As the cannabis industry continues to grow, so does its demand for banking services. Brandi Reynolds champions an enhanced due diligence (EDD) program specifically for these customers.
A quick read through recent regulatory enforcement actions against financial institutions will show that regulators are intensely interested in higher-risk customers and in the enhanced due diligence (EDD) institutions must adopt to accept them. Examiners perceive the identification and management of higher-risk customers to be a foundational topic. If problems lurk in this area, there are likely larger problems throughout the BSA/AML program. This perception adds risk when financial institutions begin offering banking services to industries such as the cannabis industry.
The Problem with Cannabis
The demand for banking services from the cannabis industry is growing rapidly as more states legalize cannabis in some form. This growing demand leaves financial institutions with competing priorities. On the one hand, the institution must meet the banking needs of the community and enjoy the fee income that comes with it. On the other hand, the institution must avoid regulatory scrutiny. With the right risk management program, financial institutions can manage both priorities.
From a money-laundering and terrorist-financing perspective, what is the biggest risk BSA officers are managing? It’s likely the risk that the cash passing through the business may be mixed with illicit cash from other activities, be it from organized crime, less sophisticated drug activities or any other form of illegal activity. This risk is enhanced with cannabis because federal restrictions have forced the industry away from most banking services. Breaking this risk down further, one could identify the following BSA/AML functions as being key:
Knowing Your Customer
Who are the real beneficial owners of the cannabis company? Determination of ownership is often particularly difficult with cannabis companies because the layers of ownership are frequently complex. Operating agreements sometimes obscure who really owns the cannabis license and who is benefiting from the cannabis company.
Monitoring and EDD
Monitoring goes beyond following the money to having a thorough understanding of how much cash that cannabis company should be generating to begin with. An institution’s monitoring and EDD analysts have to become cannabis experts. Software used by the cannabis industry referred to as “seed-to-sale” software generates tracking information and logs, and the financial institution should request this data to help its BSA/AML staff understand the origins and reasonableness of the cash deposits. Following that, the BSA/AML department’s cannabis experts should begin a daily monitoring and reconciling process.
Deep Dive into Enhanced Due Diligence
Enhanced due diligence is a regulatory creation of the federal financial institution regulators. It appears under that name in issuances from the Federal Financial Institutions Examinations Council. Originally created as an anti-money laundering protection for banks with foreign customers, it has quickly evolved as a means to protect institutions in dealing with customer they consider to be high risk. The source of the risk can be the customer’s geographic location, business organization, business (or personal) record or industry – cannabis, in this case.
The best analogy to use to describe EDD on a cannabis dispensary is to consider the early days of performing EDD on gas stations. Bankers may remember counting the number of pumps and taking into consideration how many hours per day the gas station is open and whether it’s at a busy intersection or on a quiet country road. The basic principle is the same for cannabis – get a good estimate of the volume of business. If the cannabis company is a grower, are they growing indoors? Outdoors out in the open? Outdoors in a greenhouse? It makes a difference. If the cannabis company is a dispensary, what forms of cannabis are they selling? Flower? Edibles? Vape?
To understand the nuances of growing and selling cannabis, the BSA/AML department’s cannabis experts can take classes at the local college or pursue any number of certificate programs offered by established vendors in the industry. Then they should develop a written cannabis EDD program that has all the traditional EDD elements but incorporates the nuances of cannabis. Management should be ready to evidence the expertise the EDD analysts have. The gaps traditional EDD suffers from will likely present themselves in the cannabis EDD program, so the institution should address those gaps before they even occur. Typical EDD failures are incomplete or incorrect data, incomplete or weak analysis of the factual EDD data points, conclusions that aren’t supported by the analysis and a lack of supporting documents.
There will be no retreat in the growth of the cannabis industry. The industry’s demand and attractive profits – combined with economic pressures on financial institutions – might entice more financial institutions into banking the high-risk cannabis industry. The term “high-risk” should lead BSA/AML officers straight to the EDD program. A well-designed cannabis EDD program will help manage the risk of banking the cannabis industry and give the institution an opportunity to showcase the expertise of the EDD analysts. A quality EDD program staffed with people expert in the cannabis industry should help keep negative exam findings at bay.