Is Cannabis Making You Paranoid?

Why, who’s asking?

Many cannabis-related businesses are in need of assistance with their fundraising efforts to expand their operations. Therefore, broker-dealers ask our Consultants more and more whether they can safely provide investment services to prospective customers in the cannabis industry. We understand that as the industry grows (like a weed), so too will the number of broker-dealer firms working with cannabis-related businesses and their owners.

What did the Regulators say?

Think twice before engaging in transactions with cannabis-related businesses. Any form of cannabis growing and distribution remains illegal under federal law and related financial transactions likely represent federal money laundering violations regardless of any state legalization. Previously, cannabis-related businesses and the broker-dealers serving them were making do, reassured by the “Cole Memo” (a memorandum, published by the Department of Justice, and authored by then Deputy Attorney General James M. Cole, which stipulates that the Justice Department place "low priority" on enforcing cannabis laws against businesses and organizations that comply with state law). Those not running afoul of the government’s concerns could reasonably perceive themselves as being safe from federal prosecution. However, with the rescission of the Cole Memo earlier this year, there is no longer a safe haven.

The Financial Crimes Enforcement Network (FinCEN) has indicated that financial institutions should continue to follow its guidance originally issued on February 14, 2014 (the “FinCEN Guidance”), which provides direction on how to best avoid being the subject of an investigation or prosecution for violating federal law. However, even 100% compliance is not a guarantee. You should carefully evaluate your business objectives, risk tolerance and capacity to manage those risks effectively prior to making a decision.

What do the Regulators want?

FinCEN guidance clarifies how financial institutions can provide services to cannabis-related businesses consistent with Bank Secrecy Act (BSA) requirements and did not categorically sanction the activity, but rather provided a formula for assessing risk. It states that in assessing the risk of providing services to a cannabis-related business, financial institutions should conduct customer due diligence that includes:

• verifying with the appropriate state authorities whether the business is duly licensed and registered (you may reasonably rely on the accuracy of information provided by state licensing authorities);
• reviewing the license application (and related documentation) submitted by the business for obtaining a state license to operate its cannabis-related business;
• requesting from state licensing and enforcement authorities available information about the business and related parties;
• 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);
• ongoing monitoring of publicly available sources for adverse information about the business and related parties;
• ongoing monitoring for suspicious activity, including for any of the red flags described in this guidance; and
• refreshing information obtained as part of customer due diligence on a periodic basis and commensurate with the risk.

A particularly important part of your due diligence and in assessing the risk of providing services to a cannabis-related business is considering whether the cannabis-related business violates state law. Considering this factor will also enable you to provide accurate information in BSA reports pertinent to law enforcement’s priorities. If you decide to provide financial services to a cannabis-related business, you are required to file a suspicious activity report (“SAR”) as described below.

Does this seem suspicious to you?

Financial Institutions are required to file a SAR if it knows, suspects, or has reason to suspect that a transaction conducted or attempted by, at, or through the firm:

• involves funds derived from illegal activity or is an attempt to disguise funds derived from illegal activity;
• is designed to evade regulations promulgated under the BSA, or
• lacks a business or apparent lawful purpose.

Because federal law prohibits the distribution and sale of cannabis, financial transactions involving a cannabis-related business would generally involve funds derived from illegal activity. Therefore, a financial institution is required to file a SAR on activity involving a cannabis-related business, regardless of whether or not they are duly licensed under state law.

The three cannabis-related filing categories are:

Marijuana Limited: the financial institution’s due diligence indicates that the cannabis-related business does not raise any of the red flags as defined in the Cole Memo and is compliant with the appropriate state’s regulations regarding cannabis businesses. The financial institution is providing banking services to the marijuana-related business.

Marijuana Priority: the financial institution’s due diligence indicates that the cannabis-related business may raise one or more of the red flags as defined in the Cole Memo or may not be fully compliant with the appropriate state’s regulations regarding cannabis-related businesses. The financial institution is providing banking services to the marijuana-related business while further investigation is being conducted.

Marijuana Termination: the financial institution decided to terminate its relationship with the cannabis-related business for one or more of the following reasons:

• The financial institution’s due diligence indicates that the cannabis-related business raises one or more of the red flags as defined in the Cole Memo.
• The marijuana-related business is not fully compliant with the appropriate state’s regulations.
• The financial institution has decided not to have cannabis related customers for business reasons.

Am I Being Followed?

Prior due diligence on individuals and institutions that are directly involved in the cultivation, production and sale of cannabis should be updated to confirm that they continue to comply with state laws. Due diligence on vendors that supply products and/or services to cannabis entities, such as accounting, irrigation, etc., should be updated to determine whether the product or service originally provided to the entity is still actively being provided by the vendor.

Marijuana Limited SARs must also be updated regulatory by filing Continuing Activity Reports. Simply filing an initial Marijuana Limited SAR is not sufficient if ongoing due diligence indicates that the cannabis-related activity is continuing.  SARs for continuing activity must be filed after a 90-day review with the filing deadline being 120 days after the date of the previously related SAR filing. Firms may also file SARs on continuing activity earlier than the 120-day deadline if the firm believes the activity warrants earlier review by law enforcement.

The filing timeline is as follows:

• Identification of suspicious activity and subject: Day 0.
• Deadline for initial SAR filing: Day 30.
• End of 90-day review: Day 120.
• Deadline for continuing activity SAR with subject information: Day 150 (120 days from the date of the initial filing on Day 30).
• If the activity continues, this timeframe will result in three SARs filed over a 12-month period.

What have you heard?

There are still many questions that need to be answered for broker-dealers that want to service the cannabis industry and by engaging in cannabis activity, you are exposing your firm to potential scrutiny from the Department of Justice.  While the winds can shift, and have done so a couple of times over the past few years, these shifting winds could result in serious legal action. Bills to provide more permanent clarity to the financial industry about working with cannabis-related businesses have been introduced by bipartisan groups in both the House and Senate. Until then, adherence to the guidance provided by FinCEN is the best that you can do to engage in a business that is still illegal under federal law. Stay tuned for further updates regarding the status of the FinCEN guidance and remember, “The paranoid is never entirely mistaken” – Sigmund Freud.

https://www.ncsregcomp.com/team/jane-abramczyk/

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