Pot Banking Crackdown is a Step Backward

Over the course of the past few years, the medical and recreational marijuana industry has threatened to become mainstream.

That trend is the result of legalization by Washington, Colorado, California and Massachusetts — not to mention numerous other states in which limited marijuana use is now permitted. When combined with the promise of a new stream of tax revenue at the state level, the inevitability of this movement toward marijuana becoming a legalized, taxable vice should be assumed.

However, any evolution of a verboten cultural vice toward legal acceptance is not without opposition and discord created by opponents to legalization. That was brought into focus by Attorney General Jeff Sessions earlier this year, when he rescinded prior Department of Justice guidance regarding the enforcement of federal marijuana laws, often referred to as the Cole memorandum.

Legal action against a bank that does business with marijuana companies could have a chilling effect on the financial industry.

The Cole memorandum, adopted during the Obama administration, established an enforcement position at the DOJ that significantly de-emphasized criminal actions for participants in the marijuana industry. While it preserved the ability of the DOJ to prosecute drug-related criminal activity associated with marijuana, the memo came to be relied upon by banks and investors who viewed providing support functions to marijuana activity as constituting a safe harbor from federal prosecution.

But that comfort level changed with the revocation of the memo under Sessions, just three days after recreational marijuana became legal under California’s new licensing scheme.

There are likely several takeaways from the attorney general’s action.

First, based upon the Cole memorandum, a small but growing number of banks and credit unions believed that banking marijuana businesses presented a reasonable operational risk when balanced against possible federal prosecution. The driving force behind this decision was practical: It is very hard for smaller institutions to raise deposits and originate new profitable loans, whereas cannabis businesses are rolling in cash and require financing. In conjunction with related guidance issue by the Treasury Department’s Financial Crimes Enforcement Network, it was possible to proceed with providing banking services despite the threat of federal prosecution.

The rescission of the Cole memorandum has now significantly increased the risk of prosecution — and if a high-profile criminal action were brought against a bank in this space, it is not hard to envision banks and credit unions fleeing the burgeoning marijuana market.

The shear idiocy of this policy position is to deny access to the payments system. This relegates cannabis businesses to solely rely upon cash, which prevents federal law enforcement from monitoring cannabis businesses for organized criminal activity, such as the transportation of marijuana across state lines.

Second, the recent enthusiasm of investors and corporate entrants into the marijuana business will likely be negatively affected. Investors are extremely risk averse and will now face the prospects of indirectly (or directly) facing enforcement penalties for aiding and abetting federal drug violations — most of which are terrifying. For example, offering statements will now have to describe possible actions that might be directed at investors individually, including racketeering law violations, aiding and abetting liability and asset forfeiture. Similarly, real estate lessors will face the increased risk that real estate leased to cannabis businesses may be seized by federal authorities under asset forfeiture laws.

In short, what Sessions has achieved is increased uncertainty concerning the possibility of criminal prosecution, instead of the demonstrating leadership by encouraging a serious public policy debate about the sale and use of cannabis.

As noted, there are opponents to the legalization of marijuana, but the current state of affairs is strikingly similar to the last days of prohibition. Evaluating appropriate sales, consumption and taxation of cannabis far outweighs the opposition to the legalization of the marijuana industry — not to mention that the continued opposition to legalization also preserves the continued sale of marijuana by criminal elements.

The rescission of the Cole memorandum creates the very real possibility that high-profile criminal prosecutions could be brought against a small number of banks and investor groups, which would immediately result an exiting of these participants.

Should this occur, it would constitute a repulsive use of federal law enforcement authority, which may only hinder but not prevent the eventual legalization of the cannabis industry.

[Originally published by American Banker on January 23, 2018]

Joseph Lynyak III

Joe is a long-time adviser to the financial services industry, with a depth of experience that allows him to "connect the dots" for clients in the complex (and sometimes conflicting) regulatory and statutory schemes confronting financial intermediaries.

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