and is ‘designed to comply with every relevant regulatory requirement.’It can be used by the customer at participating stores and works by transferring money from the customer’s bank account into the Tokken system, which is then recorded via a Blockchain ledger and the corresponding number of Tokkens is sent to the retailer.

Whatever the result, as more states begin to review their approach to legal marijuana and the industry continues to grow at significant rate, it is a problem that shows no signs of going away.

Beau Whitney, an industry economist in Portland who handles government affairs for a local marijuana dispensary, sums this up perfectly in a recent Associated Press piece, saying ‘Some sanity has to be brought into this banking issue. At some point in time, this is going to be an industry that's going to be too big to ignore.’ And at that point, the banking system will surely have to find a solution.

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