The following SC&H Group blog post discusses the unique federal regulations faced by cannabusinesses and the financial institutions that serve them. By gaining insight into the uncertain regulatory environment and its impact on banking, internal controls, and recordkeeping, cannabusinesses can prepare for and thrive in the future.
As discussed in our previous post, today’s cannabusinesses handle large volumes of cash in a growing but uncertain industry. And to make matters more complex, they must operate under confusing and often contrasting state and federal regulations—requiring them to overcome several cash management challenges.
Understanding the Intricate Web of Federal Cannabusiness Regulations
While cannabis has been approved for legal medical and recreational use by numerous states, it remains an illegal substance under Schedule I of the federal Controlled Substances Act, thereby receiving the tightest restrictions on its manufacture, use, and trade.
Moreover, the Bank Secrecy Act (BSA), enacted in 1970, requires financial institutions to report cases of suspected money laundering and fraud to the federal government. In 2001, the Patriot Act expanded this requirement to any business dealing with large cash volumes.
So, both cannabusinesses and financial institutions must report cash received over $10,000 to the IRS—posing risks for cannabusinesses that deal solely in cash and the banks that serve them.
However, in 2013 the Department of Justice issued the Cole Memo, which states that the department may not prosecute cannabusinesses in states where an effective regulatory system exists unless it suspects a violation of one of eight federal enforcement priorities:
- Preventing the distribution of marijuana to minors
- Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels
- Preventing the diversion of marijuana from states where it is legal under state law in some form to other states
- Preventing state-authorized marijuana activity from being used as a cover or pretext for the trafficking of other illegal drugs or other illegal activity
- Preventing violence and the use of firearms in the cultivation and distribution of marijuana
- Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use
- Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands
- Preventing marijuana possession or use on federal property
The Impact of FinCEN and Suspicious Activity Reporting
More recently, the Department of the Treasury Financial Crimes Enforcement Network (FinCEN) released guidance in 2014 that clarifies BSA expectations for financial institutions serving the industry.
However, while the FinCEN guidance has enhanced the availability of financial services for and financial transparency of cannabusinesses, it also outlines suspicious activity reporting (SAR). Under SAR guidelines, financial institutions are to distinguish between marijuana limited, priority, and termination businesses, then determine and report to what extent a cannabusiness violates a federal enforcement priority—and terminate a contract if necessary.
Although these distinctions can be beneficial, a recent FinCEN report, found that 374 individual financial institutions in at least 42 states and the District of Columbia filed 3,157 marijuana-related SARs between February 2014 and January 2015.
So, while the industry is growing, it is also seeing widespread reporting, which is exposing businesses to potential penalties. In particular, these regulations are posing challenges to cannabusinesses in three key areas:
- Opening bank accounts
- Safeguarding inventory
- Maintaining records
Opening a Bank Account
In light of these regulations and the fact that cannabis is still illegal under federal law, some national financial institutions are cautious about serving cannabusinesses. Consequently, cannabusinesses often have trouble opening bank accounts. And, they may face the challenge of learning how to run their business, maintain accurate records, and pay bills—using only cash.
If a cannabusiness is unable to open a bank account, they cannot receive loans, credit cards, or debit cards. Moreover, since most credit card companies do not allow customers to use them for cannabis-related purchases, they may have to pay in cash.
In a few states, some small, community, state chartered financial institutions have been open to serving the cannabis industry, though doing so is still difficult and costly.
For example, while Colorado chartered the Fourth Corner Credit Union in 2014 to serve the legal cannabis industry, Fourth Corner recently filed a lawsuitagainst the Federal Reserve for denying their application for a master account to process checks, deposit money, and issue credit. The Federal Reserve explained that it did so because transferring or transporting funds related to the cannabis trade is still a federally illegal activity. The case is still pending.
Safeguarding Cash with Strong Internal Controls
Cannabusinesses are also more susceptible than other business types to theft, embezzlement, and safety issues—a situation that is exacerbated by a lack of banking access.
In a recent interview, Fourth Corner Executive Vice President Mark Goldfogel stated, “In 2016, $1.2 billion in cash will be transacted by the cannabis industry in Colorado. That’s all in $20 bills. At some point, somebody will die. And then we will be allowed to bank.”
Mr. Goldfogel’s words may be dramatic, but the risks are real. So, to mitigate them, cannabusinesses must put substantial time and effort into developing strong internal controls and governance.
Like a casino, a cannabusiness needs to manage and protect their large cash volumes. This often means installing cameras in facilities, limiting who is alone with the cash to reduce theft, and creating multiple sign-offs. During a transaction, a cannabusiness should keep cash receipts for the items, and someone should count the money and have someone else put it in a safe. Controls should also include background checks.
In the face of large cash volumes and increased audit likelihood, cannabusinesses are also presented with the challenge of setting up, tracking, and maintaining records and a chart of accounts. An organized and thorough management system is critical to creating strategic business plans, providing transparency, and complying with all tax and reporting requirements.
Further, financial and business information can be virtually backed up through online platforms such as a cloud-based accounting applications. With enhanced capabilities and greater protection, these technology applications can provide several benefits to a business working with complex operations.
Ultimately, by working with an established advisor, cannabusinesses can develop best practices for strengthening internal controls and managing cash. With due diligence, audit, and tax experience, an advisor can review financial statements for red flags and advise on compliance with federal regulations and filing for large cash volumes—allowing the cannabusiness to reduce risk until the regulatory environment becomes clearer.
To learn more about federal and state regulations regarding medical cannabis, or how to prepare strategic business plans or cash management strategies, contact SC&H Group’s Medical Cannabis Advisory practice here.