Cannabis Cash Conundrum, Continued

Serving marijuana merchants is still a big gamble for banks.

During a visit to the Dixie Elixirs & Edibles plant in Denver last summer, I saw the machines the company uses to produce cannabis concentrates, the kitchen where it makes marijuana-infused chocolates, and the bottling line for its THC-spiked sodas. Toward the end of the tour, I had a semi-serious question for the company's CEO, Tripp Keber: "Where do you keep your piles of money?"

Keber laughed but quickly turned serious. "We actually have strong banking relationships," he said. "We don't talk about them. Asking someone about their banking is like asking them what they wear to bed at night. It's an intensely personal question, even within the industry." You can begin to understand why banking is such a touchy subject for the newly legal cannabusinesses in Colorado and Washington (as well as growers and dispensaries in the 21 states that allow medical but not recreational use of marijuana) if you consider the federal laws a financial institution violates when it does business with a state-licensed company like Keber's.

"By providing [a] loan and placing the proceeds in [a] checking account, the institution would be conspiring to distribute marijuana," writes University of Alabama law professor Julie Andersen Hill in a paper she presented at a conference on marijuana and federalism this month. "By facilitating customers' credit card payments, the institution would be aiding and abetting the distribution of marijuana. And by knowingly accepting deposits consisting of revenue from the sale of marijuana, the institution may be acting as an accessory after the fact."

That is not the end of the possible charges. "A financial institution that knowingly processes transactions for marijuana-related businesses commits the crime of money laundering," Hill notes. Failure to meet the detailed monitoring and reporting requirements of the humorously named Bank Secrecy Act (BSA), which requires financial institutions to keep an eye out for suspicious activity, also can be treated as a felony.

Bank employees, officers, and directors can be prosecuted for these crimes, some of which may, depending on the amount of marijuana involved, trigger five- or 10-year mandatory minimum sentences. BSA violations are punishable by up to 10 years in prison when combined with other federal offenses. Money laundering can get you up to 20 years, and life is the maximum for participating in a marijuana conspiracy. In addition to the daunting threat of criminal penalties, financial institutions that deal with cannabusinesses have to worry about offending federal regulators with the power to impose millions of dollars in fines or sentence a bank to death by revoking its deposit insurance.

It is little wonder, then, that financial institutions are wary of cannabusinesses, or that the growers, manufacturers, and retailers who are lucky enough to obtain banking services do not want to talk about how they managed to do that. The lack of banking services, which Aaron Smith, executive director of the National Cannabis Industry Association, calls "the most urgent issue facing the legal cannabis industry today," makes it difficult for marijuana entrepreneurs to raise capital and forces most of them to deal exclusively in cash, which creates administrative, logistical, and security headaches.

A recent tax dispute illustrates the complications. When a business pays federal taxes withheld from employees' paychecks (along with the employer's share of payroll taxes), the Internal Revenue Service insists that it be done electronically, which requires a bank account. Otherwise the IRS imposes a 10 percent penalty. In a U.S. Tax Court petition filed last June, Allgreens, a Denver dispensary that pays its taxes in cash, argued that it should not have to pay the penalty because it lacks a bank account due to circumstances beyond its control. The IRS disagreed, suggesting several indirect methods Allgreens could use to make electronic payments. But as Allgreens' lawyer pointed out, those tricky maneuvers probably qualify as money laundering. In effect, the IRS fined Allgreens for refusing to commit a felony.

The IRS may have no sympathy for Allgreens, but tax collectors should worry about the opportunities for evasion that a cash-only business offers. The marijuana industry's lack of access to banks is also a problem for regulators and the police. "You don't want just huge amounts of cash in these places," Attorney General Eric Holder explained during an appearance at the University of Virginia in January. "They want to be able to use the banking system. There's a public safety component to this. Substantial amounts of cash, just kind of lying around with no place for it to be appropriately deposited, is something that would worry me, just from a law enforcement perspective."

As Hill explains, however, the solution offered by Holder and other federal officials—guidelines that are more intimidating than reassuring—is woefully inadequate. Hill convincingly argues that cleaning up the marijuana money mess will require congressional action coupled with regulatory restraint.

A few weeks after Holder expressed concern about all that undeposited cannabis cash, the Justice Department released a memo saying that the eight "federal law enforcement priorities" guiding prosecution of marijuana offenses in states with legal cannabusinesses would also guide prosecution of financial crimes. But the promise of prosecutorial restraint seemed to hinge on the ability of banks and credit unions to make sure their customers not only comply with state law but do not implicate any of the eight priorities, which include sales to minors, interstate smuggling, sales of other drugs, "use of firearms," and "adverse public health consequences."

Furthermore, the promise was not really a promise at all. "If a financial institution or individual offers services to a marijuana-related business whose activities do not implicate any of the eight priority factors," wrote Deputy Attorney General James Cole, "prosecution for these offenses may not be appropriate." Then again, it might be. "Nothing herein," Cole warned, "precludes investigation or prosecution, even in the absence of any one of the factors listed above, in particular circumstances where investigation and prosecution otherwise serves an important federal interest." And whatever the policy laid out in the memo, Hill notes, "actual enforcement practices could change anytime—with or without warning."

The Justice Department memo was accompanied by guidance from the Treasury Department's Financial Crimes Enforcement Network (FinCEN) that was even less reassuring, although it ostensibly aimed to "enhance the availability of financial services for, and the financial transparency of, marijuana-related businesses." FinCEN explained that the BSA requires banks to file "suspicious activity reports" (SARs) on any marijuana businesses they serve. But it announced a new distinction: SARs on cannabusinesses that comply with state law and do not implicate any of the eight federal enforcement priorities would be labeled "marijuana limited," while SARs on other cannabusinesses would be labeled "marijuana priority." If a bank decided to sever relations with a suspicious customer, that would trigger a "marijuana termination" SAR. The implication was that regulators might not get around to the "marijuana limited" cases.

But as with the Justice Department memo, there were no promises. Worse, FinCEN told banks to be on the lookout for "red flags" that might differentiate "marijuana priority" cases from "marijuana limited" cases. FinCEN's list of warning signs, which it said was not exhaustive, included "international or interstate activity," an inability to "demonstrate the legitimate source of significant outside investments," signs that the customer is "using a state-licensed marijuana-related business as a front or pretext to launder money derived from other criminal activity," and "negative information, such as a criminal record, involvement in the illegal purchase or sale of drugs, violence, or other potential connections to illicit activity."

Don Childears, president of the Colorado Bankers Association (CBA), summed up the memos' message this way: "Serve these customers at your own risk." The CBA complained that the guidance from FinCEN and the Justice Department "reiterates reasons for prosecution and is simply a modified reporting system for banks to use," a system that "imposes a heavy burden on them to know and control their customers' activities, and those of their [customers'] customers."

John Davis, who operates two medical marijuana dispensaries in Seattle, says the memos "were a positive statement" but do not make much of a difference in practice. "The DOJ says, 'If you do this, you're violating this law, this law, and this law,'" Davis says. "And FinCEN says, 'On your filings, you are to admit to those crimes.' So the banks, very conservative institutions, are looking at this and saying, 'Nope. This doesn't give us any assurances. This says that we can be arrested.'"

In a speech last month, Hill notes, FinCEN Director Jennifer Shasky Calvery claimed "the guidance is having the intended effect." Calvery reported that FinCEN had received 502 "marijuana limited" SARs from "105 individual financial institutions." From this Calvery concluded that FinCEN's guidance "is facilitating access to financial services, while ensuring that this activity is transparent and the funds are going into regulated financial institutions responsible for implementing appropriate safeguards."

That interpretation seems rather rosy. As Hill points out, "There are more than 502 state-licensed marijuana businesses in Colorado alone," and "the 105 institutions that have filed 'Marijuana Priority' reports are a small drop in the bucket when considering the larger banking industry," which includes "more than 13,000 banks and credit unions." Furthermore, FinCEN also had received more than 475 "marijuana termination" reports, which "suggests financial institutions may actually be choosing to end relationships with state-legal marijuana businesses."

It is easy to see why banks remain wary of marijuana money. Notwithstanding the Justice Department's memo, Hill notes, "Any bank or credit union providing services could face criminal prosecution at any time." FinCEN's guidance, even if it is interpreted as creating a safe harbor, "seems to set the bar for financial institution compliance quite high." In any case, Hill writes, "the Department of Justice and FinCEN are only two of the many federal authorities with regulatory oversight of financial institutions." Banks and credit unions also have to worry about how the Federal Reserve, the Federal Deposit Insurance Corporation, and the National Credit Union Administration will view their willingness to serve state-legal businesses that routinely commit federal felonies.

An obvious solution is to make those businesses legal by carving out an exception to the federal ban on marijuana, as the Respect State Marijuana Laws Act, introduced last year by Rep. Dana Rohrabacher (R-Calif.), would do. The Marijuana Business Access to Banking Act, introduced last year by Rep. Ed Perlmutter (D-Colo.), takes a narrower approach, shielding banks that serve state-legal marijuana businesses from criminal prosecution, regulatory penalties, and loss of deposit insurance.

Even if Congress approves such legislation, Hill warns, regulators might still discourage banks from serving cannabusinesses by imposing unreasonable "due diligence" standards aimed at detecting activities, such as selling marijuana to minors or supplying the interstate market, that remain illegal. "If the compliance bar is so high that any customer misstep can result in federal criminal or civil liability for the financial institution, then marijuana banking will not occur," Hill writes. "If Congress opens the door for marijuana banking, federal financial regulators should ensure their efforts do not practically prevent banks from servicing the marijuana industry."

In the meantime, state-licensed marijuana merchants can try to access banking services by disguising the nature of their business. But as Hill points out, such subterfuge can be prosecuted as money laundering. Then again, what's one more felony?

This article originally appeared at Forbes.com.