Pot Banking 2016: More State Ballots But Continued Unease

Despite its astounding growth in recent years, the marijuana industry remains hampered by its own banking crisis. Marijuana businesses' difficulty in accessing financial services has created problems for businesses and government alike.

Billions of dollars from marijuana sales legal in multiple states remain largely outside the sanctioned financial system, impeding the ability of public officials both to tax marijuana businesses and to prevent marijuana-related funds from financing criminal activity. And most marijuana businesses continue to hit a wall in getting financial services, which is limiting their growth. Without bank accounts or payment processing relationships, businesses must endure the dangers of transacting in cash — a concern that former Attorney General Eric Holder recognized explicitly in 2014. Absent bank loans, business owners are forced to give up equity or pay enormous interest on private debt to finance growth.

These challenges are the byproduct of the stark contrast between federal and certain states' laws concerning marijuana. Federal bank regulators have attempted to sound open to pot banking, endorsing guidance by the Financial Crimes Enforcement Network. But despite the legality of at least medical marijuana in many states, and the Department of Justice's mostly hands-off approach to state-legal businesses, the federal ban still means that every financial institution serving marijuana businesses is theoretically violating anti-money laundering laws every time they accept a deposit, transfer money, or facilitate a payment using the proceeds of a marijuana sale.

Yet the rigidity of federal laws is not stopping all advances in the growing legal marijuana sector. While the federal government is unlikely to legalize marijuana in 2016, several other developments — such as private sector innovations and state ballot initiatives — will lead to both progress and new challenges.

Here are four predictions:

State Ballot Efforts May Help Motivate Congress to Act

Although marijuana advocates can claim some victories in Congress, federal legislation to solve the marijuana banking issue has not gained any significant traction. That may change in 2016, when many populous and politically-important states are expected to vote on legalizing or expanding the legalization of marijuana. California, Nevada, and Massachusetts are among states likely to hold state ballot votes on recreational marijuana, while Florida voters will consider legalizing medical marijuana. Legalization advocates have high hopes for 2016. One weapon in the arsenal for supporters is the fact that the “parade of horribles” — the consequences of legalization cited by anti-marijuana activists — has largely not materialized as more states allow marijuana use.

If legalization at the state level expands, then the constituencies demanding congressional action will also grow. These constituencies include not only marijuana businesses themselves but also the financial institutions that will profit from serving the industry as well as other groups concerned about so much business being conducted in cash. With such widespread interest in a banking solution, Congress may finally provide much-needed relief.

Small Banks Will Face Challenges Serving Marijuana Businesses

Some marijuana businesses do have bank accounts — for now. For the most part, banks serving them are smaller community banks. But those banks often lack the resources necessary to ensure that businesses are in compliance with state marijuana laws and federal enforcement guidance. As a result, such banks often close marijuana businesses' accounts once they realize the true costs and burdens of a thorough compliance program. As case studies, look no further than the 2015 decisions of MBank in Oregon and First Security Bank of Nevada to cease serving marijuana businesses. Both banks essentially declared that the compliance resources required to bank such businesses in accordance with federal guidance were too great to justify the potential revenue from servicing such customers.

The small banks that continue serving marijuana businesses are likely to follow one of two paths. They may charge extraordinary fees. Indeed, reports are common of banks charging marijuana businesses as much as $2,000 a month for the privilege of maintaining an account. Second, small banks simply may not perform sufficient due diligence to ensure their clients' compliance. Neither of these paths is conducive to industry growth, but they will remain options for many small banks and desperate businesses, absent legislation.

Bigger Banks Will Become More Interested

For banks, the question of whether to serve marijuana businesses is one of risk versus reward. For larger banks with more sophisticated compliance operations, the risk of serving the marijuana industry has been too high and the potential rewards too low. But recently, the marijuana industry's growing size has increased the profit potential, while more effective cost-efficient risk mitigation methods have become more available.

There are many new tools that banks can leverage to reduce the risk that marijuana industry clients are violating state laws or federal enforcement priorities. For example, many firms with expertise in marijuana regulation now conduct efficient and thorough compliance audits that are tailored to the marijuana laws of a given jurisdiction. These audits, which are often conducted at marijuana business' expense, can reduce the amount of in-house resources needed for the bank to perform compliance due diligence and monitoring. Additionally, data about the licensure and beneficial ownership structures of marijuana businesses is becoming more accessible, giving banks comfort that they know their customers' true identities, as is required by federal law. Better compliance tools at a lower cost, along with higher potential profits, are likely to change the risk-reward calculus of some larger banks.

Federal Regulators Will Remain Reluctant to Push Major Policy Changes

The New Year opened with a big blow to the most credible effort to date to form a new financial institution designed to serve marijuana businesses. On Jan. 5, a federal court ruled that the Federal Reserve is not required to open a master account for The Fourth Corner Credit Union, thus denying Fourth Corner the ability to participate in the banking system. The district court explained that because marijuana remains federally illegal, the court would be forcing the Fed to commit a crime if it ordered the master account be granted. Moreover, the court noted the lack of utility of Fincen's guidance, saying that only congressional action legalizing marijuana would allow banks to serve marijuana businesses. Because the court punted the issue to Congress, already risk-averse regulators are unlikely to offer further guidance or regulations that would encourage or facilitate marijuana banking on a national level.

Douglas Fischer is an associate at Cadwalader, Wickersham & Taft LLP, whose practice includes advising investors in the marijuana industry. Jodi Avergun is a partner at Cadwalader in the White Collar Defense and Investigations Group. She previously served as an assistant U.S. attorney in the Eastern District of New York, chief of the Narcotic and Dangerous Drug Section of the Criminal Division of the U.S. Department of Justice and chief of staff to the U.S. Drug Enforcement Administration.