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Legalized Marijuana, Part 5: Legal Marijuana Red Flags

Previous posts in this series looked at the FinCEN guidance’s potential impact to institutions serving marijuana-based businesses. The first took a high-level view of how the guidance impacts institutions and the decisions that need to be made. The second was a deeper look at what the guidance really says and how it impacts institutions in CDD, then we moved on to transaction monitoring and regulatory filing.

This post deconstructs the interplay with the Cole Memo, which forms a core foundation for the red flags. It also considers some additional red flags institutions may want to consider over and above what is contemplated in the guidance when developing their own policies.

A quick review of the timeline:

  • In 1996, California voters pass Proposition 215, allowing the use of medical marijuana, the first U.S. state to do so.
  • From 1998 to 2013, 20 states provide for some degree of medical cannabis use.
  • In August 2013, James Cole, Deputy Attorney General at the U.S. DOJ, released a memo for the states’ attorneys clarifying specific priorities in enforcing the federal Controlled Substances Act in light of state laws making marijuana legal for medical and/or recreational purposes.
  • In January 2014, cannabis became legal for recreational use in Colorado and Washington with substantial regulation.
  • In February 2014, FinCEN released guidance incorporating the principles of the Cole Memo and clarifying the expectations of financial institutions in their compliance obligation.

These are welcome clarifications, and they provide institutions some level of confidence should they choose to serve such businesses. The BBC estimates the value of the legal marijuana business at US$1 billion per year, which will probably grow substantially. The article also looks at the challenges these business owners have in managing their financial health in light of the difficulty of establishing traditional banking relationships.

It is important to note that the Cole Memo essentially focuses federal enforcement activities around public safety issues, such as underground drug cartels and related violence, rather than state-legal marijuana businesses. The implication is that federal prosecutors should not focus attention on marijuana-related businesses that are conducting their business within the confines of their states’ laws and regulations. The guidance extends some insight to financial institutions operating in those states on how to effectively service those customers while fulfilling their regulatory compliance obligations.

Red flags to identify priority SARs

As discussed in the last post, there are three types of SAR designations: “limited,” “priority,” and “termination.” These designations are to be noted in the SAR narrative and impact what sort of content should be in the narrative. Institutions should be careful to use exactly the spelling and format in the guidance for these designations, as it assists law enforcement in addressing the proper SARs. The important question is how one determines which designation to use. This is where the red flags in the guidance help out.

It is critical to note that the red flags outlined in the guidance are only starting points and do not constitute an exhaustive and definitive list. Institutions should add their own additional red flags and be prepared to continually review and update based on newly identified risks and updated guidance.

It is not possible here to break down each red flag individually, but there are some groupings that can help institutions ensure all the red flags are addressed and develop new institution-specific red flags.

Many of the red flags relate to CDD/EDD practices and are not very different from typical AML practices for high-risk businesses. Organizations that already serve higher-risk clients, such as MSBs, or that offer commercial banking, trade finance, or real estate should evaluate their existing program’s requirements and map them against the FinCEN red flags. These red flags especially include having a solid understanding of the ownership structure and owners’ backgrounds. In many cases there may be rather few adjustments needed to serve a marijuana-based business.

Other red flags focus more on the transactions themselves. In addition to more traditional transaction monitoring, these red flags include more unusual requirements, such as cash deposits that smell like marijuana (yes, that will happen) for undesignated businesses and understanding both interstate and international transaction activity. Interstate transaction monitoring is generally a new requirement for most banks, but with marijuana-based businesses it is important due to conflicting state-level laws.

Should an institution identify an account exhibiting any of the red flags as a “Marijuana Priority” or a “Marijuana Termination,” a SAR should be filed depending on whether the issue is significant enough to terminate an account. In many cases there is no need to terminate the account unless the account is running afoul of state laws and regulations and a “marijuana priority” SAR can be filed.

To conclude this series on banking marijuana businesses, it is important to note that the environment is rapidly changing—more states have bills or referendums coming on legalizing marijuana in some form, and changes to the U.S. administration could lead to changes in enforcement policies and regulations. It is a dynamic space, but this underserved segment could be very profitable if managed carefully. Institutions that have the most success will work closely with both their marijuana-related customers and their regulators to cost-effectively serve this type of business.