Weed banking guidance: baby steps

This month, the Obama administration issued new guidance for banks, purportedly clarifying how they can provide financial services to marijuana-related businesses. Almost immediately, credit card processors began asking whether they could start offering card payment processing services to properly licensed pot shops. The short answer is "maybe."

This uncertainty stems from a three-page memo issued by the U.S. Department of Justice in conjunction with the new banking guidelines. Instead of promising a safe harbor, Deputy Attorney General James M. Cole said that prosecutions "may not be appropriate" when doing business with state-licensed and legally operating marijuana entities. The DOJ further qualified that statement with news that while the likelihood of prosecution is currently low, facilitating the sale of marijuana and dealing in the resulting proceeds remains illegal under federal law. Consequently, any financial institution seeking to welcome these merchants will face a number of thorny issues, including the risk of the current or a future administration adopting a different view.

Twenty states and the District of Columbia have legalized marijuana for medicinal or recreational use, but federal law flatly prohibits its manufacture, distribution and possession; thus any bank providing financial services to any marijuana-related business is doing so in violation of federal law. The guidance, issued Feb. 14, does not reflect a change in substantive federal law, but simply represents a shift in enforcement policy guided by the goal of resource management.

Given the inconsistency of the federal government's stated position over the nearly 18Â years since California legalized medical marijuana, more clarification is needed before banks should feel safe performing services for marijuana businesses.

An Inconsistent History

Recognizing the industry's vast profit potential when California legalized medical marijuana in 1996, many credit card processors and banks threw caution to the wind and immediately began processing card payments - some openly, and others in more questionable manners. This era of readily available processing endured until early 2008, when the U.S. Drug Enforcement Agency began warning banks and processors to stay clear of medical marijuana businesses and intensified raids on growers and providers. These continued in the early days of Obama's tenure, despite Attorney General Eric Holder's announcement that prosecutors would no longer target medical marijuana users and caregivers as long as they followed state laws.

In October 2009, then-Deputy Attorney General David W. Ogden memorialized a new policy in a memo saying that law enforcement efforts targeting drug manufacturing and trafficking should not "focus federal resources ... on individuals ... in clear and unambiguous compliance with existing state laws providing for the medical use of marijuana." The memo also provided a list of characteristics of "illegal drug trafficking activity of potential federal interest," including sales to minors, violence, ties to other criminal organizations, and unlawful possession of firearms.

In 2011, however, the DOJ announced that larger-scale providers could still be targeted, and in October, all four U.S. attorneys for California initiated a major crackdown on marijuana-related businesses. These efforts intensified in 2012, when federal prosecutors in California implemented a strategy of pressuring commercial landlords housing pot shops to evict them or face costly legal battles, and even forfeiture of their properties. The U.S. Treasury Department also reportedly pressured credit card companies to inform merchant services providers that they'd be "dropped ... forever" unless they immediately stopped processing medical marijuana payments.

In August 2013, Cole issued a memo directing all U.S. attorneys to focus federal law enforcement resources only on marijuana-related persons and organizations implicating specified DOJ priorities (e.g., distribution to minors, preventing revenue from going to criminal enterprises, etc.), and specifically directed prosecutors to consider those same priorities in connection with money laundering and related offenses predicated on marijuana-related violations of federal law.

FinCEN Guidance

There are several points to note in the latest guidance provided by the DOJ and the Treasury Department Financial Crimes Enforcement Network (FinCEN). First, the unhelpful advice that: "The decision to open, close or refuse any particular account or relationship should be made by each financial institution based on a number of factors specific to that institution ... [which] may include its particular business objectives, an evaluation of the risks associated with offering a particular product or service, and its capacity to manage those risks effectively. Thorough customer due diligence is a critical aspect of making this assessment."

In assessing these risks, FinCEN not only counsels verifying appropriate state licensure and compliance, but also advises banks to consider the types of "products to be sold" and "customers to be served (e.g., medical versus recreational)" as well as whether a business implicates one of the Cole memo priorities. In essence, FinCEN shifts the burden of interpreting the law to the financial institutions.

Any bank that decides to provide financial services to a marijuana-related business must file a Suspicious Activity Reports (SAR) on that client - which banks are generally loath to do, and which often triggers banks to terminate their relationship with such businesses. Nevertheless, under the new guidelines, to work with any marijuana-related business, a bank should now file a "Marijuana Limited" SAR, which includes: (i) identifying information of the subject and related parties; (ii) address of the subject and related parties; (iii) the fact that the only reason for the filing is because the subject is engaged in a marijuana-related business; and (iv) the fact that no other suspicious activity has been identified.

Where a bank at any point has reason to believe that a marijuana-related business implicates the Cole memo priorities or violates state law, it should file a "Marijuana Priority" SAR; and where a bank deems it necessary to terminate a relationship with a marijuana-related business to maintain an effective anti-money laundering compliance program, it should file a "Marijuana Termination" SAR.

In addition to the DOJ's continued stance that providing banking services for a marijuana-related business violates federal law and could result in prosecution, several red flags stand out. First, that a financial institution must consider its own business objectives and risk tolerance in deciding whether to process for a "legal" marijuana-related business constitutes fair notice that it is not a risk free proposition.

Second, FinCEN puts the onus on the financial institution to interpret federal law enforcement priorities, and counsels that banks should distinguish between "medical" and "recreational" pot shops in deciding whether to provide financial services, even though both might be perfectly legal under state law. The consequences when the bank's interpretation does not accord with law enforcement's interpretation are unclear.

Third, the guidance requires banks to file SARs on all marijuana-related clients, regardless of whether the bank believes them to be in compliance with state law.

The Card Associations

In July 2012, Visa and MasterCard reportedly imposed a ban on processing for marijuana dispensaries. A Visa representative said at the time, "Visa cards should only be used in connection with legal transactions ... Merchant banks ... are responsible for ensuring that their merchant customers comply with all applicable laws."

As of January, however, they appear to have relaxed that position. Visa stated, "Given the federal government's position [that it will not challenge state laws that legalize and regulate marijuana sales] and recognizing this is an evolving legal matter with different standards applicable in different states, our local merchant acquirers (banks) are best suited to make any determination about potential illegality." Since then, Colorado merchants have accepted Visa and MasterCard, although American Express is still holding out.

Visa and MasterCard appear to have adopted essentially the same view as the DOJ, putting the onus entirely on merchant banks, and past experience suggests that they will likely continue following the federal government's lead when it comes to making future policy decisions.

For now, it bears emphasis that card associations have not seen fit to create a Merchant Category Code (MCC) for marijuana-related businesses. Thus, even if a merchant bank is fully complying with its FinCEN obligations, it must still submit the underlying card transactions to Visa/MasterCard for processing under a general MCC.

On a practical level, processing for marijuana-related businesses has continued on a covert level for some time, with most of the businesses and their processing partners mischaracterizing the businesses as non-marijuana related such as "flower shops" or "health clubs."

Brave New World

Other thorny issues remain. The FDIC and state banking regulators have yet to comment upon the FinCEN announcement, much less jump on board. Even the most risk-tolerant bank will be reluctant to jump in knowing that it will face scrutiny and possible future sanctions from regulators. As the American Bankers Association said in a memo following the Feb. 14 press release, because marijuana remains illegal under federal statute, "guidance alone isn't enough."

"There's a great deal of guidance that banks would want to see in terms of banking with these types of businesses but guidance alone doesn't change the fundamental prohibition," the memo states. "In order for banks to be comfortable banking marijuana businesses, the federal statute must be changed by Congress."