Cannabis conundrum: What to do with billions of dollars that banks won’t touch
By Mark Anderson – Staff Writer, Sacramento Business Journal
he billions that will be generated from California’s soon-to-be-legal recreational marijuana industry cannot be banked legally.
And that presents a real conundrum for companies that sell pot.
With the passage of Proposition 64 last year, California is scheduled to legalize adult-use recreational marijuana on Jan. 1, 2018. However, under federal law, marijuana is still illegal, so banks, credit unions and brokerages — all of which have federal oversight — are at risk of losing their licenses to operate if they take money associated with cannabis.
The majority of recreational marijuana transactions are in cash, as opposed to other industries that typically use electronic payments or direct deposits.
That means the state’s newest legal industry will be swimming in cash, but won’t have access to the traditional banking system.
“You cannot have a multi-billion industry that is cash only. The federal government will have to do something,” said Simone Lagomarsino, CEO of the California Bankers Association in Sacramento.
So far, however, there is no indication the federal government is considering a change. In fact, U.S. Attorney General Jeff Sessions has been outspoken in his criticism of the movement to legalize marijuana. In a March speech, he reportedly suggested that marijuana was only slightly less destructive than heroin.
“I reject the idea that America will be a better place if marijuana is sold in every corner store,” Newsweek quoted Sessions as saying. “And I am astonished to hear people suggest that we can solve our heroin crisis by legalizing marijuana—so people can trade one life-wrecking dependency for another that’s only slightly less awful. Our nation needs to say clearly once again that using drugs will destroy your life.”
With current federal law on cannabis expected to remain in effect, the industry’s access to federally regulated parts of the financial system will be limited. That includes the Automated Clearinghouse, used to clear debit and check transactions. It also includes banks insured by the Federal Deposit Insurance Corp. and credit unions insured by the National Credit Union Association.
“It is an industry that really needs access to the banking system, if only for the safety and security of the businesses. You don’t want businesses sitting on a lot of cash, and you don’t want employees carrying a lot of cash,” said Steve Fleming, CEO of River City Bank. “It is a complicated topic, because it is legal at the state level but it is still considered a Schedule 1 drug at the federal level.”
While it is a complicated topic, it is a simple decision for the bank, he said.
“I’m sympathetic to the industry. We’d like to help these legitimate businesses, but we really have our hands tied, because there is no ambiguity in the federal position,” Fleming said.
Cannabis money eventually touches the banking system in one way or another, as the cash derived from the sale of recreational marijuana is eventually spent on other goods and services and deposited into banks, said Linda Navarro, CEO of the Oregon Bankers Association. But there is still no direct link between the banking and cannabis industries in Oregon and Washington, where pot has been legal for several years, said Navarro.
“I would like to believe that over time it has gotten better, but it hasn’t. The federal message seems to be: Don’t get too comfortable,” Navarro said.
Ignorance is not bliss
Banks can’t even feign ignorance of where their customers’ money comes from, Lagomarsino said. Federal laws designed to deter money laundering, drug sales and tax avoidance put federally regulated institutions like banks and credit unions on the hook for knowing where their customers’ money comes from, especially if it is a lot of cash. Under anti-money-laundering rules known as “Know Your Customer,” banks are in jeopardy of regulatory sanction if they don’t investigate the provenance of their client’s income, she said.
Any cash deposit or series of deposits of more than $10,000 over a period of three months triggers a mandatory warning, and banks are required to file suspicious activity reports, or SARS, with the Financial Crimes Enforcement Network, said Lagomarsino. If banks don’t file SARS, they can be sanctioned.
The California State Treasurer’s Office held a series of meetings statewide earlier this year to consider issues surrounding the pending inflow of money from recreational marijuana. The office published report on its findings last week.
One major takeaway was that “it is pretty difficult without the feds,” said Marc Lifsher, communications director for California State Treasurer John Chiang.
“Clearly, the biggest impediment is the federal government when the federal government considers marijuana a Schedule 1 drug in the same category as heroin and cocaine,” Lifsher said. “We can make some things better, but we are hampered by the federal government.”
The federal stance on marijuana also poses a threat to the public, Lifsher said. Without access to the banking system, marijuana-business owners and employees would have to carry around bags of cash — always a risky proposition.
“The feds should be looking at a way of protecting people in a legal business,” Lifsher said. “The state is in no position to solve the problem without help from the federal government.”
In a report issued last week, Chiang suggests studying the feasibility of creating a public bank or other state-backed financial institution that could provide banking services to the cannabis industry.
He also said local governments and state agencies should coordinate and schedule armored-car delivery of cannabis taxes, because most state tax offices aren’t prepared to take large amounts of cash.
A closed loop
Even in the treasurer’s strategy paper suggesting a state bank, the report outlines problems a state bank would face.
First, because cannabis businesses face the risk of having their assets seized by federal authorities, the bank’s collateral and assets are subject to forfeiture with no recourse if they are taken.
And second, even a state bank would need access to the fund transfer systems under the Federal Reserve or it would become a “closed loop system.”
Given the federal government’s stance on marijuana, Joe Devlin, Sacramento chief of cannabis policy and enforcement, anticipates big problems in the new year.
“The volume of cash we are talking about is incomprehensible, even compared to the other states,” he said. “It will be more than Colorado, Oregon, Washington combined — and all in cash.”
University of the Pacific economists have forecast that the recreational marijuana business could add $4.2 billion a year the region’s economic output and create as many as 20,000 jobs.
Currently, about 30 Sacramento medical marijuana dispensaries pay approximately $4.6 million in business opportunity tax, Devlin said. He estimated that is less than half of the taxes that medical dispensaries should be paying. Devlin estimated Sacramento’s current medical marijuana sales at about $250 million annually.
Washington and Colorado legalized marijuana for adult use in 2012. Following those state decisions, the Obama administration issued what is known as the “Cole Memo,” by then-Deputy Attorney General James Cole. The memo said essentially that the federal government would make prosecution of legal marijuana businesses a low priority as long as states could track the industry, make the information transparent and meet certain federal standards.
In an email exchange with the Business Journal, Justice Department spokeswoman Lauren Ehrsam declined to comment on the Trump administration’s stance on the Cole Memo, or on the anticipated in flow of cash into California.
“As the legal cannabis train keeps on going down the track … something will have to be done at the federal level,” said Navarro with the Oregon Bankers Association. “It would be better for everyone to have the industry have access to the real banking system.”