Getting pot banking legislation right
The House Financial Services Committee’s efforts to mark up and approve the Secure and Fair Enforcement Banking Act of 2019 are commendable — they represent a high-profile first step to permit banks to provide financial services to cannabis-related persons and entities.
However, the draft legislation, which would prohibit federal regulators from taking action against financial institutions for banking cannabis-related companies, requires several modifications to its approach based upon a few key considerations.
As a basic operating principle, banks want (and need) to base their compliance programs on clear-cut rules, regulations and interpretive guidance. In light of the fact that the SAFE Act does not decriminalize cannabis and cannabis products, Congress needs to focus on eliminating the ambiguity that currently exists regarding providing legally permissible banking services to cannabis entities in a manner that minimizes the currently required extensive due diligence and follow-up required by Fincen pronouncements. For example, many bank board members are perplexed that a bank can enter this market when doing so constitutes a felony. (The answer is very nuanced and to many bank board members not very reassuring.)
The cannabis industry has dramatically evolved in the past five years from small agricultural and retail operations to that of an emerging agribusiness. All indications are that traditional corporations are quickly entering the cannabis market — with many of them attempting to achieve vertical integration via the acquisition of a variety of cannabis licenses. Not only is this development occurring on a state-by-state basis, but large national and multinational companies have adopted business models that would create a nationally organized agribusiness (and in many instances those efforts are being coordinated or affiliated with mainstream retail consumer drink, food and cosmetics companies).
This evolution in the cannabis industry cannot effectively proceed without adopting a fundamental change in the governmental approach to the regulation of cannabis. Not only are there currently a plethora of small cultivators, transporters, processors, testing laboratories and retail establishments, there now has emerged holding companies and subsidiary structures, management consultants and equity and debt participants — many of which do not fall within the ambit of “cannabis-related” entities as commonly understood only a few years ago.
Importantly, this dramatic expansion of the range of participants in the cannabis industry not only complicates compliance with current Fincen guidance, it is an indication that the cannabis industry is quickly maturing in a manner whereby banks feel comfortable with providing services to these new entrants — provided that clarity is achieved in any remedial legislation.
Regarding the regulatory agencies, the prudential banking agencies have appropriately confined themselves to ensuring that a bank’s policies and procedures for providing banking services to cannabis-related entities is adequate from traditional safety and soundness perspectives. Unfortunately, both the Department of Justice and Fincen have failed to a considerable degree in recognizing the evolution in the cannabis market, which has resulted in available guidance being hopelessly outdated and in need of significant revision. Having said that, enforcement agencies have been clear that they want the cannabis industry to operate within the banking system and not outside of it.
As noted above, the SAFE Act is a useful first step in resolving the conundrum that banks must currently address as they navigate and evaluate the risk presented. Several suggested approaches might be considered.
First, the current version of the legislation incorrectly limits permitted financial services to consumer financial services, which is a nonstarter (and probably an innocent misunderstanding). In its place, financial institutions should be authorized to provide a range of financial services that are either authorized to be offered by a bank holding company or by a national bank. This approach would provide, for example, the ability of a bank to offer not only deposit and lending services, but related brokerage and other financing services necessary as the industry matures and requires traditional commercial bank products and services.
Second, the SAFE Act should clearly spell out that indirect participants that focus their efforts in the cannabis industry (including holding companies, investment vehicles, consultants and others) are covered by the proposed safe harbor in order to permit banks to provide financial services directly to this category of cannabis industry participants. Similarly, companies whose businesses only remotely touch cannabis entities (such as accounting firms, landlords and equipment suppliers) should be clearly deemed to fall outside the scope of concern and thus treated as ordinary businesses.
Third, statutory language or accompanying legislative history should instruct Fincen and the DOJ to refrain from adopting regulations that would de facto reinstitute the impediments to banking cannabis entities that currently exist. Among other things, Fincen should be instructed to amend its anti-money-laundering guidance for financial institutions to reduce or eliminate repetitive “suspicious activity report” filings and follow-up due diligence.
Unless cannabis is decriminalized, it is probable that there will only be one bite at the apple to fix these issues — the Congress needs to get it right in a manner that provides banks clear authority and guidance.