FTC Settlement with Payment Processor Highlights Importance of Anti-Money Laundering Programs for Non-Bank Financial Institutions

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On June 11, 2014, the Federal Trade Commission (“FTC”) announced that it had entered into a stipulated permanent injunction with Independent Resources Network Corp., a payment processor, to settle charges that it knowingly assisted and facilitated a telemarking scam that swindled nearly $10 million from unsuspecting consumers. A copy of the FTC’s press release can be read here.

In its most simple terms, payment processors are entities that process credit or debit card transactions between merchants and consumers. As described by FinCEN:

Non-bank, or third party, Payment Processors … provide payment processing services to merchants and other business entities, typically initiating transactions on behalf of merchant clients that do not have a direct relationship with the Payment Processor’s financial institution. Payment Processors use their own deposit accounts at a financial institution to process such transactions and sometimes establish deposit accounts at the financial institution in the names of their merchant clients.

See FinCEN Advisory FIN-2012-A010.

In its Complaint, FTC alleged that Independent Resources either knew or consciously avoided knowing facts about the illegal conduct of a telemarketing scam operated by one of its merchants, Innovative Wealth Builder, Inc. (“IWB”). According to the complaint, IWB operated a phony debt relief scam wherein IWB would cold call its victims explaining how, for a fee, IWB could reduce the interest rates the customers were correctly paying on their outstanding credit card debt. In reality, no such program existed.

As alleged in the complaint, Independent Resources ignored several indicators of potential fraud including: 1) that IWB had an “F” rating with the Better Business Bureau; 2) that IWB was the subject of an investigation by the Florida Attorney General’s Office for unfair and deceptive trade practices; 3) that MasterCard identified IWB as “tier 3” or “high fraud alert” because of the number of fraudulent transactions which were associated with the debt relief company; 4) that IWB was the subject of an FTC investigation for unfair and deceptive trade practices; and 5) from August 2009 until January 2013 (the filing date of the complaint) IWB’s chargeback rate exceeded 40% multiple times despite the average chargeback rate for all other merchants of the payment processor was below 1%. In addition, the complaint alleged that the payment processor assisted IWB in responding to and defeating thousands of chargeback requests and helped structure sales transactions in order to divide fees over multiple transactions.

In an effort to settle the FTC’s allegations of violations of the Telemarketing Sales Rule, Independent Resources entered into a Stipulated Order. As part of the Stipulated Order for Permanent Injunction and Monetary Judgment, the payment processor agreed to pay $1.1 million. In addition, the order prohibits the payment processor from processing payments for any client that sells debt relief products or services. Further, the payment processor cannot process payments from collection agencies, credit card protection services, lead source provides, mortgage loan modifications, or outbound telemarketing without conducting upfront screening and ongoing monitoring.

As the Independent Resources settlement makes clear, in addition to the numerous agencies which regulate the financial services industry, including FinCEN, FDIC, OCC, and the IRS, non-bank financial institutions must also ensure that the business practices of their customers are not false, misleading, or unlawfully deceptive so as to violate the FTCA. The stipulated order and settlement highlights the need for payment processors, and the financial institutions that serve them, to develop, implement, and maintain robust anti-money laundering compliance programs. See generally, 31 U.S.C. § 5318. A properly constructed AML program — even for companies which are not technically required to have one – will be helpful in accomplishing two critical tasks: 1) detecting potential fraud and abuse by merchants, and 2) ensuring that the company is not unwittingly participating in the legal violations of third parties. As we have previously reported with regards to internet gambling, in addition to civil liabilities, third party payment processors face potential criminal prosecution for facilitating violations of federal law. (Our previous reports regarding payment processor liability can be read here and here.)

We will continue to watch for the latest developments. Fuerst Ittleman David & Joseph’s Anti-Money Laundering practice covers a wide range of businesses and legal issues. Our AML practice group has represented a wide array of financial services providers in all aspects of their business. In addition, our attorneys have experience working with regulated industry to ensure that marketing, advertisements, and disclosures are in compliance with applicable FTC law and regulation. For more information regarding the Bank Secrecy Act or if you seek further information regarding the steps which your business must take to become or remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Corporate Compliance Officers Face Threat of Civil Monetary Penalties and Criminal Prosecution for Institutional AML Deficiencies

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While financial institutions have long faced the possibility of civil monetary penalties and criminal prosecution for violations of the Bank Secrecy Act (“BSA”) and its implementing regulations, found at 31 C.F.R. Chapter X, a recent FinCEN enforcement action against former MoneyGram chief compliance officer Thomas Haider highlights the most recent trend in BSA enforcement: holding compliance officers personally liable for corporate AML deficiencies.

In November 2012, MoneyGram entered into a deferred prosecution agreement with the United States Department of Justice stemming from allegations that MoneyGram failed to maintain an effective anti-money laundering compliance program and, as a result, aided in multiple instances of wire fraud. In the agreement, MoneyGram admitted that its AML program was ineffective due to the company’s failure to report the perpetrators of the fraud. As part of the deferred prosecution agreement, MoneyGram agreed to forfeit $100 million. A copy of the deferred prosecution agreement can be read here.

Pursuant to 31 U.S.C. § 5324, FinCEN is authorized to assess civil monetary penalties against a financial institution and its partners, directors, officers, or employees for violations of the Bank Secrecy Act. At the time of the signing of the deferred prosecution agreement, FinCEN did not assess any additional civil monetary penalties. However, as reported in a recent Reuters article, earlier this year, FinCEN sent former MoneyGram chief compliance officer Thomas Haider a letter notifying him of that he may be liable for a potential civil monetary penalty of $5 million stemming from the admissions made by MoneyGram in its deferred prosecution agreement. A copy of the article can be read here.

The Haider penalty comes as FinCEN has faced increased pressure from Congress to hold individual officers and personally accountable for institutional BSA violations in the wake of the HSBC Consent Decree and Deferred Prosecution Agreement wherein HSCB agreed to a record $1.9 billion in penalties but no individuals were held civilly or criminally liable. After the HSBC case concluded and in the face of mounting pressure from Congress, Treasury undersecretary David Cohen assured the Senate Banking Committee that FinCEN would look for more opportunities to issue civil penalties to partners, officers, directors, and employees of financial institutions who actively participated in the misconduct. A transcript of Mr. Cohen’s testimony before the Senate Banking Committee can be read here.

FinCEN’s new focus on individual corporate compliance officer liability has drawn harsh criticism from the regulatory compliance community for the potential chilling effect it will have on financial institutions’ willingness to cooperate with law enforcement and on quality personnel avoiding entering the field. As explained by Rob Rowe of the American Bankers Association in a recent interview, the potential for corporate officer civil liability, regardless of the amount, “will cause all compliance officers to think” and could “lead to a shortage of compliance officers.”

Although cases like Mr. Haider’s are relatively new in the BSA/AML environment, they are not unique, and we can point to various cases in other environments where individuals have been held personally liable for institutional misdeeds. For example, as we previously reported, although criminal sanctions against corporate officers for violations for the Food, Drug & Cosmetic Act (FDCA) have been on the books since 1938, federal prosecutors have recently taken aim at individual executives through the use of the “responsible corporate officer doctrine,” better known as the Park doctrine. (More information regarding the Park doctrine can be read in our other reports here, here, here, and here.)

We will continue to watch for the latest developments. Fuerst Ittleman David & Joseph’s Anti-Money Laundering practice covers a wide range of businesses and legal issues. Our AML attorneys advise a wide variety of financial institutions regarding their licensing and anti-money laundering requirements as set forth by the Bank Secrecy Act and individual state laws. The anti-money laundering law firm of Fuerst Ittleman David & Joseph, PL has represented a wide array of financial services providers in IRS-BSA audits, OFAC licensing issues, grand jury investigations, state investigations, criminal and civil litigation, and commercial transactions. For more information regarding the Bank Secrecy Act or if you seek further information regarding the steps which your business must take to become or remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Choked Out: Operation Choke Point seeks to eliminate financial services for “high risk” businesses

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Since early 2013, the United States Department of Justice (“DOJ”) has been formally targeting banks that service a wide range of lawfully operating businesses that it and the Federal Deposit Insurance Corporation (“FDIC”) consider “high risk.” The probe, known as “Operation Choke Point,” was started as an outgrowth of the Financial Fraud Enforcement Taskforce and seeks banks’ assistance in choking off access to the financial services industry by shutting down the bank accounts of high risk businesses.

As described in the April 24, 2014 Wall Street Journal Op-ed article by American Bankers Association CEO Frank Keating:
Justice’s premise is simple: Fraudsters can’t operate without access to banking services, and so the agency is going after the infrastructure that questionable merchants use rather than the merchants themselves. Most of these merchants are legally licensed businesses on a government list of “risky profiles.”
 
Mr. Keating’s Op-ed can be read here.
Operation Choke Point initially focused on online payday lenders operating in states that prohibit payday lending activity. However, Operation Choke Point has expanded its focus to a wide variety of areas that the FDIC has categorized as being “associated with high-risk activity.” According to the FDIC, such “high-risk” merchant activity includes ammunition, tobacco, fireworks, firearms, pornography, life-time membership clubs, and coin dealers, just to name a few. A complete list of the FDIC’s “high-risk” merchant categories can be found in its Summer 2011 Supervisory Insight entitled, Managing Risks in Third-Party Payment Processor Relationships.
In an effort to increase scrutiny of these so called “high-risk” activities, federal authorities are focusing on where these merchants receive financial services, particularly banks and payment processors. As a result, banks and payment processors have been forced between two difficult options: either discontinue servicing commercial customers which the federal government deems to be engaging in questionable although legal behavior, or continue and risk being the subject of heightened regulatory scrutiny and penalties.
Not surprisingly, Operation Choke Point has drawn harsh criticism from Congress due to the potentially devastating impact it has on millions of Americans’ access to legitimate nontraditional banking systems such as payday lenders and check cashers. As detailed in an August 22, 2013 letter from Congress to Attorney General Eric Holder, “[m]ore than one in four American households conducts some or all of their financial transactions outside the mainstream banking system.” Further, as explained by the House Committee on Oversight and Government Reform in its January 8, 2014 letter to Attorney General Holder, “[w]hile online leading, like all financial services, can be susceptible to fraud, the overwhelming majority of lenders fully comply with all applicable statutes, regulations, and industry-recognized best practices.” Thus, because Operation Choke Point “would eliminate the basic processing services that legitimate lenders rely upon to serve millions of Americans[,] [a] much more targeted approach is required.”
The banking industry has also voiced concern about Operation Choke Point because of the increased strain it has caused for banks’ anti-money laundering (“AML”) compliance programs. On April 8, 2014, the Independent Community Bankers of America (“ICBA”) described Operation Choke Point as “impos[ing] ill-considered and costly mandates on payment systems” and “threaten[ing] to close access to the financial system to law-abiding businesses, because the mere prospect of an enforcement action is sufficient to cause financial institutions to restrict access to their payment systems to only established companies that present low risks.” Thus, the ICBA requested that “DOJ suspend Operation Choke Point immediately and focus its resources directly on businesses that may be violating the law, rather than targeting banks providing payment services.” ICBA’s complete statement can be read here.
 
Similar thoughts were echoed by Frank Keating in his Wall Street Journal Op-ed:
[L]aw-enforcement agencies and courts, not banks, are responsible for determining criminal violations. The 1970 Bank Secrecy Act spells out the proper partnership for banks and law-enforcement agencies. The law established record keeping and reporting requirements for banks so that law-enforcement agencies would have the evidence needed to prosecute criminals effectively. That is the division of labor and responsibility envisioned by Congress: drawing upon each other’s strengths to fight crime.
 
Although Operation Choke Point was only formally launched in 2013, the purposes behind it are nothing new. Similar efforts have been launched in the past with respect to money services businesses (“MSBs”) and a variety of other “high risk” industries. For example, both the Office of the Comptroller of the Currency and FDIC have previously recommended that banks engage in enhanced due diligence, including ceasing the provision of services entirely, to MSBs due to the money laundering risks associated with such businesses. While Operation Choke Point is unquestionably damaging for banks and their “high risk” commercial customers, it will also hurt those individuals who utilize nontraditional financial services for their everyday banking needs.
The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, regulatory compliance, and litigation against the U.S. Department of Justice. If you are a financial institution seeking information regarding the steps your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Despite FinCEN and Department of Justice Guidance, Difficulties Remain for Financial Institutions Providing Services to Marijuana-Related Businesses

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A. Introduction: The great divide between State and Federal law.

As more States move towards the legalization of marijuana in various forms and to various degrees, marijuana is quickly becoming a growing and profitable industry. Despite changing state legislation, the federal government still lists marijuana as a Schedule I controlled substance under the Controlled Substances Act (“CSA”) 21 U.S.C. § 801 et seq. As a result, the possession, use, and distribution of marijuana in an state remain crimes under federal law. In addition, as described in a February 14, 2014 Department of Justice (“DOJ”) Memorandum by Deputy Attorney General James Cole entitled, Guidance Regarding Marijuana Related Financial Crimes: “The provisions of the money laundering statutes, 18 U.S.C. §§ 1956, 1957 the unlicensed money remitter statute, 18 U.S.C. § 1960, and the Bank Secrecy Act (“BSA”), 31 U.S.C. §§ 5311-5330, remain in effect with respect to marijuana-related conduct.” A copy of the February 14, 2014 DOJ Memo can be read here.

Moreover, the United States Supreme Court has found that the federal government has the power under the Commerce Clause to regulate, prohibit, and criminalize the possession, sale, and use of marijuana regardless of whether such activities are legal under State law. As explained by Justice Scalia in his concurrence in Gonzalez v. Raich:

Not only is it impossible to distinguish ‘controlled substances manufactured and distributed intrastate’ from ‘controlled substances manufactured and distributed interstate,’ but it hardly makes sense to speak in such terms. Drugs like marijuana are fungible commodities. As the Court explains, marijuana that is grown at home and possessed for personal use is never more than an instant from the interstate market and this is so whether or not the possession is for medicinal use or lawful use under the laws of a particular State.

545 U.S. 1 (2005). Thus, the Court held that even small amounts of home grown marijuana legally grown pursuant to State law triggered the CSA because there was a threat of unwanted commodity diversion that could disrupt Congress’s control over interstate commerce.

However, on August 29, 2013, Deputy Attorney General Cole issued a memorandum to federal prosecutors regarding the DOJ’s enforcement priorities with respect to marijuana. The Cole Memo lists eight priorities that guide DOJ in its enforcement of the CSA against marijuana-related conduct in light of the growing number of States which have legalized its sale and use. These priorities include:

  • Preventing the distribution of marijuana to minors;
  • Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
  • Preventing the diversion of marijuana from states where it is legal under state law in some form to other states;
  • Preventing state-authorized marijuana activity from being used as a cover or pretext for trafficking of other illegal drugs or other illegal activity;
  • Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
  • Preventing drugged driving and the exacerbation of other adverse public health consequences associated with marijuana use;
  • Preventing the growing of marijuana on public lands and the attendant public safety and environmental dangers posed by marijuana production on public lands; and
  • Preventing marijuana possession or use on federal property.

A copy of the August 29, 2013 Cole Memo can be read here.

An example of DOJ’s exercise of prosecutorial discretion in CSA enforcement was the subject of an indictment recently unsealed in the Federal District Court in Denver. In November 2013, federal agents raided several Colorado medical marijuana dispensaries for alleged ties to international money laundering. The investigation has so far resulted in the indictment of four individuals on money laundering charges. According to the Indictment, the conspiracy centers around the defendants’ alleged creation of a shell corporation known as Colorado West Metal, LLC. The Indictment alleges that defendants opened a Wells Fargo bank account using the Colorado West Metal name to accept international money transfers from Columbia with the purpose of using that money to purchase marijuana warehouse facilities. The Indictment further alleges that the funds were then transferred out of the Colorado West Metal account and through the accounts and trusts of several other entities prior to the purchase of the dispensary property in an effort to conceal its source. The defendants also allegedly used the Colorado West Metal account to wire proceeds from the sale of marijuana in their dispensary internationally back to Columbia. As part of the ongoing criminal investigation, the defendants’ marijuana dispensary was again raided by federal agents on April 30, 2014. The Department of Justice press release detailing the indictment can be read here.

The Indictment is instructive in several respects. First, the Indictment highlights the difficultly banks face in establishing AML procedures for effectively complying with their responsibilities under the Bank Secrecy Act when dealing with the cash intensive business of marijuana as well as the ease with which criminally-derived funds can quickly become commingled with lawfully earned funds. The case also highlights how critical it is for the federal and state governments to resolve their marijuana-related differences.

B. Financial Institutions’ Responsibilities under the Bank Secrecy Act.

In addition to direct criminal penalties for drug trafficking and money laundering, marijuana-related businesses face additional legal barriers which make operation difficult. One such barrier is finding financial institutions to process the proceeds of marijuana sales due to the criminal status of marijuana sales under federal law.

Pursuant to the Bank Secrecy Act (“BSA”), financial institutions are required to create reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. More specifically, federal law requires that financial institutions file Suspicious Activity Reports (“SAR”) if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320; see also 12 C.F.R. § 21.11; (more information on BSA requirements can be found on the Office of the Comptroller of the Currency’s website here).

Moreover, in addition to reporting requirements under the BSA, financial institutions also face the realistic possibility of federal criminal penalties for assisting in money laundering should they knowingly accept and process money received from dispensaries. Under a plain reading of the BSA and the money laundering statutes, banks cannot provide financial services to marijuana-related businesses without violating federal law. Consequently, financial institutions have been hesitant or have simply refused to allow marijuana dispensaries to maintain accounts or conduct business with them. Banks’ refusal to do business with marijuana-related businesses has been the subject of numerous articles including those by the New York Times and the Huffington Post.

As it applies to the proceeds derived from the sale of marijuana pursuant to state law, FinCEN has explained:

Because federal law prohibits the distribution and sale of marijuana, financial transactions involving a marijuana-related business would generally involve funds derived from illegal activity. Therefore, a financial institution is required to file a SAR on activity involving a marijuana-related business (including those duly licensed under state law), in accordance with this guidance and FinCEN’s suspicious activity reporting requirements and related thresholds.

(emphasis added). See FinCEN, FIN-2014-G001, BSA Expectations Regarding Marijuana-Related Businesses, (February 14, 2014), available here. Thus, because the sale of marijuana remains prohibited under federal law, financial institutions are placed in a position where, if they agree to service marijuana dispensaries, they would be required to report any transaction regardless of State law.

Financial institutions’ refusal to allow marijuana-related businesses to use their services and maintain bank accounts has made it extremely difficult for these businesses to operate. As a result, many legal marijuana businesses have resorted to all cash operations. Further, with the banking situation as it is, some marijuana-related businesses have sought “creative” solutions to their banking problems, including: 1) establishing shell companies to disguise marijuana proceeds; 2) funneling marijuana derived profits into accounts of other legitimate businesses; 3) placing marijuana derived profits into bank accounts of family members or personal accounts; and 4) flying cash out of country to locations such as the Cayman Islands. Our previous report regarding the potential criminal and civil liabilities associated with such activities can be read here. Kristen Wyatt of the Associated Press has highlighted several of these and other “creative” solutions on her Twitter feed which can be followed here.

However generally speaking, the use of shell companies or other accounts to mask the profits derived from the sale of marijuana could subject the owner of a marijuana-related business to a wide variety of federal criminal penalties, including bank fraud, 18 U.S.C. § 1344, wire fraud, 18 U.S.C. § 1343, and money laundering. Additionally, those who assist in such actions, for example the friend or family member who allowed for money to be transferred through his or her account, could also face similar criminal charges. Moreover, should such fraud occur, the financial institutions that process this money can still be held liable for money laundering and face criminal and civil fines and penalties, all of which are available regardless of whether marijuana is legal under State law. Regardless of whether marijuana is involved, if a company lies for the purpose of opening a bank account, the consequences can be incredibly severe.

C. The federal government’s attempt to create a compromise to allow for access to financial services: FinCEN’s “BSA Expectations” Guidance and the Department of Justice Cole Memorandums

FinCEN has made clear that a financial institution’s obligation to file a SAR is unaffected by any state law that legalizes marijuana-related activity. However, given the burgeoning marijuana industry, FinCEN recently undertook to explain how financial institutions can provide services to marijuana-related businesses while maintaining their responsibilities under the BSA by publishing its Guidance: BSA Expectations Regarding Marijuana-Related Businesses. FinCEN’s Guidance focuses on three areas: 1) increased due diligence; 2) new marijuana-related businesses SAR filing responsibilities; 3) “red flag” examples which may indicate a violation of state law or implicate a Cole Memo priority.

At the outset, it must be noted that FinCEN’s guidance should be read in conjunction with the August 29, 2013 and February 14, 2014 DOJ memorandums issued by Deputy Attorney General Cole to federal prosecutors regarding DOJ’s enforcement priorities with respect to marijuana. It is against this backdrop and with these priorities in mind that FinCEN drafted its guidance. FinCEN has explained that this Guidance furthers the objectives of the BSA “by assisting financial institutions in determining how to file a SAR that facilitates law enforcement’s access to information pertinent to a [enforcement] priority.”

1. Financial Institutions are required to engage in “thorough due diligence” prior to accepting marijuana-related businesses as clients.

FinCEN’s guidance makes clear that before providing financial services to a marijuana-related business, a financial institution must conduct a thorough customer due diligence. FinCEN noted that this due diligence should include: 1) verifying that the business is licensed and registered with state authorities; 2) a review of the state license application and supporting documents to operate as a marijuana business; 3) requesting available information about the prospective customer from state licensing and enforcement authorities; 4) obtaining an understanding of the nature of the business including the types of products sold and the customers to be served; 5) monitoring of publicly available sources for adverse information about the potential business customer; and 6) monitoring for suspicious activity, including whether the business implicates one of the DOJ enforcement priorities or violates state law. Further, financial institutions should continue their due diligence efforts and periodically refresh such information throughout the time they provide financial services to marijuana related businesses.

2. Financial Institutions New Marijuana-Related Businesses SAR filing responsibilities.

While the traditional filing of SARs has been limited to “suspicious” transactions, SARs for marijuana-related activity are more complex due to the conflict between state and federal law. Thus, while other businesses rarely trigger an SAR filing, every single marijuana-related business will trigger the filing of an SAR.

Towards that end, FinCEN has established three categories in describing a financial institution’s SAR filing responsibilities when engaging in services for marijuana-related businesses: 1) “Marijuana Limited” SAR filings; 2) “Marijuana Priority” SAR filings; and 3) “Marijuana Termination” SAR filings.

Regarding the first category, FinCEN explains that financial institutions should file a “Marijuana Limited” SAR when the institution reasonably believes, based on its due diligence, that the potential marijuana-related business customer does not implicate one of the DOJ Memo priorities or violate state law. It is important to note that this SAR filing should state “the fact that the filing institution is filing the SAR solely because the subject is engaged in a marijuana-related business,” and that no additional suspicious activity has been identified. Further, the financial institution must file continuing marijuana-related SARs which detail the amount of deposits, withdrawals, and transfers from the account since the previous SAR filing throughout the time that a financial institution provides services to a marijuana-related business. However, should a financial institution’s continued due diligence reveal a potential violation of state law or implicate a DOJ Memo priority, the financial institution should file a “Marijuana Priority” SAR.

A “Marijuana Priority” SAR is only to be filed when a violation of state law is suspected or when the activities of a marijuana-related business may implicate DOJ Memo enforcement priorities. A Marijuana Priority SAR will be substantially more detailed and should include: 1) identifying information of the subject and related parties; 2) addresses of the subject and related parties; 3) dates, amounts, and relevant details of the financial transactions involved; and 4) “details regarding the enforcement priorities that the financial institution believes have been implicated.”

Additionally, financial institutions must be aware that these filing obligations also apply when the institution provides “indirect services” to a marijuana-related business such as providing services to a another domestic financial institution which in turn services marijuana-related businesses or to a non-financial customer who provides goods or services to a marijuana-related business. (FinCEN uses the example of a commercial landlord who leases its property to a marijuana-related business). This naturally will require that financial institutions perform robust due diligence on all customers with potential indirect ties to marijuana-related businesses. However, FinCEN explains that “[i]n such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.”

The final category of SAR filings is the “Marijuana Termination” SAR. “If a financial institution deems it necessary to terminate a relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program, it should file a SAR and note in the narrative the basis for the termination.”

3. Red flag monitoring to indicate a violation of law or DOJ enforcement priority

In addition to making clear that prior to providing financial services to a marijuana-related business a financial institution must conduct a thorough customer due diligence, FinCEN has identified a series of red flags that would indicate that a marijuana-related business may be engaged in activity that implicates one of the Cole Memo priorities or violates state law. Such red flags include: that the business receives significantly more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates; that the business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law; a customer seeks to conceal or disguise involvement in a marijuana-related business activity; and that a business is unable to demonstrate the legitimate source of significant outside investments. The complete list of red flags can be found in FinCEN’s BSA Expectations Guidance.

However, FinCEN has also made clear that these red flags do not constitute an exhaustive list. As such, FinCEN has emphasized the importance of viewing any red flag(s) in the context of other indicators and facts, such as the financial institution’s knowledge about the underlying parties obtained through its customer due diligence.

D. Analysis of FinCEN’s new “protections” for financial institutions.

FinCEN’s guidance may in fact be a good faith attempt by the federal government to ease anxieties about providing financial services to marijuana-related businesses. However, the banking industry’s reaction has been lukewarm at best.

As explained by the Colorado Bankers Association:

Bankers had expected the guidance to relieve them of the threat of prosecution should the open accounts for marijuana businesses, but the guidance does not do that. Instead, it reiterates reasons for prosecution and is simply a modified reporting system for banks to use. It imposes a heavy burden on them to know and control their customers’ activities, and those of their customers. No bank can comply.

 (emphasis added). The Colorado Bankers Association’s statement is available in full here.

Similar thoughts were echoed by the American Bankers Association: “While we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.” The American Bankers Association’s statement is available in full here.

The sentiments of the CBA and the ABA were recently echoed by the Colorado State Senate in Senate Resolution 14-003 entitled, “Concerning Congressional Action to Facilitate Legal Financial Services for the Marijuana Industry.” In its resolution the Colorado Senate noted that both the Controlled Substances Act and the Bank Secrecy Act prohibit banks from providing financial services to marijuana businesses. The Colorado Senate further noted, among other things, that “[d]irectives from federal regulatory agencies such as the Federal Reserve, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Office of the Comptroller of the Currency also prohibit bankers from accepting deposits from marijuana or hemp businesses.” Thus, the Colorado Senate passed a resolution stating:

Be It Resolved by the Senate of the Sixty-ninth General Assembly of the State of Colorado:

(1) That the ability of the federal executive branch to facilitate a reasonable regulatory structure for the marijuana industry is limited as long as federal law categorizes marijuana as an illegal substance.

(2) That the best solution to the problem of a lack of financial services for the legal marijuana industry will be comprehensive federal legislation authorizing banks and credit unions to serve legal marijuana and hemp businesses.

Be It Further Resolved, That copies of this Resolution be sent to all members of the Colorado delegation to the United States Congress, the speaker of the United States House of Representatives, the United States Senate majority leader, the United States Senate majority leader pro tempore, and the president of the United States.

Here, a careful reading of FinCEN’s guidance reveals that FinCEN’s red flags go above and beyond the anti-money laundering programs banks are required to keep. Further, these red flags may present more of a problem than a solution to financial institutions looking to provide services to marijuana-related businesses and to marijuana-related businesses looking to benefit from basic banking services. Asking a financial institution to dig deep into whether the business is receiving substantially more revenue than may be reasonably expected given the relevant limitations imposed by the state, what its competitors are making or what it reported on its income tax returns is essentially asking financial institutions to audit businesses they know nothing about in the first place. In effect, these red flags are totally impractical for typical banks looking to provide basic services to marijuana-related businesses because they raise more questions than they provide answers.

To take on this new industry, banks must acquire new tools for their anti-money laundering programs to comply with FinCEN’s Guidance. Full compliance will require both a comprehensive understanding of a bank’s requirements under the BSA and the intricacies of any given State’s marijuana dispensary and use laws. Compliance with FinCEN’s Guidance is possible, but banks willing to take on the new business must be cautious, flexible, and elegant in their approach. Without new tools, lack of access to the banking and financial services industry presents a potentially disastrous situation to the legal marijuana industry.

Fuerst Ittleman David & Joseph, PL will continue to watch for the latest developments in the regulation of financial services and the marijuana industry. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution or marijuana-related business, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Casino AML Compliance Update: Las Vegas Sands Corp. Places Macau Casino Junkets Under Increased Scrutiny.

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On April 4, 2014, Bloomberg reported that the Las Vegas Sands Corp. (“Sands”) has increased its scrutiny of casino junket operators in Macau. The decision comes as casinos seek to meet the increased demands of federal regulators to prevent money laundering.

Macau’s casino industry relies heavily on junket operators to connect wealthy Chinese mainland gamblers with the casinos. However, as the U.S.-China Economic Security Review Commission notes, “[t]he main channel for money laundering [in Macau] is in the gaming sector through underregulated junket operators and their affiliates, which include the underground banking system, that supports their operations.” As described in 2013 Annual Report of the Congressional-Executive Commission On China, the “movement of money through Macau is fueled by a ‘junket’ system, which reportedly aids mainland VIP patrons in bypassing China’s limits on how much money can be taken out of China.” The 2013 Annual Report estimated that $202 billion in ill-gotten funds are laundered through Macau each year.

Although Sands has not disclosed how, exactly, it plans on conducting enhanced due diligence on junket operators, the measure no doubt comes as part of a designed series of steps that Sands has taken to increase its AML Compliance program. In January 2013, the Wall Street Journal reported that the Sands was bolstering its anti-money laundering compliance program, and ceased executing international money transfers for its high-rolling customers. Sands also reportedly limits the use of checks and money transfers from business accounts and restricts the amount of cash a customer can withdraw from their casino account on a given day.

Like banks and money services businesses (“MSBs”), federal law defines casinos as financial institutions. See 31 U.S.C. § 5312 (X). As financial institutions, casinos are required to maintain robust anti-money laundering compliance programs designed to protect against the unique money laundering and terrorist financing risks posed by each individual casino.

The minimum elements which must be included within any casino’s AML plan can be found at 31 C.F.R. § 1021.210. See also 31 U.S.C. § 5318(h). These include, at a minimum, the following:

(i) A system of internal controls to assure ongoing compliance;

(ii) Internal and/or external independent testing for compliance. The scope and frequency of the testing shall be commensurate with the money laundering and terrorist financing risks posed by the products and services provided by the casino;

(iii) Training of casino personnel, including training in the identification of unusual or suspicious transactions, to the extent that the reporting of such transactions is required by this part, by other applicable law or regulation, or by the casino’s own administrative and compliance policies;

(iv) An individual or individuals to assure day-to-day compliance;

(v) Procedures for using all available information to determine:

(A) When required by this part, the name, address, social security number, and other information, and verification of the same, of a person;

(B) The occurrence of any transactions or patterns of transactions required to be reported pursuant to § 103.21;

(C) Whether any record as described in subpart C of this part must be made and retained; and

(vi) For casinos that have automated data processing systems, the use of automated programs to aid in assuring compliance.

31 C.F.R. § 1021.210; see also 31 U.S.C. 5318(h). In addition, the casino’s AML Compliance program must be designed to protect against the unique money laundering and terrorist financing risks posed by the individual casino. Further, to the extent that a casino employee (including dealers and cage personnel) will confront money laundering activities, they must be included as part of the program and given instructions and training on how to report suspicious activity.

In addition, U.S. based casinos must ensure that these AML Compliance programs which are required under U.S. law are implemented in their Macau facilities due to the potential effects extraterritorial violations could have on the casinos’ domestic licenses. (U.S. Casino operators Sands, MGM Resorts International, and Wynn Resorts Ltd. each have subsidiaries operating in Macau.) For example, the Nevada Gaming Control Board has exercised its authority under Nevada law to oversee U.S. casinos’ Macau operations. As the Bloomberg article explains, “[r]ules in Nevada and other local jurisdictions require regulators to monitor licensees’ activities elsewhere to guard against cross-border violations and damage to the market’s reputation.”

Sands’ change in policy comes as the casino industry as a whole, and Sands in particular, has faced increased scrutiny from State and federal regulators regarding the industry’s AML compliance efforts. As we have previously reported here and here, both Sands and Caesars Entertainment Corp. have been the subjects of Department of Justice investigation into alleged violations of the Bank Secrecy Act. In the case of Sands, on August 27, 2013, Sands resolved its money laundering investigation and agreed to forfeit $47 million to the Department of Justice in order to avoid criminal prosecution based on the Sands’ relationship with a high-stakes gambler who was later linked to international drug trafficking. We assume that Sands’ enhanced responsibilities under its non-prosecution agreement played a critical role in its decision to increase scrutiny of Macau junket operators.

Fuerst, Ittleman, David & Joseph, PL will continue to monitor the Department of Justice and the casino industry for the latest developments. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

 

Anti-Money Laundering Compliance Update: FinCEN Guidance Regarding Banking Marijuana-Related Businesses Raises Many Questions, Answers Very Few

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As we reported last Monday, on February 14, 2014, the Financial Crimes Enforcement Network (“FinCEN”) issued its guidance “BSA Expectations Regarding Marijuana-Related Businesses” in an effort to clarify Bank Secrecy Act (“BSA”) expectations for financial institutions looking to provide services to marijuana-related businesses. As we further noted on Monday, despite the growing number of States that have legalized the use of marijuana in various forms and to various degrees, the federal government has continued its efforts to crack down on dispensaries. For instance, on June 29, 2011, U.S. Department of Justice Deputy Attorney General James M. Cole had issued a memorandum (the “Cole Memo”) to all United States Attorneys providing updated guidance to federal prosecutors concerning marijuana enforcement under the Controlled Substances Act (“CSA”). In his memo, Cole reiterated Congress’s determination that marijuana is a dangerous drug and that its illegal distribution and sale is a serious crime.

As we previously explained, because the sale of marijuana remains prohibited under federal law, financial institutions are required to file with FinCEN suspicious activity reports (“SARs”) on activity involving a marijuana-related business (including in those states where medical and/or recreational marijuana is legal). In an effort to explain how a financial institution can provide services to marijuana-related businesses while maintaining its responsibilities under the BSA, FinCEN issued its February 14th guidance. In addition to making clear that prior to providing financial services to a marijuana-related business a financial institution must conduct a thorough customer due diligence, FinCEN has identified a series of red flags that would indicate to a financial services institution that a marijuana-related business may be engaged in activity that implicates one of the Cole Memo priorities or violates state law. The following is a list of the red flags identified by FinCEN:

  • A customer appears to be using a state-licensed marijuana-related business as a front or pretext to launder money derived from other criminal activity (i.e., not related to marijuana) or derived from marijuana-related activity not permitted under state law. Relevant indicia could include:
  • The business receives substantially more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates.
  • The business receives substantially more revenue than its local competitors or than might be expected given the population demographics.
  • The business is depositing more cash than is commensurate with the amount of marijuana-related revenue it is reporting for federal and state tax purposes.
  • The business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law, as opposed to revenue derived from (i) the sale of other illicit drugs, (ii) the sale of marijuana not in compliance with state law, or (iii) other illegal activity.
  • The business makes cash deposits or withdrawals over a short period of time that are excessive relative to local competitors or the expected activity of the business.
  • Deposits apparently structured to avoid Currency Transaction Report (“CTR”) requirements.
  • Rapid movement of funds, such as cash deposits followed by immediate cash withdrawals.
  • Deposits by third parties with no apparent connection to the accountholder.
  • Excessive commingling of funds with the personal account of the business’s owner(s) or manager(s), or with accounts of seemingly unrelated businesses. Individuals conducting transactions for the business appear to be acting on behalf of other, undisclosed parties of interest. Financial statements provided by the business to the financial institution are inconsistent with actual account activity. A surge in activity by third parties offering goods or services to marijuana-related businesses, such as equipment suppliers or shipping services. The business is unable to produce satisfactory documentation or evidence to demonstrate that it is duly licensed and operating consistently with state law. The business is unable to demonstrate the legitimate source of significant outside investments. A customer seeks to conceal or disguise involvement in marijuana-related business activity. For example, the customer may be using a business with a non-descript name (e.g., a “consulting,” “holding,” or “management” company) that purports to engage in commercial activity unrelated to marijuana, but is depositing cash that smells like marijuana.
  • Review of publicly available sources and databases about the business, its owner(s), manager(s), or other related parties, reveal negative information, such as a criminal record, involvement in the illegal purchase or sale of drugs, violence, or other potential connections to illicit activity.
  • The business, its owner(s), manager(s), or other related parties are, or have been, subject to an enforcement action by the state or local authorities responsible for administering or enforcing marijuana-related laws or regulations.
  • A marijuana-related business engages in international or interstate activity, including by receiving cash deposits from locations outside the state in which the business operates, making or receiving frequent or large interstate transfers, or otherwise transacting with persons or entities located in different states or countries.
  • The owner(s) or manager(s) of a marijuana-related business reside outside the state in which the business is located.
  • A marijuana-related business is located on federal property or the marijuana sold by the business was grown on federal property.
  • A marijuana-related business’s proximity to a school is not compliant with state law.
  • A marijuana-related business purporting to be a “non-profit” is engaged in commercial activity inconsistent with that classification, or is making excessive payments to its manager(s) or employee(s).

FinCEN has made clear that these red flags indicate only possible signs of Cole Memo violations, and thus do not constitute an exhaustive list. Therefore, FinCEN has emphasized the importance of viewing any red flag(s) in the context of other indicators and facts, such as the financial institution’s knowledge about the underlying parties obtained through its customer due diligence.  Further, FinCEN explained that these red flags are based primarily upon schemes and typologies described in SARs or identified by its law enforcement and regulatory partners, and reserved the right to update them in future guidance.

A careful reading of these red flags makes clear that this new FinCEN guidance goes above and beyond the anti-money laundering programs banks are required to keep. Further, these red flags present more of a problem than a solution to financial institutions looking to provide services to marijuana-related businesses and to marijuana-related businesses looking to benefit from basic banking services. Asking a financial institution to dig deep into whether the business is receiving substantially more revenue than may be reasonably expected given the relevant limitations imposed by the state, what its competitors are making or what it reported on its income tax returns is essentially asking financial institutions to turn into a Big 4 auditor of medical marijuana dispensaries.

In effect, these red flags are totally impractical for banks looking to provide basic services to marijuana-related businesses because they raise more questions than they provide answers. A thorough reading of these red flags poses questions such as:

  • How can financial institutions practically implement measures to carry out this additional due diligence?
  • Will financial institutions need to hire new due diligence personnel with expertise in the state sanctioned marijuana industry?
  • Can financial institutions rely on the work of internal and external auditors?
  • What steps will professionals engaged to perform this due diligence have to follow?
  • Is there a practical and effective way to implement a set of internal controls to prevent, detect or monitor these red flags?

These are only a few of the countless questions that these new SAR requirements for marijuana-related businesses raise. Given all these questions, it comes as no surprise that FinCEN received such a lukewarm response from the Colorado Bankers Association and the American Bankers Association. As the American Bankers Association explained it “while we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.” We agree.

Fuerst Ittleman David & Joseph, PL will continue to watch for the latest developments in the regulation of financial services and the marijuana industry. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution or marijuana-related business, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Anti-Money Laundering Compliance Update: FinCEN Issues Guidance For Financial Institutions Providing Services To Marijuana-Related Businesses

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On February 14, 2014, the Financial Crimes Enforcement Network (“FinCEN”) issued its guidance “BSA Expectations Regarding Marijuana-Related Businesses” in an effort to clarify Bank Secrecy Act (“BSA”) expectations for financial institutions seeking to provide services to marijuana-related businesses. The guidance was issued in response to the growing number of states which have legalized the use of marijuana (recreational and/or medicinal) recent Department of Justice statements regarding marijuana enforcement priorities, and the uncertainty financial institutions in the United States face in providing financial services to this burgeoning industry.

Introduction

As we have previously reported, despite the growing number of States that have sanctioned the use of marijuana in various forms, the federal government has continued its efforts to crack down on dispensaries. (Our recent articles discussing these efforts can be read here, here, here, here, and here.). In addition to direct criminal prosecution for drug trafficking, dispensaries face additional legal barriers which make operation difficult. One such barrier dispensaries face is finding banks, credit card companies, and payment processors to process the proceeds of marijuana sales. As we have previously explained, because the sale of marijuana remains prohibited under federal law, banks are placed in a position where they would be required to report any banking transactions involving proceeds from marijuana dispensaries. Moreover, banks face the realistic possibility of criminal penalties for assisting in money laundering should they knowingly accept and process finds from dispensaries. As a result of these risks and possible penalties, banks have simply refused to do business with marijuana dispensaries.

Financial Institutions’ responsibilities under the BSA

Pursuant to the BSA, 31 U.S.C. §§ 5311-5330, financial institutions are required to create certain reports and records in order to combat fraud, money laundering, and protect against criminal and terrorist activity. For example, financial institutions are required to file with FinCEN suspicious activity reports (“SARs”) reporting any suspicious transaction relevant to a possible violation of law or regulation. More specifically, federal law requires that a financial institution file a SAR if the financial institution “knows, suspects, or has reason to suspect” that an attempted or fully conducted transaction: 1) involves funds derived from illegal activities or is an attempt to disguise or hide such funds; 2) is designed to evade the requirements of the BSA and its implementing regulations; or 3) lacks an apparent lawful or business purpose. See 31 C.F.R. § 1020.320.

As it relates to the proceeds derived from the sale of marijuana, FinCEN explained in its Guidance Document as follows:

Because federal law prohibits the distribution and sale of marijuana, financial transactions involving a marijuana-related business would generally involve funds derived from illegal activity. Therefore, a financial institution is required to file a SAR on activity involving a marijuana-related business (including those duly licensed under state law), in accordance with this guidance and FinCEN’s suspicious activity reporting requirements and related thresholds.

(emphasis added).

FinCEN’s guidance makes clear that a financial institution’s obligation to file a SAR is unaffected by any state law that legalizes marijuana-related activity. Thus, in an effort to explain how a financial institution can provide services to marijuana-related businesses while maintaining its responsibilities under the BSA, FinCEN issued this latest guidance.

Financial Institutions are required to engage in “thorough due diligence” prior to accepting marijuana-related businesses as clients.

FinCEN’s guidance makes clear that prior to providing financial services to a marijuana-related business, a financial institution must conduct a thorough customer due diligence. The guidance notes that this due diligence should include: 1) verifying that the business is licensed and registered with state authorities; 2) a review of the state license application and supporting documentation to operate as a marijuana business; 3) requesting available information about the prospective customer from state licensing and enforcement authorities; 4) obtaining an understanding of the nature of the business including the types of products sold and the customers to be served (recreational v. medical user); 5) monitoring of publicly available sources for adverse information about the potential business customer; and 6) monitoring for suspicious activity, including whether the business implicates one of the DOJ enforcement priorities or violates state law. In addition, FinCEN advises that financial institutions should periodically refresh their due diligence information once a business commences banking.

 

Financial Institutions  new marijuana-related businesses SAR filing responsibilities.

FinCEN’s “BSA Expectations” guidance should be read in conjunction with August 29, 2013 and subsequent February 14, 2014 DOJ memorandums issued by Deputy Attorney General James M. Cole to federal prosecutors regarding DOJ’s enforcement priorities with respect to marijuana. The “Cole Memo” lists out eight priorities that will guide the DOJ in its enforcement of the Controlled Substances Act against marijuana-related conduct. A copy of the DOJ’s August 29, 2013 memorandum can be read here. It is against this backdrop and with these priorities in mind that FinCEN drafted its guidance. FinCEN explains that the new guidance furthers the objectives of the BSA “by assisting financial institutions in determining how to file a SAR that facilitates law enforcement’s access to information pertinent to a [enforcement] priority.”

In describing a financial institution’s SAR filing responsibilities, FinCEN has established three categories: 1) “Marijuana Limited” SAR filings; 2) “Marijuana Priority” SAR filings; and 3) “Marijuana Termination” SAR filings.

In its Guidance, FinCEN explains that financial institutions should file a “Marijuana Limited” SAR when the institution reasonable believes, based on its due diligence, that the potential marijuana-related business customer does not implicate one of the DOJ Memo priorities or violate state law. It is important to note that this SAR filing should state “the fact that the filing institution is filing the SAR solely because the subject is engaged in a marijuana-related business,” and that no additional suspicious activity has been identified.

Throughout the time that a financial institution provides services to a marijuana-related business, the financial institution must file continuing activity reports which detail the amount of deposits, withdrawals, and transfers from the account since the previous SAR filing. (Guidance for filing timeframes for submitting a continuing activity report can be found at Question #16 of FinCEN’s Frequently Asked Questions Regarding the FinCEN Suspicious Activity Report.). However, FinCEN notes that should a financial institution’s continued due diligence reveal a potential violation of state law or implicate a DOJ Memo priority, the financial institution should file a “Marijuana Priority” SAR.

A “Marijuana Priority” SAR is only to be filed when a violation of state law is suspected or when the activities of a marijuana-related business may implicate DOJ Memo enforcement priorities. A Marijuana Priority SAR will be substantially more detailed should include: 1) identifying information of the subject and related parties; 2) addresses of the subject and related parties; 3) dates, amounts, and relevant details of the financial transactions involved; and 4) “details regarding the enforcement priorities that the financial institution believes have been implicated.”

In order to assist financial institutions in making the determination of whether to file a Marijuana Priority SAR, FinCEN’s Guidance includes two dozen “red flag” examples which may indicate a violation of state law or implicate DOJ Memo priorities. Such red flags include: that the business receives significantly more revenue than may reasonably be expected given the relevant limitations imposed by the state in which it operates; that the business is unable to demonstrate that its revenue is derived exclusively from the sale of marijuana in compliance with state law; a customer seeks to conceal or disguise involvement in a marijuana-related business activity; and that a business is unable to demonstrate the legitimate source of significant outside investments.

Additionally, financial institutions must be aware that these filing obligations also apply when the institution provides indirect services to a marijuana-related business such as providing services to a another domestic financial institution who in turn services marijuana-related businesses or to a non-financial customer who provides goods or services to a marijuana-related business (FinCEN uses the example of a commercial landlord who leases its property to a marijuana-related business). This naturally will require that financial institutions perform robust due diligence on all customers with potential indirect ties to marijuana-related businesses. However, FinCEN explains that “[i]n such circumstances where services are being provided indirectly, the financial institution may file SARs based on existing regulations and guidance without distinguishing between “Marijuana Limited” and “Marijuana Priority.”

The final category of SAR filings is the “Marijuana Termination” SAR. “If a financial institution deems it necessary to terminate a relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program, it should file a SAR  and note in the narrative the basis for the termination.”

Analysis and Conclusion

FinCEN’s guidance may in fact be a good faith attempt by the federal government to ease financial institutions anxieties about providing services to marijuana-related businesses. However, the banking industry’s reaction has been lukewarm at best.

As explained by the Colorado Bankers Association:

After a series of red lights, we expected this guidance to be a yellow one. This isn’t close to that. At best, this amounts to ”˜serve these customers at your own risk’ and it emphasizes all of the risks. This light is red.

Bankers had expected the guidance to relieve them of the threat of prosecution should the open accounts for marijuana businesses, but the guidance does not do that. Instead, it reiterates reasons for prosecution and is simply a modified reporting system for banks to use. It imposes a heavy burden on them to know and control their customers’ activities, and those of their customers. No bank can comply.

(emphasis added). A full copy of the Colorado Bankers Association Press Release can be read here.

Likewise, on February 14, 2014, the American Bankers Association commented as follows:

While we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution and assorted sanctions.

These fears are well founded. The FinCEN Guidance is not a regulation, does not amend existing law, and does not have the force and effect of law. Instead, financial institutions which choose to engage in providing services to marijuana-related businesses do so with only the words of FinCEN and the DOJ that it will exercise its prosecutorial discretion and not indict institutions for money laundering violations.

Moreover, regardless of the FinCEN Guidance, marijuana-related businesses also face potential violations of a host of federal laws, ranging from drug trafficking and money laundering to violations of the FDCA and the internal revenue code, for engaging in activities which are otherwise legal under state law.

In reality, the inability to access the banking and financial services industry may be potentially disastrous to the legal marijuana industry. The only true solution for both financial institutions and the marijuana-related businesses which seek their services is a comprehensive overhaul of the manner by which federal law governs marijuana and the businesses engaged in the sale of marijuana. The starting point is the Controlled Substances Act, but changes must also be made to the Banking Code found in Title 12, the bank fraud and money laundering statutes found in Title 18, the Food, Drug, and Cosmetic Act at Title 21, and the Internal Revenue Code found at Title 26. (A comprehensive overview of the most recent proposed amendments to the federal code, the “Marijuana Businesses Access to Banking Act of 2013” can be found in our previous report.). So long as federal law classifies marijuana as a Class I drug and all who deal in it “drug traffickers,” no mere Guidance Document will create the practical changes necessary to allow federally regulated banks to service the burgeoning marijuana industry.

Fuerst Ittleman David & Joseph, PL will continue to watch for the latest developments in the regulation of financial services and the marijuana industry. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a financial institution or marijuana-related business, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

Bitcoin Regulatory Update: FinCEN Publishes Administrative Rulings Further Clarifying When Virtual Currency Activity Constitutes Money Transmission

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On January 30, 2014, the Financial Crimes Enforcement Network (“FinCEN”) of the United States Department of the Treasury published two administrative rulings directly addressing when specific virtual currency activities constitute money transmission and thus requires registration with FinCEN as a money services business. The administrative rulings provide additional clarification to the guidance issued by FinCEN on March 18, 2013, “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies.”

In the March 18, 2013 Guidance, FinCEN distinguished between a “user,” an “exchanger,” and an “administrator” of virtual currency. As described in the Guidance:

A user is a person that obtains virtual currency to purchase goods or service. An exchanger is a person engaged as a business in the exchange of virtual currency for real currency, funds, or other virtual currency. An administrator is a person engaged as a business in issuing (putting into circulation) a virtual currency, and who has the authority to redeem (to withdraw from circulation) such virtual currency.

(emphasis in original). The Guidance went on to explain that a user who obtains convertible virtual currency and uses it to purchase real or virtual goods or services is not an MSB under FinCEN regulations as such activity does not fit within the definition of “money transmission services.” However, an administrator or exchanger that accepts and transmits a convertible virtual currency or buys or sells convertible virtual currency for any reason is a money transmitter under FinCEN regulations, and must therefore register with FinCEN and is subject to reporting and recordkeeping regulations for MSBs, unless a limitation to or exemption from the definition applies.

Last week’s first administrative ruling, “Application of FinCEN’s Regulations to Virtual Currency Mining Operations,” addresses the circumstances under which a miner of Bitcoin would be considered an MSB under FinCEN regulations. FinCEN explains that a Bitcoin miner does not constitute an MSB to the extent it uses the Bitcoin solely for its own purposes and not for the benefit of another “because these activities involve neither ”˜acceptance’ nor ”˜transmission’ of convertible virtual currency and are not the transmission of funds within the meaning of the Rule.” FinCEN went on to explain that a miner may convert its Bitcoin into real currency or another convertible virtual currency and not be considered an MSB if the miner is undertaking the transaction solely for the miner’s own purposes ad not as a business service performed for the benefit of another. When a miner engages in both of these limited activities it will be considered a user of virtual currency and not an MSB. In making its determination, FinCEN stated that “[w]hat is material to the conclusion that a person is not an MSB is not the mechanism by which a person obtains the convertible virtual currency, but what the person uses the convertible virtual currency for, and for whose benefit.” A copy of FIN-2014-R001 can be read here.

Last week’s second administrative ruling, “Application of FinCEN’s Regulations to Virtual Currency Software Development and Certain Investment Activity,”  addresses whether the periodic investment of a business in convertible virtual currency, and the production and distribution of software to facilitate the businesses purchase of virtual currency for purposes of its own investment, constitute money transmission under the Bank Secrecy Act. Regarding investing, FinCEN determined that a business that purchases and sells convertible virtual currency exclusively as investments for its own account will be considered a user of virtual currency and not an MSB because “it is not engaged in the business of exchanging convertible virtual currency for currency of legal tender for other persons.” Regarding the production and distribution of software intended to facilitate the sale of virtual currency, FinCEN ruled that mere production or distribution of such software does not constitute “money transmission services” and therefore a business’s production and distribution of such software would not make the company a money transmitted subject to BSA regulation. A copy of FIN-2014-R002 can be read here.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. If you or your company has a question related to its anti-money laundering compliance obligations, our anti-money laundering attorneys can provide further information. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

 

 

Charlie Shrem And Why We Need To Change Our Perspective Of Bitcoin

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On Monday, January 27, 2013, Charlie Shrem, the 24 year old CEO of BitInstant and Vice Chairman of the Bitcoin Foundation, was arrested for his role operating a Bitcoin exchange service popular among users of Silk Road. Before being seized and shut down by the United States government in October 2013, Silk Road was a hugely popular online black market which allowed users to buy and sell  illegal drugs using Bitcoin as the primary medium of exchange. As described in the Complaint against Mr. Shrem, available here, “[t]he illegal nature of the commerce hosted on Silk Road was readily apparent to anyone visiting the site. The vast majority of the goods for sale consisted of illegal drugs of nearly every variety, openly advertised on the site as such and prominently visible on the home page.”

The Complaint against Mr. Shrem presents the underlying facts in excruciating detail. First, the Complaint makes clear that Shrem was the CEO and Chief Compliance Officer for BitInstant, referred to throughout the Complaint as simply “the Company.” Using his position at BitInstant, the Complaint also makes clear that Shrem helped a third party – Robert M. Faiella, a/k/a BTCKing – acquire Bitcoins for purposes of selling them to his own (Faiella’s) customers on Silk Road. The Complaint also alleges, primarily by quoting email exchanges between Shrem and Faiella, that Shrem knew that the Bitcoins he made available to Faiella would be used for unlawful purposes, and moreover that he circumvented the BitInstant anti-money laundering protocols he was responsible for controlling in order to sell Bitcoins to Faiella without raising any red flags.

Unfortunately, there is nothing new about the Shrem case, and at least as far as the technicalities of the legal case is concerned, not at all surprising. Indeed, given the allegations described above, the actual charges make perfect sense. Count One against Mr. Shrem is a violation of 18 U.S.C. § 1960, for operating an unlicensed money transmitting business. § 1960 proscribes the operation of an “unlicensed money transmitting business,” which is defined as:

”¦a money transmitting business which affects interstate or foreign commerce in any manner or degree and””

(A) is operated without an appropriate money transmitting license in a State where such operation is punishable as a misdemeanor or a felony under State law, whether or not the defendant knew that the operation was required to be licensed or that the operation was so punishable;

(B) fails to comply with the money transmitting business registration requirements under section 5330 of title 31, United States Code, or regulations prescribed under such section; or

(C) otherwise involves the transportation or transmission of funds that are known to the defendant to have been derived from a criminal offense or are intended to be used to promote or support unlawful activity;

18 U.S.C. § 1960(b)(1)(A)-(C).

Although BitInstant had registered with FinCEN is required by section (b)(1)(B) and other provisions of federal law, BitInstant was not licensed by any state, and thus the government likely could have brought charges under § 1960(b)(1)(A). However, such a charge would have raised questions about whether BitInstant was required to become licensed and, if so, in which state(s), so the government appears to have taken the easier approach and pursued its case under § 1960(b)(1)(C). The Government’s § 1960 charge against Shrem describes that the Bitcoins Shrem made available to Faiella were “known to Shrem to have been intended to be used to promote and support unlawful activity, to wit, the operation of an unlicensed money transmitting business on Silk Road”¦and ultimately narcotics trafficking”¦”

The question of whether a Bitcoin exchange service like BitInstant can be labelled a money transmitting business may one day prove to be an interesting legal question. For now, the basis of the charge is derived from FinCEN’s March 18, 2013 Guidance Document, “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies.” In FinCEN’s Guidance, FinCEN does not mention Bitcoin by name, but does include a discussion of “De-Centralized Virtual Currencies” which explains as follows:

A final type of convertible virtual currency activity involves a de-centralized convertible virtual currency (1) that has no central repository and no single administrator, and (2) that persons may obtain by their own computing or manufacturing effort.

A person that creates units of this convertible virtual currency and uses it to purchase real or virtual goods and services is a user of the convertible virtual currency and not subject to regulation as a money transmitter. By contrast, a person that creates units of convertible virtual currency and sells those units to another person for real currency or its equivalent is engaged in transmission to another location and is a money transmitter. In addition, a person is an exchanger and a money transmitter if the person accepts such de-centralized convertible virtual currency from one person and transmits it to another person as part of the acceptance and transfer of currency, funds, or other value that substitutes for currency.

To the extent that Mr. Shrem may ever challenge the § 1960 allegation against him, he may argue that the FinCEN guidance document is not binding or legally enforceable and therefore should not be used in the government’s case against him. He may also argue that the allegation – which turns an exchange service into a transmitter without the presence of a third party recipient of funds – should be dismissed as a matter of law. Whether Shrem will pursue any defenses in court remains to be seen.

Mr. Shrem was also charged for participating with Faiella in a conspiracy to commit money laundering in violation of 18 U.S.C. § 1956(a)(2)(A), which provides that “(2) Whoever transports, transmits, or transfers, or attempts to transport, transmit, or transfer a monetary instrument or funds from a place in the United States to or through a place outside the United States or to a place in the United States from or through a place outside the United States ”” (A) with the intent to promote the carrying on of specified unlawful activity” is subject to inter alia a twenty year prison term. This provision of the federal money laundering statute requires an international movement of money, and the government’s complaint therefore alleges that when Faiella ordered Bitcoins from BitInstant, Shrem “filled the orders by causing funds to be transferred to an account that Faiella controlled” at Mt. Gox in Japan. This will be a very difficult allegation for Mr. Shrem to defeat.

Finally, Mr. Shrem – BitInstant’s Chief of Compliance – was also charged with wilfully failing to file suspicious activity reports in violation of 31 U.S.C. § 5318(g) and 5322(a), and 31 C.F.R. § 1022.320. Again, given his position at BitInstant and his understanding of Silk Road, we see this as a very difficult allegation to defeat. Worse, with all of these charges, given Shrem’s sophistication and the manner by which he made use of that sophistication, the Federal Sentencing Guidelines do not play in his favor. Mr. Shrem will likely do real prison time here.

When the news about Mt. Gox broke in May of last year, we wrote not only about the case itself (which was primarily based on Mt. Gox’s alleged deception of its U.S. bank, Wells Fargo), we also discussed the widespread media attention it received. Seemingly within minutes of the government executing the Mt. Gox seizure warrant, the story was picked up by Gawker, CNN, PC World, the Financial Times, and a host of underground websites. We commented at the time as follows: “Tragically for this upstart currency, the mainstream will learn of Bitcoin for the first time as a fringe currency under attack by the federal government. Whether Bitcoin will survive this attack and shed itself of the stigma associated with this seizure is a matter for another day and another article. We certainly hope that it does.”

Those who had never heard of Bitcoin before Charlie Shrem was arrested have certainly heard of it now. Once again, seemingly within minutes following his arrest, the Shrem case was picked up by virtually every major news outlet, from Time, to the New York Times, the Wall Street Journal, the Los Angeles Times, the Washington Post, Bloomberg, the International Business Times, Reuters, Wired, and literally hundreds of others. If the mainstream had not heard of Bitcoin after the Mt. Gox story broke or after Silk Road was shut down, it has heard about it now, and the context is terrible.

That said, our concerns about this stigma potentially destroying Bitcoin are different today than when we commented last May. Indeed, in the intervening months, we have spoken with (and in many cases, represented) numerous players in the Bitcoin space and educated ourselves about some of the emerging technology. For instance, we attended the North American Bitcoin Conference last week in Miami Beach and had the opportunity to hear Vitalik Buterin speak about Ethereum, described by Wired as: “an online service that lets you build practically anything in the image of bitcoin and run it across a worldwide network of machines. At its core, bitcoin is a way of reliably storing and moving digital objects or pieces of information. Today, it stores and moves money, but Buterin believes the same basic system could give rise to a new breed of social networks, data storage systems and securities markets ”” all operated without the help of a central authority.” In other words, Ethereum borrows the concept of the Bitcoin blockchain, but allows users to interact with one another ways that are far more advanced than a typical Bitcoin transaction. We see Ethereum as a “Web 3.0” of sorts, and Buterin’s lecture in Miami Beach was simply mindblowing. We frankly had no idea that the technology – or even the vision of what the technology might someday be – was as far along as it apparently is.

For Buterin’s discussion, we sat next to Jay Postma with  MSB Compliance Inc.. Buterin ended his discussion to a standing ovation, and Jay turned to us and said, “this is the future.” We agree. Our chief concern when the Mt. Gox story broke, and even more so when the Silk Road story broke, was that the stigma could prevent Bitcoin from ever being used on a mass scale. But after hearing Buterin speak, we had to change our perspective in two critical ways. First, we need to stop looking at Bitcoin solely as an underground medium of exchange. It is so much more than that. Yes, it is a medicum of exchange, but it is also a cultural movement and radical technological development based upon the idea that people should be able to communicate directly with one another – in customizable language – with neither the involvement nor interference of anyone. And second, we need to stop looking at Bitcoin as meek and vulnerable to the taint that comes with stories like Mt. Gox, Silk Road, and Charlie Shrem. Bitcoin – as a medium of exchange but much more importantly as a totally radical idea of direct communication – is not going anywhere. We need to embrace it and take it very, very seriously.

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in anti-money laundering compliance with a focus on non-bank financial institutions, including all varieties of money services businesses and Bitcoin dealers and exchangers, as well as white collar criminal defense, complex commercial litigation, tax compliance and tax litigation, international trade and corporate transactions. You can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.

CFPB Proposes To Regulate Large International Money Transfer Providers

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On January 23, 2014, the Consumer Financial Protection Bureau (“CFPB”) issued a proposed rule that would extend its regulatory authority to certain nonbank international money transfer providers. A copy of CFPB’s press release can be read hereand the proposed rule can be read here.

Generally speaking, CFPB regulates electronic fund transfers through a series of regulations known as “Regulation E” found at 12 C.F.R. Part 1005. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), CFPB was tasked with supervising an additional comprehensive system of new consumer protections for remittance transfers sent by consumers in the United States to individuals and business in foreign countries. Dodd-Frank expanded the scope of the Electronic Funds Transfer Act to cover international remittance transfers. (Generally speaking, prior to Dodd-Frank, international money transfers were not specifically covered by federal consumer protection regulations, but have always been regulated for purposes of combating money laundering, terrorist financing, drug trafficking and fraud.)

Pursuant to this authority, CFPB issued its “Remittance Rule” which implemented new protections, including disclosure requirements, and error resolution and cancellation rights, to consumers who send remittance transfers to foreign countries. (The Remittance Rule is actually a series of regulations within Regulation E found at 12 C.F.R. Part 1005, Subpart B.). The Remittance Rule went into effect October 28, 2013. More information regarding the Remittance Rule can be found on CFPB’s website here.

Currently, CFPB has authority to assess large banks’ and credit unions’ compliance with the Remittance Rule. However, the proposed rule would subject any nonbank international money transfer provider that provides more than $1 million in international money transfers annually to CFPB’s regulatory authority. (Dodd-Frank gave CFPB the authority to supervise “larger participants” in consumer financial markets as defined by rule.)This would include brick and mortar and online money transmitting businesses, and may also include remitters and issuers of virtual currencies, such as Bitcoin.

The proposed rule would not only require that these larger nonbank institutions be compliant with the Remittance Rule, but it would also subject them to possible CFPB on-site examination and follow-up monitoring. CFPB’s examination methods are set forth in the proposed rule and allow CFPB to use the same examination procedures it uses for banks. Further, the proposed rule makes clear that money remitters who would not be considered “larger participants” may still be subject to CFPB’s supervisory authority if the Bureau has reasonable cause to determine that they pose a risk to consumers. Comments on the proposed rule may be submitted through www.regulations.gov for 60 days after the proposed rule’s publication in the federal register.

Fuerst Ittleman David & Joseph, PL will continue to monitor the progress of CFPB’s proposed rule for the latest developments. The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of anti-money laundering compliance, administrative law, constitutional law, white collar criminal defense and litigation against the U.S. Department of Justice. You can reach an attorney by emailing us atcontact@fidjlaw.com or by calling us at 305.350.5690.