Government Assurance Aside, Marijuana Money Still Risky for Banks

Bankers beware: Until the feds confirm that they won't prosecute banks for dealing with state-licensed pot dealers, you do business at your own risk.

Financial institutions in states that have legalized marijuana for recreational or medical use may be able to provide services to "marijuana-related businesses" under certain circumstances, according to guidance issued by the U.S. Treasury Department's Financial Crimes Enforcement Network in February. But while well-intentioned, neither Fincen’s guidance nor a memorandum from the Justice Department outlining its enforcement priorities provide sufficient assurance for financial institutions to safely take on the considerable risk of dealing with dealers.   

Legalized marijuana is now big business. Approximately 20 states now permit medical marijuana sales under some circumstances, and Colorado and Washington have legalized non-medical possession and use by adults. If current trends continue, Colorado may well double the $35 million in taxes, licenses, and fees from retail marijuana sales it projected for fiscal year 2013-14. It expects to see nearly $118 million in the next fiscal year, as well as additional revenues from medical marijuana sales. Meanwhile, California’s medical marijuana tax revenues are estimated to be over $105 million per year.

Yet marijuana remains a Schedule I controlled substance under federal law, along with heroin and methamphetamine. Thus, a marijuana business that is regulated, licensed and taxed under state law is wholly illegal under federal law. This means that financial institutions are exposed to severe federal penalties if they do business with pot dealers.  

In the past, if a bank’s customer due diligence indicated that the customer was involved with drug sales, the institution simply turned them away. While the Fincen guidance is intended to "enhance the availability of financial services for, and the financial transparency of, marijuana-related businesses," in practice it creates a new set of headaches for bankers.

Maintaining compliance while doing business with legal pot dealers is likely to be extremely burdensome — especially for smaller institutions. Banks must monitor the customer for red flags, file marijuana-related suspicious activity reports when deemed appropriate and terminate the account if it appears the customer is operating outside the scope of its license or is otherwise engaged in illicit activity.

But the red flags for which banks are supposed to be alert are vague and open to interpretation. Fincen's list of 11 red flags include that the customer appears to be using the licensed business as a front for illegal activity or cannot "demonstrate the legitimate source of significant outside investments. Other red flags include the owner residing out-of-state or engaging in international or interstate activity and nonprofits that are "engaged in commercial activity inconsistent with that classification" or making "excessive payments" to managers and employees.

Not only are these red flags ambiguous, they would be very onerous for most banks to investigate. To determine whether the licensed business is a sham, for example, a bank would have to find out whether the customer’s revenues are greater than expected given the state’s limitations; compare the customer’s cash deposits to those of its competitors; and examine its deposits to see if they are consistent with revenues reported for tax purposes.

Even full compliance may prove cold comfort. A banker charged with violating federal drug trafficking or money laundering laws might argue that he complied with Fincen’s guidance, but doing so means admitting to having taken deposits from marijuana sellers.

Banks therefore do business with marijuana-related businesses at their peril. Moreover, while the Justice Department has indicated that its enforcement actions will focus on more serious drug-related activity including sales to minors, the use of state-licensed businesses as a cover for illegal activity and cases involving gangs, firearms, violence and drug cartels, it has yet to say it will refrain from prosecuting those who facilitate sales of marijuana that are legal under state but not federal law. Accordingly, caveat banker.

Nicole Healy is a partner in the Redwood City office of Ropers, Majeski, Kohn & Bentley. She is the author of the Anti-Money Laundering Deskbook: A Practical Guide to Law and Compliance.