March 27, 2017 7 min read

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Federal banking regulations effectively trap the legal marijuana industry in its cash-only, black-market history. Current rules keep cannabis-related businesses in a regulatory gray area that discourages the investment necessary to grow.

The current problem dates to the 2013 Cole Memo, written by Deputy Attorney General James M. Cole and directing Federal prosecutors on how to interpret the Controlled Substances Act (CSA) in states that have legalized marijuana. The Cole Memo reiterated that, “Congress’s determination that marijuana is a dangerous drug and that the illegal distribution and sale of marijuana is a serious crime that provides a significant source of revenue to large-scale criminal enterprises, gangs, and cartels.” In general, the guidelines established a hands-off federal enforcement policy toward businesses that were in compliance with state law.

The U.S. Department of Treasury’s 2014 statement on Financial Crimes Enforcement Network (FinCEN) took the logic from there. FinCEN puts the burden on the bank to perform due diligence on marijuana-related business customers to see if that investigation “implicates one of the Cole Memo priorities or violates state law. This is a particularly important factor for a financial institution to consider when assessing the risk of providing financial services to a marijuana-related business.”

Such financial services include checking, deposits, savings, credit card administration, funds transfers, lending and all the services necessary to running a business. For practical purposes, this largely limits cannabis businesses to operating on a cash-only basis, complicates recordkeeping, taxes and security.

Businesses that work with legal marijuana businesses should not be frozen out of traditional banking services. Our letter: pic.twitter.com/qcW9dIeZXu — Ron Wyden (@RonWyden) December 14, 2016

The statement from FinCEN lists what banks must do to avoid working with businesses posing as legitimate but acting as fronts for criminal enterprise in need of money laundering.

What’s a cannabis biz to do?

Banks can smell the lucrative potential of the cannabis industry in the states that decriminalized medical marijuana and/or adult-use recreational cannabis. Here are the big banking changes in the works to bring the cannabis industry in from its cash-only pariah status.

Related: Cryptic Warnings From the Trump Administration Shake Recreational Marijuana Industry

1. Look for state solutions.

States eager for the economic growth expected from legalized cannabis businesses will collaborate on state banking solutions. Having passed legislation giving the cannabis economy a presence, it's in their interest to resolve the related problems.

Brooke Edwards Staggs, writing for the Orange County Register, quoted California State Treasurer John Chiang, leader of the Cannabis Banking Working Group, who said, “We need quick action and practical solutions." He added that, "California is willing to assume a leadership role nationally to effectively achieve this goal.”

The working group met in Sacramento in December 2016 and has solicited President Trump and California’s congressional leaders to clarify the industry’s banking situation. Treasurer Chiang sees the opportunity to “to gain ever more clarity on precisely what should be done and how.”

Related: Here's Where Colorado Spends Its Skyrocketing Pot Tax Revenue

2. Look to local banking.

Most national and international depository institutions won't work with cannabis companies because of the compliance burden. These larger depository organizations must follow strict compliance guidelines, including the regular filing of Suspicious Activity Reports (SARs) per FinCEN regulations, to legally bank cannabis companies.

Cautious big banks, always the last ship to change course, don't see the potential business from legalized cannabis as offsetting compliance risks. They will continue to refuse cannabis business. With the support of maturing state banking regulations, cannabis-related businesses will seek safe harbor in credit unions and community banks.

The cannabis industry is in its infancy but already has $7 billion in yearly sales and is growing rapidly. Local banks and credit unions have less access to deposits than do larger institutions but they are located near cannabis businesses and have the resources for the due diligence FinCEN mandates. They're better positioned to make on-site checks, listen to local customers and closely analyze cash flow. These smaller banking institutions have a powerful economic incentive manage the compliance risk of working with marijuana businesses.

“Because larger banks tend to have significant assets in their accounts, the marginal benefit to taking on clients in the cannabis industry is usually far outweighed by the marginal cost of maintaining compliance,” remarks Scott L. Greiper, President, Viridian Capital Advisors, a cannabis strategic and financial advisory firm.

Related: Microsoft to Offer Software for Local Governments to Regulate and Tax Legal Cannabis

3. Look to best practices.

If lending and investing become more common, owners and managers can expect specifically marijuana-business targeted Generally Accepted Accounting Practices (GAAP). Such practices will, of course, police the business. But, they'll also help and support owners who lack a full financial background.

GAAP principles and procedures will educate and secure good business performance. They will list dos and don’ts, and they'll create self-audits that owners and managers can follow to maintain consistently positive behavior. They'll establish a transparent performance behavior that is meaningful to banks.

Currently, the extensive use of cash in the industry makes financial analysis and reporting very difficult to vet. Much of the business is off of the books and lacks the standard paper trail of companies that are properly banked.

Related: How Do We Measure the Statistical Significance of Legal Cannabis?

4. Look to the Treasury Department.

President Donald Trump hasn't staked out a firm position on the cannabis industry. It’s not likely to become a priority for him, one way or the other. States’ rights concerns give him something to hide behind.

But, Justin Strekal reports that Trump’s new Secretary of the Treasury, Steve Mnuchin, “indicated that he is open to the idea of working with financial regulatory agencies to level the playing field for local marijuana businesses.” On the other hand, he will have to work with the very conservative new U.S. Attorney General Jeff Sessions.

The best scenario, and one consistent with President Trump's general ideology, would be if the administration just pursued a hands-off policy allowing the states to determine the best administrative path for the new above ground economy. Senators Elizabeth Warren (MA), Bernie Sanders (VT), Lisa Murkowski (AK) and Angus King (ME) are specifically supporting easing of banking restrictions on vendors doing business with cannabis businesses. The outcome could establish a path and format for additional moves.

Related: Congressional Cannabis Caucus Unites to Protect Marijuana Industry

5. Look to the market.

Right now, the term “cannabis market” refers to the number of citizens and users. It also refers to the economic and tax impact. Over 50 percent of Americans nationwide favor access to medical marijuana and/or adult-use recreational use. That constituency represents a real lobbying force.

The economic and tax potential will become real and impressive enough to swing votes. It will empower or hurt candidates for state offices, and their experiences will read as trends and directions in public opinion.

Related: Will the 'Entrepreneur' President Embrace the Cannabis Economy?

The cannabis industry moving forward.

Mark Malone, executive director of the Cannabis Business Association, indicates, "the industry hopes to see more uniform regulation." It is believed that, "in turn, [it] will help the industry grow and aid law enforcement in policing the legal cannabis industry.” He is levelheaded enough to see that states need time to find a footing in their respective constituencies.

Colorado will be surrendering its market size leadership to the power of the California market. The Trump administration will reveal some inclination on cannabis policy.

You may see cannabis business mergers and buyouts. You'll probably see some break in banking for suppliers to marijuana stores and dispensaries. And, you will start to see individual states coming to terms with decisions by the various commissions and working groups now underway.

You won't see changes in the immediate future but important and lasting banking changes are in the works for the cannabis industry.