Between COVID & Compliance – The Current Highs and Lows of the Dope Industry

The decriminalization of marijuana has been gathering increased momentum in recent years, particularly in the United States. At least 35 states currently allow the use of marijuana in one way or another (recreational vs medicinal). Driven by exceptional demand and growing support for legalization, the legal cannabis industry was valued at $13.2 billion in 2019. Investors poured close to $120 billion into marijuana-related businesses (MRBs) that year, as forecasts predicted a CAGR of 21% extending to 2022 and beyond.

Riding on such a high, how did the marijuana industry cope with unprecedented challenges posed by the COVID 19 pandemic last year? And what about the financial aspects of regulations and compliance in an industry that handles a product that is still considered a controlled substance by the Federal government? Let’s first address the more straightforward question on the impact of the pandemic on the legal marijuana industry.

The Impact of COVID 19 on Cannabis

While other retail businesses and sectors struggled to cope with the pressures of lockdowns and social distancing in 2020, the cannabis sector may have actually thrived. The single biggest reason has to be the very nature of the product the industry is selling. The vast majority of cannabis users belong to the recreational category – they use the substance to handle stress and relax. And the fears and uncertainties associated with a dangerous threat like the coronavirus undoubtedly increased the demand for marijuana.

An industry whitepaper from the middle of 2020 clearly depicted a spike in product sales even as the first lockdowns were enforced in March. And as many states deemed cannabis dispensaries as “essential services,” retail sales also remained largely unaffected. As the economy limped towards a semblance of recovery and normalcy in late 2020, the cannabis sales also stabilized to levels that were above those set in the previous year. While the pandemic has changed customer behavior in some ways (online purchases, curbside pickups, no social consumption) demand has remained constant or even increased in some instances.

The Compliance Burden on Banks Dealing with MRBs

The current financial regulations regime for marijuana-related businesses date back to the Financial Crimes Enforcement Network’s (FinCEN) 2014 guidelines related to the Bank Secrecy Act and MRB customers. The guidelines specified a mandatory SAR filing framework for all banks and financial institutions dealing with MRBs, even if the business was operating legally under state law. It also prescribed extremely strict due diligence protocols, with numerous actions that should be considered as red flags.

There was a minor update to these guidelines in late 2019, in response to the decriminalization of hemp cultivation in the 2018 Farm Bill. Banks are no longer required to automatically fire SARs on any MRB that is involved in the cultivation of hemp. But the legally defined “hemp” is a cannabis plant with low THC (unsuitable for the dope industry). As a result, the 2019 refresh could not have a significant impact on the pattern of financial institutional dealings with the marijuana industry. And this was indeed borne out by a subsequent report released by the FinCEN – the Marijuana Banking Update for SARs (PDF link) filed up until the end of 2020. The number of institutions dealing with MRBs declined from an average of 740 per month in Q4 2019 to around 700 by mid-2020, and 685 by the end of the year.

After that initial decline in which the disruptions caused by COVID may have played a part (both for MRBs and bank compliance teams), the numbers have shown no change. Those numbers, derived from a total of 170,975 SARs received by FINCEN, show an ongoing disconnect between a rapidly expanding industry and a financial system that is still somewhat reluctant to engage with it.

How Things Could Change Drastically in 2021

The main issue for many banks and credit institutions is the persistent Federal stance on marijuana as a controlled substance. Regardless of the legalization at the state level, marijuana’s status as a Schedule 1 substance means that banks must classify MRBs as being involved in illegal acts in one form or another. But the arrival of a new administration in Washington under the Democrats has significantly boosted chances of legalization of marijuana. A legalization bill has already been passed by the Democrat-controlled House in December 2020.

Though it was expected to stall in Senate, the Georgia runoffs have left the Democrats with a slim majority. Senate Majority Leader Chuck Schumer has already indicated that the Democrats will make a strong push for the legalization of marijuana at the Federal level. With nearly 70% of the US population showing support for legalization, it seems like only a matter of time now. The implications for banks and regulatory agencies would be massive, as legalization would reduce the burden of due diligence and mandatory SARs on MRBs.

Further, it would also allow big banks and other financial institutions to even consider MRBs as their customers. Given the resilience displayed by the industry during COVID, it should find no shortage of creditors. Everything hinges on legalization though – it remains to be seen how that will pan out in the next 12-18 months.