Why Recreational Marijuana Should Not Yet Be Federally Legalized: A look at how to keep law enforcement intelligence flowing and help banks achieve AML objectives in a pre and post-legalization world

By Alex Muench
Student at Cardozo Law School  
December 10, 2018

Although marijuana is still classified as a controlled substance under federal law, optimism surrounding the legalization of recreational marijuana has never been higher.

This momentum, while creating both opportunities for banks and businesses to grow revenues, also brings new financial crime compliance challenges and potential intelligence blind spots for law enforcement.

Nationally, an estimated sixty-two percent of Americans favor the legalization of recreational production and use.[1]  As the public’s positive perception toward marijuana continues to grow, financial institutions are gradually providing services to Marijuana Related Businesses (MRBs).[2]

Currently, 10 states and Washington, D.C. have legalized marijuana for recreational purposes while another 21 states allow only some form of medical marijuana and 16 allow a lesser medical marijuana extract, according to media reports and industry analyses.

This rising tide of legalization has made legal cannabis – recreational or medicinal – a multi-billion dollar business in the U.S., with California nudging near the $3 billion mark alone, which begs the question: where are these companies putting their money if the plant is still considered illegal at the federal level?

This query is inextricably interlinked with an equally relevant question: how are federal law enforcement investigators analyzing these financial flows to ensure they are not tied to illicit entities and organized criminal groups and would legalization be a bane or boon to these agencies in terms of intelligence?

At issue is would law enforcement be better served by a current regime where banks must report to varying degrees of depth on all transactions with the MRBs – but the flow of intelligence is likely a fraction of the actual budding marijuana sector due to the challenges of getting and keeping bank accounts.

Or would federal investigators find more intelligence value and and garner more leads into potential bad actors with federal legalization, resulting in a possible dynamic where banks file fewer reports of suspicious activity, but file more reports on overall industry transactional activity?

Many institutions reticent to canna-bank

The U.S. Treasury agency tasked with being the arbiter of the country’s AML laws has some insight.

A recent report produced by The Financial Crimes Enforcement Network (FinCEN), the country’s financial intelligence unit (FIU), illustrates that from the second quarter of 2014 through the second quarter of 2018, roughly four hundred depository institutions have begun to service MRBs.[3]

Because marijuana remains illegal at the federal level, the proceeds from MRBs are technically “derived from illegal activity,” thus requiring financial institutions to file Suspicious Activity Reports (SARs).[4]

Considering financial institutions face civil-penalties of up to $25,000 a day for non-compliance with the requirement to file SARs, institutions must approach banking MRBs with caution.[5]

A missed SAR is just one avenue of regulatory knuckle-wrapping that could come into play as banks intersect the marijuana sector.

That’s because in many instances, due to the challenges of acquiring and holding bank accounts, many MRBs have surreptitiously gained bank accounts by not mentioning the cannabis side of the business, or worked through other means to move funds into the financial system, such as armored car services, virtual currencies and even virtual currency ATMs.

If a regulator or law enforcement investigator later uncovers that a bank has been banking one or even several MRBs, and the bank didn’t realize it, that could call into the question the banks customer due diligence (CDD) and know-your-customer (KYC) provisions.

Examiners then could later deem such a foible a failure in customer risk assessments, and call into question the purported health of the institution’s anti-money laundering (AML) program.

The issue of how banks should best juggle the potential criminal risks of legal and illegal MRBs – and even how to police the sector through state or federal inspections writ large – is very much on the minds of law enforcement.

Last month, the U.S. Drug Enforcement Agency (DEA), released its 2018 threat assessment reviewing the top drug and organized crime risks to the U.S., with the report noting that as national and international laws related to marijuana fluctuate – going from illegal to legal for medicinal or personal uses – it could further open the door for small and larger illicit networks to move product and launder money.

The report also noted that the divergence in state and local marijuana laws – some states have medical and personal use laws – complicate enforcement and open the door for consumers to accidentally support illicit networks.

“Money-laundering and the opportunities the state-marijuana businesses afford for DTOs and others to launder money through U.S. banks is a significant concern,” the report stated. “The ability to regulate and monitor the capacity of the various sizes and types of personal grows provides opportunity for individuals and DTOs to profit from production and sales under the guise of legality.”

FinCEN guidance keeps a Cole burning

Where FinCEN stands on the banking side of the issue is spelled out in its banking guidance.

FinCEN’s recent Marijuana Banking Update demonstrates that FinCEN’s regulatory goals regarding marijuana remain consistent with the previously issued Cole Memorandum (Cole Memo).[6] 

The Cole Memo was the Department of Justice’s guidance to U.S. Attorneys under the Obama administration, which was subsequently rescinded by former Attorney General Jeff Sessions.[7]

The most pressing enforcement issues identified in the Cole Memo include preventing MRBs from serving as fronts for illicit activities, and thwarting MRBs’ sales revenue from reaching cartels and gangs.[8] 

If none of the issues identified in the Cole Memo appear to apply to the MRB seeking service, a “Marijuana Limited” SAR must be filed with FinCEN.[9] 

A “Marijuana Limited” SAR designates that the financial institution has performed its “due diligence” inquiring as to whether the MRB is compliant with applicable state law and enforcement priorities identified in the Cole Memo.[10]

Once a “Marijuana Limited” SAR is filed, the institution must continue to assess whether the MRB is complying with state regulations or violating the Cole Memo priorities.[11] 

After the initial “Marijuana Limited” SAR is filed, the financial institution has a ninety-day review period where it is required to continue to assess the MRB, providing information such as, “the amount of deposits, withdrawals, and transfers in the account since the last SAR.”[12] 

If review identifies a problem, a “Marijuana Priority” SAR is filed providing FinCEN with data concerning the Cole Memo priorities that may be present.[13] 

Should the institution determine a successful anti-money laundering program would be incompatible with servicing the MRB, a “Marijuana Termination” SAR disclosing the reasoning for termination must be filed.[14] 

If a financial institution later tries to do business with the MRB, FinCEN “urges” the institution that filed the “Marijuana Termination” SAR to provide the second institution with the relevant information supporting termination.[15] 

Through September 30, 2017, financial institutions filed 28,689 “Marijuana Limited” SARs, compared to 2,744 “Marijuana Priority SARs”, and 9,409 “Marijuana Termination” SARs.[16] 

The problem is that these statistics may not accurately portray the number of financial institutions providing services to MRBs as anecdotally and in published reports, many operations selling marijuana legally acquire bank accounts under false pretenses due to the herculean task of getting a bank to bank them legally.

Would legalization dry up MRB intelligence wellspring?

As well, as the FinCEN update demonstrates, a number of filers “take 180 days or more” to report the requisite continuing activity.[17]  If an institution does not file within the ninety-day window, FinCEN no longer considers the institution is providing service until a later SAR is filed.[18] 

The true number of institutions banking marijuana may therefore be unknown. 

If recreational use were to be federally legalized the MRB proceeds would no longer be “derived from illegal activity.”  This would simplify the regulatory environment for banks as they would no longer have to comply with the requirement to file SARs.

From a law enforcement perspective, however, recreational legalization could result in the loss of valuable data evidencing possible illegal activities MRB’s are engaging in.

While there is a strong argument for legalizing recreational marijuana due to its recognition by some as an acceptable alternative to alcohol and purported medicinal benefits, the federal government should not yet legalize the drug.[19] 

That is, until the government can create a system that, post-legalization, would allow banks to offer accounts to what is an inherently risky – and in this future scenario recently illegal – industry, allow the compliance sector to craft a paradigm that allows institutions to fulfill their AML objectives, but doesn’t cut off critical intelligence to law enforcement.

How could this be done?

Just looking at the powers available to FinCEN, for example, several ways that can take the form of guidance or formal industry orders.    

If the federal government were to legalize marijuana, or remove it from the schedule of the nation’s most dangerous drugs, FinCEN has the power to issue guidance that calls on entities subject to AML rules to keep the same tiered SAR filing system in place.

One con of this is system is that if banks warmly welcome a newly-legalized marijuana sector, and institutions have many MRBs or a few large operations, filing so many SARs could get costly, cumbersome or become a resource drain.

Another idea, similar to what FinCEN did with the CDD beneficial ownership rulethat became effective in May, is to require banks to engage in extra compliance steps related to MRBs, to balance out the resources required to bank them.

So rather than banks filing SARs on all MRB clients, FinCEN could require institutions to engage in enhanced due diligence, detail beneficial owners, suppliers and countries the MRB will do business with, and similar steps, to more accurately gauge risk of the business at the outset of a relationship.

As well, FinCEN could order MRBs to capture customer details with cash or beneficial ownership details for corporates and lower thresholds than currently employed, such as the IRS Form 8300 for transactions eclipsing $10,000, the same threshold as the bank version, the customer transaction report, (CTR).

FinCEN could, say, require MRBs to capture customer details at the same threshold as a SAR, $5000, or even lower, and similar to many money remitters, $3,000, and send those details to the FIU directly through a secure portal, quickly making the figures available to all law enforcement agencies through the bureau’s AML filing database.

Such a move would be similar to what FinCEN did with the real estate sector and its geographic targeting orders, where the agency subjected title insurance companies to certain AML duties – capture true ownership details on individuals attempting to hide behind shell companies for real estate purchases of certain amounts in several bustling states – even though title insurance companies are not subject to formal financial crime compliance rules.

Also on the table is not legalizing and reverting back to the prior administration’s doctrine – at least until these questions can be answered and an implementation strategy structured for a post-legalization financial crime, compliance and investigations environment.  

In that case, the administration should return to the Cole Memo, allowing states to create their own regulatory systems, while federal law enforcement entities continue to accumulate valuable data necessary for a complete and accurate assessment of the marijuana industry.

*With minor edits and content additions by ACFCS Director of Content, Brian Monroe. Special thanks to Barry Koch for his expert guidance, direction and insight. 

About the author

Alex Muench is from Rye, NY, and is a 2L at Cardozo School of Law.  Prior to attending law school, Alex worked for a year as a legal assistant in complex product liability litigation. This past summer, Alex worked at the Nassau County District Attorney’s Office in the Special Operations, Narcotics, and Gangs Bureau.

[1] Abigail Geiger & Hannah Hartig, About six-in-ten Americans support marijuana legalization, Pew Research Center (Oct. 8, 2018), http://www.pewresearch.org/fact-tank/2018/10/08/americans-support-marijuana-legalization/

[2] FinCEN, Marijuana Banking Update, at 1-2 (Data ending Mar. 31, 2018).

[3] FinCEN, Marijuana Banking Update, at 1-2.

[4] FinCEN, BSA Expectations Regarding Marijuana-Related Businesses, FIN-2014-G001 (Feb. 14, 2014).

[5] Id.see also 31 U.S.C. § 5321(a)(1).

[6] James M. Cole, Deputy Attorney General, U.S. Department of Justice, Memorandum for All United States Attorneys: Guidance Regarding Marijuana Enforcement (Aug. 29, 2013), available athttp://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf

[7] Jefferson B. Sessions, Attorney General, U.S. Department of Justice, Memorandum for All United States Attorneys: Marijuana Enforcement (Jan. 4, 2018), available athttp://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf

[8]FinCEN, BSA Expectations Regarding Marijuana, FIN-2014-G001.

[9] Id.

[10] Id.

[11] Id.

[12] Id.see also FinCEN, Marijuana Banking Update, at 1.

[13] FinCEN, BSA Expectations Regarding Marijuana, FIN-2014-G001.

[14] Id.

[15] Id.see also USA PATRIOT ACT § 314(b).

[16] FinCEN, Marijuana Banking Update, at 2-3.

[17] FinCEN, Marijuana Banking Update, at 1.

[18] Id.

[19] State Proposal-18-1: Legislative Initiative: Coalition To Regulate Marijuana Like Alcohol, 2018 Michigan Election Results (Last updated Nov. 26, 2018) (Proposal passed with 55.89% of vote), available at http://mielections.us/election/results/2018GEN_CENR.html