What Canada's Pot Legalization Means For U.S. Financial Cos.


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O Canada! This month marked a significant milestone for the cannabis industry as Canada became the first industrialized nation — and only the second in the world — to legalize cannabis nationwide. This followed the passage of the Cannabis Act in June of this year, which legalized cannabis at all levels of government.

With this blessing from the highest level of the Canadian government, Canada’s legal cannabis industry is expected to grow to $7.2 billion by 2019.[1] Combined with the $21 billion in sales expected in 2021 in the United States in states where cannabis has been permitted under state law, investors are eyeing a lucrative and growing North American market for legal cannabis.[2] Fueled by the desire to enter the largely untapped legal cannabis market and hungry for capital, cannabis companies have begun listing on stock exchanges in both Canada and the United States. Several major players in the Canadian cannabis industry have up-listed to United States exchanges. In the last eight months alone, Canopy Growth, the largest Canadian cannabis company, up-listed to the New York Stock Exchange, Cronos up-listed to Nasdaq, and Tilray became the first cannabis initial public offering on a United States exchange. Following the lead of these companies, Aurora Cannabis will debut on the New York Stock Exchange this fall.

Alternatively, because United States exchanges refuse to list companies that violate United States federal law, United States cannabis-related businesses have looked north. The Canadian Securities Exchange, in particular, has become a haven for United States cannabis businesses seeking to raise capital but unable to list on the major United States exchanges. Prominent United States cannabis businesses Acreage Holdings — backed by former Speaker of the House John Boehner — and LivWell have announced plans to follow in the footsteps of MedMen and list on the Canadian Securities Exchange this fall.

These developments raise issues for American financial services providers offering, or seeking to offer, services for cannabis businesses from both nations. Despite the legalization of cannabis to some extent in approximately 30 states, cannabis remains illegal at the federal level in the United States. This open split between federal and state cannabis laws raises a number of tricky questions for American financial services providers seeking to comply with a set of laws that can seem at times opaque and at times downright contradictory.

So What’s the Law?

To determine how it should proceed in the face of divergent state and federal laws, an American financial services provider must understand the laws potentially implicated by the manufacture and sale of cannabis here and abroad. First is the Controlled Substance Act. The CSA establishes five categories or classifications (“schedules”) of regulated drugs, based on the drugs’ potential for abuse, their accepted medical use, and their treatment in international treaties. Cannabis is listed as a schedule I narcotic — the most dangerous category of narcotics under federal law. Manufacturing, distributing or dispensing cannabis is a violation of the CSA, as is conspiring with another to do so. Aiding or abetting another to violate the CSA is itself a crime, as is knowingly assisting a violator after the fact.[3] Fines and imprisonment are established as penalties for violations of the CSA, and anyone who conspires to commit an offense under the CSA is subject to the same penalties as prescribed for the offense itself. The fines range from $1,000 to $2 million and prison sentences from less than a year in jail to sentences of 10 years. As an initial matter, then, American financial services providers must first satisfy themselves that any contemplated activity does not run afoul of the CSA.

Second, the company must determine its obligations under the Money Laundering Control Act. The MLCA prohibits the transfer of proceeds related to “specified unlawful activities,” including violations of the CSA. Notably, any act “involving ... dealing in a controlled substance or listed chemical (as defined in section 102 of the Controlled Substances Act)” is a specified unlawful activity, the transfer of proceeds from which could lead to a charge of money laundering under § 1956.[4] Because cannabis is now legal in Canada, the underlying manufacture or sale of cannabis inside of Canada arguably is no longer a “specified unlawful activity” under the MLCA.

Third, companies must be mindful of the Bank Secrecy Act’s record-keeping and reporting requirements on statutorily defined “financial institutions” to assist the federal government in combating money laundering. The BSA requires financial institutions to report certain transactions, file suspicious activity reports when it knows or suspects a violation of federal law or a violation of the BSA or detects suspicious transactions related to money laundering, and establish anti-money laundering compliance programs.[5] Willful violations of the BSA reporting requirements can result in civil penalties ranging from $25,000 to $100,000 for each day an institution is noncompliant.[6]

In addition to understanding its obligations under these federal statutes, an American financial services provider should stay abreast of oft-shifting guidance from federal regulators tasked with enforcing these statutes. Under the Obama administration, then-Deputy Attorney General James Cole issued a guidance memorandum deprioritizing enforcement against cannabis-related businesses operating in states where cannabis was permitted under state law.[7] While the Cole memorandum was in effect, certain manufacturers, distributors and sellers of cannabis in states where cannabis was permitted under state law felt more comfortable entering the cannabis business under the theory that they would avoid prosecution by the DOJ as long as their businesses did not implicate one or more of the priorities set out in the Cole memorandum.[8] The “legal cannabis” industry in the United States boomed.

Relying on the Cole memorandum, the Treasury Department’s Financial Crimes Enforcement Network issued guidance on Feb. 14, 2014, clarifying how financial institutions could transact with cannabis-related businesses while still remaining compliant with federal reporting obligations.[9] But with new leadership came new policies, and Attorney General Jeff Sessions rescinded the Cole memorandum on Jan. 4, 2018.[10] Despite the rescission, FinCEN has indicated its previous guidance — which was premised on the Cole memorandum — remains in effect.[11] Because of the cloud of uncertainty surrounding the guidance related to transacting with cannabis-related businesses, and the federal prohibition on cannabis in the United States, many financial services providers have chosen to avoid working with cannabis-related businesses altogether rather than navigate the compliance and reporting requirements associated with these businesses.

Complying With This Federal Regime

Let’s say you are an American financial services company and have reason to believe that a customer or potential customer has some involvement in the Canadian cannabis industry. What then?
The first step any financial services provider should take when assessing the risk of transacting with a cannabis-related business is determining whether any activity undertaken by the customer violates the CSA or whether the financial services provider is being asked to take some action that gives rise to liability under the CSA for conspiracy or aiding and abetting a CSA violation. If so, the financial services provider should strongly consider terminating its relationship with the customer or potentially face American criminal liability.

Next, the financial services provider must determine whether it is a BSA-covered “financial institution.” There has been significant media coverage devoted to cannabis-related businesses’ difficulty obtaining traditional banking accounts, but the BSA applies to an array of entities much broader than traditional depositories, including trust companies, private banks, credit unions, foreign banks, broker-dealers, commodities brokers and mutual funds. If an entity is covered by the BSA, it must implement a monitoring program and file suspicious activity reports for certain transactions. Specifically, and pertinent to cannabis-related businesses, a financial institution must file a suspicious activity report if it knows, suspects or has reason to suspect that a transaction conducted through it involves funds derived from illegal activity, specifically including the production, distribution or sale of cannabis in the United States.[12]

Broadly speaking, the requirement to file a suspicious activity report requires addressing two preliminary questions. First, a financial institution must determine if the services it is providing constitute “transactions” under the BSA. Second, a financial institution must determine if the funds involved with the transaction were derived from illegal activity. The second question is of particular importance now that Canada has legalized cannabis, and financial institutions should not be lulled into a false sense of security simply because they are providing services to a Canadian cannabis company. While the proceeds of any cannabis-related activity originating in Canada generally should not trigger money laundering concerns or SAR reporting obligations, companies should be aware that there is no definitive FinCEN guidance on this point. Regardless, financial institutions are still obligated under the BSA to maintain customer risk profiles and should be vigilant about any indications that a Canadian company’s activities are being unlawfully expanded outside that country’s borders. Although the risk of providing services to Canadian cannabis companies has diminished greatly, the compliance obligations for American financial institutions have not.

With the legalization of cannabis at all levels of Canadian government, the trend of Canadian cannabis businesses listing on United States exchanges likely will continue, adding more complexity and uncertainty to an already murky landscape. And while the official legalization of cannabis in Canada is a significant development in the growing trend of loosening cannabis laws here and abroad, it also presents a risk to both American investors and financial institutions transacting with these businesses. Anyone investing in or transacting with companies listed on either country’s exchanges should also carefully consider the legal and financial risk those relationships may carry. In particular, investors and financial services providers should note that whether the proceeds of a cannabis-related business originate in Canada or the United States may determine whether criminal liability or compliance obligations under American law attaches to those proceeds. While the cannabis industry in Canada and elsewhere celebrates this landmark legislation, American companies investing in or providing financial services to cannabis-related businesses should take a fresh look at their compliance programs to ensure consistency with the most recent rules and guidance in this rapidly evolving space.

The article, "What Canada's Pot Legalization Means for U.S. Financial Cos.," first appeared on law360.com on October 26, 2018.