May cause headaches

Murky banking laws and regulations causing consternation for legal cannabis market

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March 2020
By Tatiana Walk-Morris
Chicago Lawyer correspondent

In Illinois’ budding cannabis business, where does a cannabis company get a bank account? In the state’s newly opened recreational market, the answer to that question remains hazy.

As the state’s cannabis market finds its footing, banks are navigating the regulatory uncertainty surrounding these businesses. Though Illinois has tried to lure banks into the sector, financial services firms remain apprehensive about catering to cannabis companies.

Regulatory tension

Though Illinois has joined 10 states and the District of Columbia in legalizing recreational marijuana use, the substance remains classified as a Schedule 1 drug, alongside LSD, Ecstasy and peyote, according to the U.S. Drug Enforcement Administration. This remains the critical source of friction for banks operating in states where cannabis consumption has been legalized, according to experts in the field.

State banking laws in Illinois require state-chartered banks to have Federal Deposit Insurance Corp. backing and thus adhere to federal banking regulations, according to Chasse Rehwinkel, the Illinois Department of Banking acting director.

But as other states legalize cannabis consumption, the federal government has introduced conflicting guidelines on whether financial institutions can serve cannabis companies.

On Aug. 29, 2013, former deputy attorney general James Cole issued a memorandum, commonly referred to as the Cole Memo, which explained the Department of Justice would direct its enforcement authority toward large scale criminal enterprises engaged in cannabis cultivation and sales and away from states that legalized cannabis for medicinal use.

In 2014, the U.S. Department of Treasury issued guidelines to financial institutions explaining what regulations they must adhere to when banking with cannabis businesses in states that legalized cannabis consumption.

But on Jan. 4, 2018, former attorney general Jeff Sessions issued a memo reiterating that the Justice Department continues to consider cannabis as a “dangerous drug and that marijuana activity is a serious crime” as well as urging prosecutors to follow the established practices for prosecuting cannabis transgressions.

“I don’t think that the feds are going to be running to Illinois or anywhere just to get some low level or just a small town weed dealer or a local business that’s banking these folks,” said Mallory Fisk, a St. Louis-based partner at Summers Compton Wells. “But the fact remains that they said they weren’t going to prosecute and they said ‘Oh, never mind, we’re going to take this memo back’ … you’ve got to take that as a chance that they could prosecute that.”

Meanwhile, Congress has several proposed bills that could resolve the cannabis industry’s regulatory ambiguity entirely or, at minimum, clear a pathway for financial services firms to work with cannabis companies: the Secure and Fair Enforcement Banking Act, the Marijuana Justice Act, the Strengthening the Tenth Amendment Through Entrusting States Act, said Thomas Howard, attorney and founder of Collateral Base in Peoria.

The SAFE Banking Act creates protections for financial institutions that serve legal cannabis businesses to reduce the amount of cash these companies manage. The Marijuana Justice Act sponsored by U.S. Sen. Cory Booker, D-N.J., removes cannabis and tetrahydrocannabinols from the list of Schedule 1 drug substances and eliminates criminal penalties for those who manufacture, distribute or possess cannabis with an intent to distribute it.

The STATES Act also amends the Controlled Substances Act by implementing a new rule for how the act applies to cannabis.

Howard said the SAFE Banking Act doesn’t fix the core problem of the classification of cannabis as a Schedule 1 controlled substance; it merely allows federal agencies to oversee the banking sector as it services a business that remains federally criminal.

“That descheduling absolutely makes the SAFE Banking Act meaningless, because you don’t need it anymore, because all of those crimes that the banks are staying away from cannabis for would no longer be crimes,” Howard said. “If it’s not in that list, it’s not a crime.”

Though the proposed bills that would deschedule cannabis as a Schedule 1 substance would resolve the regulatory ambiguity surrounding banking and cannabis businesses, such legislation appears to be unlikely to make it through Congress with bipartisan support, the state Banking Department’s Rehwinkel said. Some members of Congress, such as Sen. Mike Crapo, R-Idaho, continue to hold reservations about cannabis businesses, making it difficult to pass any legislative resolutions.

“We’re obviously quite focused on the SAFE Act, because it was in the works for a period of time and it passed the House with bipartisan support and we believe it has bipartisan support in the Senate,” Rehwinkel said.

Running up the credit

The regulatory uncertainty also affects credit card issuers, which are large national firms and face scrutiny from federal examiners, according to Ben Jackson, vice president of government relations at the Illinois Bankers Association.

Fisk noted some credit card processors will typically process debit card transactions at a higher cost due to the regulatory risks associated with the industry.

Until any federal legislation passes both houses of Congress and is signed into law, banks servicing cannabis companies are beholden to increased regulatory compliance requirements, Jackson said.

For example, they must file suspicious activity reports, commonly referred to as SARs, to the Department of Treasury’s Financial Crimes Enforcement Network, or FinCEN. As a result, banks file SARs across three categories for cannabis clients, he said.

“Banks under federal law oftentimes are quasi-law enforcement agencies,” Jackson said. “They identify fraud. They regularly report to the government … That’s why there’s such a level of anxiety related to this as well.”

In order to satisfy those regulatory requirements, banks must hire staff to keep up with regulatory compliance on the state and federal level, a cost which is passed onto the cannabis account holder, Fisk said.

The fees banks charge on cannabis companies’ accounts can start at 5% of account holders’ business revenue but can go up to 7.5% to 10% of revenue, said Seke Ballard, CEO of the alternative small business lending startup Good Tree Capital, which is aimed at covering the bank’s regulatory compliance costs as well as “pure capitalistic greed.”

Illinois does not restrict how much banks can charge cannabis account holders, but it does regulate how many account holders a bank has in any given industry, including cannabis, Rehwinkel said.

“That’s pretty insane the fact that they’re targeting 5% of your revenue, because if you’re any small business in any other industry, maintaining an account is free or $50 a month, but it’s certainly not 5% of your revenue,” Ballard said.

Questionable solutions

Illinois regulators have attempted to lure the banking profession into the cannabis sector, but banks have concerns about the risks associated with federal regulations, particularly FinCEN guidelines and the state’s interpretation of that, Rehwinkel said. Though banks may be worried about federal regulatory risks related to the cannabis sector, he said the Illinois Department of Financial and Professional Regulation will not penalize banks solely for providing financial services to cannabis companies, because it’s against state law to do so.

“We don’t treat cannabis differently than another risky asset,” Rehwinkel said. “[Banks] just need to make sure that they have the right people in place that understand that it’s a cash-heavy industry, that there’s particular difficulties on a federal level, that can fill out SAR reports.”

Besides unforeseen federal consequences stemming from holding cannabis businesses’ bank accounts, Jackson said banks are worried about how engaging in the industry might affect their overall reputation, particularly in communities that don’t support the legalization of cannabis.

Each bank determines which cannabis companies to work with based on its appetite for risk, instructions from their board of directors, the amount of capital it has and local regulatory compliance requirements based on its location, he added.

The Illinois Department of Treasury has introduced the Community Invest Cannabis Banking Services Program, which provides local banks and credit unions with financial support to provide banking services to cannabis businesses.

Rehwinkel confirmed the professional regulation department informally keeps track of how many financial firms are servicing cannabis businesses and said that he was aware of between five and eight currently doing so, but he declined to share which specific institutions are actively providing accounts to cannabis companies because of the opaque regulatory situation. However, that number “changes constantly,” more so increasing than decreasing, he noted.

Many financial institutions don’t advertise that they’re servicing cannabis clientele, so cannabis companies typically find a bank via word-of-mouth, Jackson said. And some banks, such as the Bank of Springfield, have pulled out of the cannabis sector in part because the Justice Department decided to rescind the Cole Memo, Fisk said.

As some cannabis companies come to his company for financing, Good Tree Capital’s Ballard said that a number of them operate “unbanked,” while others use their personal accounts for company cash, open a management entity to handle their cannabis cash and other operations or secure a cannabis-focused business account.

Ballard said he is aware of cannabis companies that resort to using their personal accounts to transact employee payments or when covering business expenses.

Rehwinkel confirmed that the professional regulation department can track cannabis dispensary transactions regardless of whether they have a bank account or not. Even so, Fisk said having access to bank accounts would ease cannabis companies’ ability to pay taxes and better manage their cash.

Protecting investment

Handling cash could leave customers and store employees vulnerable to theft, Fisk said, adding that only accepting cash may disincentivize customers from patronizing your company.

Reports of at least one dispensary robbery in Chicago have already surfaced. However, the state requires cannabis companies to have security protocols, including high-definition cameras that are subject to law enforcement monitoring as well as vaults for currency and product storage, Howard said.

“You can try to rob a dispensary. I just don’t think you’ll get home if you do it. You just won’t,” Howard said.

Cannabis companies that can’t secure a bank account may have to turn to the nondepository sector, such as the predatory lending firms or private equity firms, which is riskier than banking with FDIC-insured financial institutions, Rehwinkel said.

“I think we have enough financial institutions that are trying in this state that most of our businesses should be able to get accounts, but I can’t say that that’s always going to be the case. That could change day to day,” Rehwinkel said.

However, as the sector continues to grow, FinTech firms will likely be uniquely positioned to provide financial services to cannabis companies without the steep costs associated with legacy banks and doing so with modern technology that aligns with how today’s consumers manage their money, Ballard said.

As Congress sits on legislation that could clear a path for cannabis banking, the lack of banking services available to aspiring cannabis entrepreneurs is a social equity issue, Ballard said. The cost of applying for licensing, acquiring real estate and other expenses associated with starting a cannabis business prices out applicants who can’t finance companies on their own or with the help of high-net-worth contacts and the banking profession will not finance aspiring cannabis entrepreneurs with debt, he said.

Under Illinois’ Cannabis Regulation and Tax Act, the state granted medical cannabis cultivators and dispensaries proper licensing to sell to recreational cannabis beginning Jan. 1. But to become a licensed medical cannabis cultivator and thus be operating prior to the legalization required substantial capital upfront. Cultivation applicants, for example, had to prove that they had $500,000 in liquid assets.

Obtaining the recreational license cost cultivators $100,000 for a permit fee and up to $500,000 for a cannabis development fund fee. For dispensaries, the fees can add up to $130,000 or $230,000 depending on the licensing they’re seeking, though those fees are reduced for social equity applicants.

Following a Feb. 3 statement from the professional regulation department, statewide recreational cannabis sales reached nearly $40 million in its first month. According to the same department, the state currently has 48 licensed adult-use cannabis dispensaries.

“In the cannabis industry, debt is completely off the table, so that means you only have your net worth or the net worth of the people in your network to rely on,” Ballard said. “So the question then becomes if you’re providing pathways for social equity applicants … Do they have that personal net worth or a network that has the kind of wealth to be able to finance that business? The answer is a resounding no.”