The End of Marijuana Prohibition: A Joint Effort
Welcome to RDC Insider Insights. This monthly series covers a multitude of modern-day financial crimes. We’ve analyzed our global datasets to understand how certain types of crimes and risks are changing over time, both globally and in regional splits, to uncover trends and provide insights.
Marijuana taboos are loosening worldwide. The breakdown of state cannabis restrictions in the US yields differing legal gray areas requiring financial institutions to use KYC risk-screening. There are many lessons to be learned as this emerging industry develops its best practices.
Screening the Green Market: A Legal Gray Area
Cannabis’ complex history in the United States began with its federal prohibition in 1937. In 1970, the Controlled Substances Act (CSA) classified it as a Schedule I drug. This made it illegal to publicly use, be under the influence of, manufacture, transport, or possess any part of the genus cannabis. However, the evolution of a once fully underground market is transforming because of modern state laws that allow differing means of cannabis dispensing—all of which are contrary to the ongoing federal prohibition of the marijuana market. The divergence of state laws from federal laws requires financial institutions to take special risk considerations when onboarding clients of this rapidly growing industry.
Puff, Puff, Pass Legislation
Since 2012, the year cannabis became recreationally legal in Colorado and Washington, a wave of state cannabis legalizations has placed the legal status of marijuana on a spectrum of illegal to medicinal to recreational. As of April 2020, there are 13 US states or territories, including Guam and the Northern Mariana Islands, that have legalized recreational marijuana. Legal bud, however, does not guarantee free reign. In no state is it legal to consume cannabis publicly, and private consumers of cannabis must be over the age of 21. Beyond that, recreation in one legal state is not equivalent to legal recreational use in another.
Marijuana has been regulated for medicinal purposes since 1996. The breakdown of state policies started in California eight years ago when they tested the Supremacy Clause for recreational consumption. Shortly after, there was a wave of state cannabis legalizations that broadened marijuana’s legal status from illicit to medicinal to recreational, highly motivated by the potential tax benefits.
The variation in regulations makes it harder to track Marijuana Related Businesses (MRBs) and their operations. In turn, business is made more difficult for financial institutions, especially for global banks outside the US who are less familiar with state-specific legislation. However, RDC and other KYC/AML third-party risk screening organizations are capturing and recording these MRBs, so that financial institutions have the capabilities to identify risk-relevant entities and ‘weed out’ money launderers. To aid big banks in further assessing the risks, we can provide some insights on the cultural nuances of US cannabis regulation.
Regional Recreational Restrictions
Washington, D.C. legalized recreational use in 2014, creating a unique juxtaposition in which powerful federal forces and laws are in direct conflict with district sovereignty and legal guidance. The Washington D.C. legalized use comes with a catch: cannabis is only legal as a gift or donation. Thus, dispensaries require you buy a non-cannabis item, such as a T-shirt, in order to receive a free “gifted” cannabis product.
Beyond conflicts of federal and state governance, state recreational laws have varied since their inception. In Colorado, adults may grow a limited number of plants and offer up to an ounce as a gift. In Washington state, however, growing unlicensed and unregulated marijuana remains illegal. Nevada permits growing for personal use only if there is no dispensary within 25 miles of your home.
Cannabidiol (CBD) products add more ambiguity to the legal status of marijuana in jurisdictions where recreation is illicit at both the state and federal level. Although federally legal, CBD, or cannabis with less than 0.3% concentration of Tetrahydrocannabinol (THC), the psychoactive component of cannabis, remains restricted by certain state laws. In 2019, Texas legalized CBD without having the equipment to test the flower’s potency, making it impossible for crime labs to prove the chemical makeup of any cannabis product and harder to prosecute marijuana possession.
Case Study: Nevada, Idaho, and Adverse Media
Open borders between the country’s sovereign states imply a high-risk of federal financial crime. In Idaho, cannabis remains illegal both on the state and federal levels, but its bordering neighbor states – Nevada, Oregon, and Washington – are legal recreational use states.
Conflicting Borders: Marijuana-Related Prosecutions Since 2018
Since 2018, when Nevada legalized recreational products, cannabis-related offenses reported in Idaho have been proportionately double that of Nevada. Nevertheless, shifting cultural attitudes of the region have had an effect. The number of cannabis prosecutions in Idaho have seen a drop since 2017.
Marijuana Trafficking vs Possession Charges, Nevada 2018
Nevada saw an uptick in in cannabis-related cases in 2018, post-legalization. In 2018, Drug Possession (DPS) marijuana cases were more than double Drug Trafficking (DTF) in Nevada. Because prosecutions dropped in 2019, we can attribute this to regulatory enforcement as practices are adjusted to legal changes.
The Crux of the Cash Cow
Despite significant state developments in medical and recreational legal markets, the persistent catch-22 for financial institutions seeking to engage with and profit from the lucrative new industry is the illegality of cannabis cash operations. Financial institutions must comply with federal regulations, and, although MRB profits might be ‘legal’ in a state, they are subject to federal regulatory scrutiny when funds are placed in a financial institution. As a result, financial institutions need to take special precautions to cope with the ambiguity surrounding marijuana proceeds. Third-party risk screening companies with data on MRBs provide a powerful resource to benefit both financial institutions and MRBs in need of a secure place to store their cash. The ability to easily identify MRBs and their associates allows financial institutions to bank with these entities while maintaining proper due diligence measures, such as MRB-specific Suspicious Activity Reports (SARs).
Furthermore, there is a three-tier classification system to support banks in their risk-based approach to Marijuana Related Businesses:
- Tier I: Companies that “touch” the marijuana plant (I.e. Seed to Sales, cannabis farms, dispensaries)
- Tier II: Companies that do not “touch” marijuana, but whose revenue is primarily determined by doing business with Tier 1 companies. (I.e. Hydroponic suppliers, payment processors, advertising and public relations companies)
- Tier III: Companies that provide products and services to Tier I MRBs, but the revenue is incidental to their core business. (I.e. Attorneys. accountants, real estate agents)
These classifications facilitate greater understanding of MRB supply chains and industry networks to provide guidelines for financial institutions, allowing them to perform enhanced due-diligence according to their risk-based KYC methodology.
Setting Risk Standards
While the ambiguity of profits requires regulators to exercise vigilance onboarding MRBs as clients, implementing legal frameworks for dispensaries, processors and growers can significantly reduce risk for financial institutions long-term. Registration processes and the three-tier classification system allow banks to easily trace their clients that pose MRB-specific risks. Additionally, state regulations have proven to diminish some black-market networks, transferring profits away from money launderers. Nevertheless, high tax rates and municipal prohibitions in some regions allow underground operations to continue flourishing.
As a new industry, MRBs have an opportunity to set the standard for the future of emerging markets or those whose business models are non-traditional for proceeds or profits. With more legislation being drafted to address discrepancies in cannabis sales and use, a goal of financial institutions should be to maximize legal profits while providing clarity around due diligence measures to minimize risk. Right now, financial institutions are primarily concerned with the legal gray area of MRB supply chain profits. However, as policies establish greater anti-money laundering security measures between MRBs and financial institutions, and partnerships with KYC screening companies develop to clarify risky entities, we anticipate an expansion in the risk evaluation of MRBs, particularly in areas of Environmental Social Governance (ESG) best practices.