California’s Department of Business Oversight issued guidance to the banking industry on how to safely provide services to cannabis clients. The regulator is taking this proactive step as more state-chartered banks take on cannabis accounts. The guidance is in the form of a questionnaire that will help banks comply with federal anti-money laundering requirements. It is also a road map that banks will use to determine whether to onboard a client or reporting suspicious activity.
The guidance instructs banks on how to (1) perform due diligence on new cannabis clients, (2) test accounts in order to identify possible money laundering activity, and (3) file suspicious activity reports with the federal banking regulators. Cannabis businesses should be familiar with these requirements as it will impact their present and future banking services.
Banks must file a suspicious activity report with the federal regulators for each cannabis business. There are three types of reports. A bank will file a limited report to notify the federal regulators of a cannabis client that has no suspicious activity and is complying with state regulations.
A bank must file a “marijuana priority” report to notify federal regulators that it has identified red flags or suspicious activity during the due diligence process or through account monitoring. A red flag can be any information that shows that the business or person is violating the Cole Memo or state regulations such as engaging in black market activity. Persons or businesses with this account designation are considered high risk. It is difficult, if not impossible, for businesses or persons with this account designation to find banking relationships.
A bank that is concerned that it is helping a client launder money must terminate the relationship and file a “marijuana termination” report with the federal regulator. Federal regulators pass this information on to law enforcement agencies for further investigation.
So how does a bank determine what bucket a prospective cannabis client should be placed in?
The bank collects documents, asks questions and monitors account activity. Cannabis businesses should take extreme care, from the first conversation with a bank, to project a lawful business that complies with all rules and regulations.
Under the guidance, banks may consider the following as red flags:
Enforcement actions brought against the cannabis business by state or federal regulators.
Negative information is publicly available about the business or related parties.
Revenues are substantial given state limitations, local competition and demographics.
Deposited cash is greater than revenues.
Inability to demonstrate that cash is derived from lawful state cannabis activity.
Cash deposits and withdrawals are made within a short period of time as compared to local competitors or expected business activity.
Withdrawal of cash shortly after it is deposited.
Cash deposit by unrelated third parties.
Financials do not foot with actual business activity.
Businesses that trigger some of the red flags are considered very high risk. These accounts are subject to a heightened level of scrutiny or even termination. Once terminated, a “Scarlet A” will attach to the business, its owners, and possible employees. This designation will prevent the business from finding another banking relationship.
Cannabis businesses should familiarize themselves with this questionnaire and ensure that their banking processes will not trigger a red flag. California’s guidance is good news for the industry. We would expect that the state regulator reviewed the guidance with the federal regulators, which will make it easier for California banks to service the industry. However, we expect that the cost of services will remain high until the banking industry obtains more experience with the industry and cannabis is legalized at the federal level.