Loading…

FinCEN Updates its Marijuana SAR Data… but Information is needed!

The U.S. financial industry is in its 5th year of filing “marijuana” Suspicious Activity Reports (SARs) pursuant to guidance issued by FinCEN on February 14, 2014.  As FinCEN reports this week, 334 banks and 107 credit unions (out of approximately 11,000) are “providing banking services to marijuana-related businesses” or “actively providing banking services to marijuana-related businesses” or “actively banking marijuana-related businesses” (quoting from the title of chart 1 of the update, the text accompanying chart 1, and chart 2, respectively).  But I believe FinCEN’s descriptions are not accurate, as many financial institutions are not, in fact, knowingly providing banking services to marijuana-related businesses (MRBs). Instead, they consider these to be prohibited businesses that they do not knowingly bank, and if they uncover any MRBs through due diligence, monitoring, or surveillance, file a “Marijuana Termination” SAR and exit the relationship.

There is some good data in this report, but not much usable information.  For example, there is nothing on the size and locations of the banks and credit unions filing the marijuana SARs, which states are involved, whether the activity involves medicinal/medical or recreational/adult-use MRBs, or how many MRBs are being reported and why. Next quarter, I’d like to see FinCEN report provide some of this information.  In addition, FinCEN should consider “cleaning up” the report. I offer three suggestions.

First, when describing the three marijuana SAR categories (Limited, Priority, and Termination), FinCEN refers to Cole Memo “red flags” … but none of the three Cole Memos (or the Ogden Memo) have any “red flags”. Rather, the Cole Memos instruct federal prosecutors to “focus enforcement resources on persons or organizations whose conduct interferes with any one or more of the [eight] important priorities”.  The red flags are actually set out in the FinCEN guidance – and there are 23 red flags to consider – and that original guidance correctly refers to the Cole Memo “priorities” when describing the three marijuana SAR types.  Although some may quibble with my distinction, the term “red flags” is a red flag for banking auditors and regulators … the Cole Memo has priorities, the FinCEN guidance has red flags.

Second, footnote 1 of this recent Report describes when to use each of the three marijuana SAR types. For the marijuana “Termination” SAR, FinCEN indicates that it is to be used when the financial institution has decided to terminate its relationship with the MRB because (1) the financial institution “has decided not to have marijuana related customers for business reasons” or (2) the MRB is not fully compliant with the appropriate state’s marijuana regulations, or (3) the MRB raises one or more of the Cole Memo red flags. (Note the use of the alternative “or”). This language is different than the 2014 guidance, which has nothing about deciding not to have marijuana related customers for business reasons.  I would like to see FinCEN provide the industry with guidance for not only exiting MRBs, but also about simply not providing banking services to marijuana related customers for business/risk reasons.  It is clearly needed if only 440 of more than 11,000 banks and credit unions are knowingly or unknowingly providing banking services to MRBs.

Third, there is nothing in the 2014 guidance, nor in this report, that defines a “marijuana related business”.  It is certainly implied that to be an MRB requires being subject to state marijuana regulations, but clear guidance would be helpful. Also, there are many businesses that do not have to be licensed and are not governed by state marijuana regulations, but are indirectly dealing with MRBs. Footnote 7 of the 2014 guidance referred to indirect services (“a financial institution could be providing services to a non-financial customer that provides goods or services to a marijuana-related business (e.g., a commercial landlord that leases property to a marijuana-related business). In such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.”): but it did not differentiate between (what I’ll call) Direct MRBs (those that are required to be licensed under state marijuana regulations) and Indirect MRBs (those that capital, services, products, property to Direct MRBs).  The Small Business Administration has addressed these “indirect” MRBs – see the News from May 2, 2018, below. It would be great if FinCEN did, also.

Finally, this Report describes the marijuana Limited-Priority-Termination SAR categories as “three phases for describing a financial institution’s relationship to marijuana-related businesses.” That isn’t accurate: there is not a progression or phasing of these categories, and the original 2014 guidance didn’t describe them that way. A bank or credit union doesn’t have to start with a Limited SAR, then progress to a Priority SAR, then end with a Termination SAR: they are three distinct SARs, dependent on the circumstances of each case.

Marijuana Looping & Cash Structuring – the Sweet Leaf decision reveals a glaring weakness in states’ controls over their retail marijuana regimes

County of Denver v Sweet Leaf Final Decision 7-5-18

On July 5th the City/County of Denver revoked all 26 marijuana licenses held by 9 businesses operating as Sweet Leaf. For more than two years Sweet Leaf knowingly engaged in “looping” – the practice of making multiple one-ounce transfers of marijuana to the same customer within a single day. According to the Final Decision, “Sweet Leaf’s practice of artificially dividing a single transaction into multiple transfers of marijuana to the same customer was done for the purpose of evading quantity limitations on the sale of marijuana.”

Marijuana Looping: artificially dividing a single transaction into multiple transfers of marijuana to the same customer done for the purpose of evading quantity limitations on the sale of marijuana.

Cash Structuring: artificially dividing a single transaction into multiple transfers of cash by the same customer done for the purpose of evading reporting requirements on cash transactions.

In this case, Sweet Leaf fully acknowledged that it engaged in a looping scheme, but argued that it was simply exploiting a gap in the law limiting customers’ purchases to 1 ounce per day “as long as the customer left the premises and came back without the previously purchased marijuana.” The Final Decision offered some examples, including a medical marijuana patient who purchased 446 pounds of marijuana for more than $577,000 in 137 days over a six month period. In those 137 “loopy” days, Sweet Leaf’s medical marijuana patient purchased enough marijuana to roll about 300,000 joints … 

Critically, the hearing officer concluded that “Sweet Leaf’s actions have put all other marijuana businesses in Denver and Colorado at risk of federal enforcement.”

This case highlights a problem that California’s “pot czar”, Joe Devlin identified in a statement published in the Sacramento Bee on December 29, 2017: “How to enforce a new limit on how much pot a person can buy per day: ‘Does the dispensary have to create a customer account or do you just check ID? I don’t know how you prove you’re not exceeding the daily limit without creating a customer account.’”

No states (I’m aware of) require marijuana/cannabis dispensaries or stores to (1) record the identification of customers/purchasers, and (2) make those identifications available real-time to all retailers to prevent customers from “looping” … but when a dispensary knowingly engages in looping, it deserves to not only lose its license, and have its marijuana stock forfeited (As happened to Sweet Leaf), but there should be criminal actions taken – at both the state and federal level.  I would be surprised if the Colorado US Attorney’s office didn’t step in.

FinCEN’s Marijuana SAR Update …

FinCEN doesn’t seem keen on publicizing these updates … and the media doesn’t seem keen to pick them up. But there is some interesting information …

Since it’s Valentine’s Day 2014 guidance for banks to (not) bank marijuana-related businesses (MRBs) and to file the three types of “marijuana” SARs, FinCEN has been tracking the numbers and types of SARs filed and how may banks and credit unions are banking MRBs (based on the SAR filings). https://www.fincen.gov/sites/default/files/shared/277157%20EA%202nd%20Q%20MJ%20Stats_Public.pdf

  • Limited Marijuana SARs are those where the bank is simply reporting the existence of an MRB – no Cole memo or other red flags. There have been 37,885 of these since 2Q 2014 and they are going up linearly.
  • Priority Marijuana SARs are those where one or more red flags is/are triggered but the bank is not exiting the MRB. There have been 3,809 of these since 2Q 2014 and they are going up linearly.
  • Termination Marijuana SARs are those where one or more red flags is/are triggered and the bank is exiting or has exited the MRB. There have been 12,331 of these since 2Q 2014 and they are going up linearly.

That’s a total of ~52,000 marijuana-related SARs filed since 2Q2014. To put that number in perspective, in that same period, depository institutions filed just over 3.7 million SARs … so marijuana SARs filed by depository institutions accounted for 1.4% of all depository institution SARs.

Another (more) interesting fact. FinCEN reports that, based on SAR filings, about 310 banks and 100 credit unions are “actively banking” marijuana businesses. That’s about double the number from three years ago, but only about 20 higher than a year ago (suggesting that those institutions that are going to actively bank marijuana businesses have already decided to do so, and the rest will sit on the sidelines until the regulatory and criminal prospects are more settled). But it’s still a small fraction of the total number: using FDIC and NCUA data from June 2015 (roughly the middle of the “marijuana SAR” period and published in FinCEN’s final rule for beneficial ownership), there are ~6,350 banks and ~6,165 credit unions. So … just less than 5% of banks and 2% of credit unions are “actively banking” marijuana businesses, according to FinCEN.  But those numbers may be high – those institutions that are filing “Termination” SARs may not, in fact, be knowingly, actively banking marijuana related businesses, but exiting those it finds through monitoring and surveillance – or they may be low – it’s possible that not all banks and credit unions that are “actively banking” marijuana businesses are actively filing Marijuana Limited SARs. It’s hard to tell, since FinCEN seems reluctant or unable to publish detailed, actionable information.

SBA’s new Marijuana Business Policy – Is SBA-backed lending to the budding indirect marijuana industry up in smoke?

On April 3rd, the US Small Business Administration issued a benignly-titled policy notice that could have a profound impact on the “budding” marijuana industry. Title “Revised Guidance on Credit Elsewhere and Other Provisions”, the policy notice essentially extends the prohibition on banks using SBA-backed loans from just direct marijuana businesses to indirect marijuana businesses.  The notice notes that the prohibition “currently provides that businesses engaged in any activity that is illegal under federal, state or local law are ineligible for SBA financial assistance. SBA is issuing additional guidance to specifically address businesses that derive revenue from marijuana-related activities or that support the end-use of marijuana.”

What is meant be “businesses … that support the end-use of marijuana”? These are defined as “Indirect Marijuana Businesses”, which is “a business that derived any of its gross revenue for the previous year (or, if a start-up, projects to derive any of its gross revenue for the next year) from sales to Direct Marijuana Businesses of products or services that could reasonably be determined to support the use, growth, enhancement or other development of marijuana. Examples include businesses that provide testing services, or sell grow lights or hydroponic equipment, to one or more Direct Marijuana Businesses. In addition, businesses that sell smoking devices, pipes, bongs, inhalants, or other products that may be used in connection with marijuana are ineligible if the products are primarily intended or designed for such use or if the business markets the products for such use.”

So what small businesses could derive any of their gross revenue from products or services sold to direct marijuana businesses? The list is long and varied: garden supply companies (you need to read about Hawthorne Gardening Company’s marijuana-related business … and Hawthorne is a subsidiary of Scott’s Miracle-Gro, SMG on NYSE), lawyers, architects, engineers, web designers, etc.

And the Notice forges on, specifically calling out commercial property owners that have the temerity to have tenants such as lawyers, architects, engineers, web designers, etc.,  …

“Leasing Part of a Building Acquired with Loan Proceeds (13 CFR § 120.131). Chapter 2, Paragraph V.F.1.g) (page 131). Currently, this SOP paragraph provides that, during the life of an SBA-guaranteed loan, the borrower may not lease space to a business that is engaged in any activity that is illegal under federal, state or local law. For consistency with the changes identified above regarding marijuana-related businesses, Lenders are advised that, during the life of the SBA-guaranteed loan, a borrower may not lease space to the ineligible businesses described above because the collateral could be subject to seizure and because payments on the SBA loan would be derived from illegal activity. If a borrower does lease to an ineligible marijuana-related business, SBA District Counsel should be consulted to determine what action should be taken.”

So it looks like SBA-backed lending to the budding indirect marijuana business industry may be up in smoke! But as indicated above, whether and how this policy could be enforceable, other than on an after-the-fact basis, is doubtful. At best, hedge funds, private equity lenders, and as always lawyers, stand to do well.

The policy is available at:

https://www.sba.gov/sites/default/files/resource_files/SBA_Policy_Notice_5000-17057_Revised_Guidance_on_Credit_Elsewhere_and_Other_Provisions.pdf