Colorado has legalized marijuana for medical and recreational use. Kentucky has legalized the production of industrial hemp. Both substances are derived from the same species, cannabis sativa l., which Congress has declared unlawful under the Controlled Substances Act (CSA).¹ In both these states, new businesses see lots of economic opportunity and are rapidly organizing and expanding to take advantage. Can banks assist in these new economic ventures? Can Kentucky banks learn anything from recent litigation in Colorado?

Although marijuana is still illegal under the CSA, more than 20 states have legalized marijuana for medical or recreational purposes. Rather than strictly enforce the federal prohibition, the Justice Department issued guidance to local U.S. attorneys as to its “enforcement priorities”: distribution to minors; gang activity; export to states where marijuana is still illegal; preventing violence; illegal use of firearms; and drugged driving.² Many inferred from this memo that federal law enforcement will “look the other way” if lower-priority marijuana activities are involved. Colorado bankers must comply with the Bank Secrecy Act,³ which requires banks to report suspicious transactions in order to help federal law enforcement detect and stop money laundering, drug trafficking, and other criminal activities. They wonder if they are required to file Suspicious Activity Reports (SARs) on customers operating in medical or recreational marijuana dispensaries. In response, the Department of Treasury Financial Crimes Enforcement Network (FinCen) published guidance in which it proposed a “Marijuana-Limited” SAR filing, where a bank could indicate that its customer was engaged in marijuana activities that were of low-priority in the eyes of federal law enforcement.⁴ If the customer were engaged in higher-priority marijuana activity, the bank would be required to file a “Marijuana-Priority” SAR. But banks still remain concerned that federal law enforcement could invoke the onerous civil forfeiture laws to seize bank accounts, real estate, and other collateral used by marijuana-related businesses (the new acronym is MRB), thereby endangering loan portfolios.

To encourage Colorado bankers to do business with the MRBs, a creative solution was needed. MRBs sought and received from the Colorado Division of Financial Institutions a license to establish their own credit union to serve their industry. However, the Federal Reserve Bank of Kansas City denied their application for a “master account.”⁵ A “master account” or access to one through a correspondent bank is a practical necessity to have access to the Federal Reserve payments system. The Fourth Corner Credit Union sued the Kansas City fed, asking the federal district court to order the bank to set up a master account. But the court, observing that federal law still prohibits growing and selling marijuana and assisting those who do, refused, stating that courts cannot use their equitable powers to facilitate criminal activity.⁶ The court refused to rely on the recent advice from the regulators that seemed to suggest that they might “look the other way” for “low-priority” activities. The frustrated judge observed: “a federal court cannot look the other way.” The court called the current inconsistency between state and federal law “untenable” and pleaded for congressional action to clear up the confusion. Under this ruling, it appears that MRBs will have to continue to operate as cash businesses, lacking access to the banking system. This decision is pending in the Tenth Circuit Court of Appeals.⁷

Fortunately, the legal framework governing industrial hemp in Kentucky is much different and much more business-friendly. Even though industrial hemp is the same species, cannabis sativa l., by statutory definition it is limited to 0.3% of tetrahydrocannabinols (THC), an amount that has no psychoactive properties. Unlike the marijuana at issue in Colorado, industrial hemp is legal, not just under state law, but under federal law. In the 2014 Farm Bill, Congress specifically authorized “agricultural pilot programs” to research industrial hemp. Such pilot programs must be conducted only by (or under the supervision of) institutions of higher learning and state departments of agriculture, and are limited to the study of the growth, cultivation and marketing of industrial hemp.

In Kentucky, growers and processors may participate in a pilot program only after a criminal background check and approval of a proposed research program by the Kentucky Department of Agriculture (KDA). Then the grower or processor must enter a memorandum of understanding with the KDA, confirming the scope of research and agreeing to certain other parameters. Banks considering lending to industrial hemp businesses should confirm that the proposed borrowers have passed the criminal background check and have a valid MOU with an approved research program. Then banks may take the usual real estate, equipment and accounts as collateral.

As to the raw industrial hemp and hemp seeds, banks cannot rely on such property as collateral, because possession by anyone without an MOU is still prohibited. However, guidance from the Drug Enforcement Administration and the Kentucky Attorney General has indicated that industrial hemp products may be sold once they are processed or once they have no measurable THC in them. A potential concern is that new MOUs must be approved by the KDA and executed on an annual basis, a short period that seems likely to limit investment, due to the risk that future applications might not be granted. KDA should consider extending the term of MOUs for processors due to the greater capital investment required as compared to growers.

Kentucky’s legal framework should allow banks to begin doing business with industrial hemp growers and processors in the Farm Bill pilot program. Ultimately, to expand hemp production to commercial scale, additional federal legislation is needed. Senate Bill 134, the “Industrial Hemp Farming Act of 2015,” has eleven cosponsors including the two Kentucky senators, and is currently before a Senate committee. This legislation would expand the existing exemption from the Controlled Substances Act to allow commercial scale industrial hemp production, expanding economic opportunity in the Commonwealth.

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¹ THE COMPREHENSIVE DRUG ABUSE PREVENTION AND CONTROL ACT OF 1970, 21 U.S.C. § 801 et seq.
² U.S. Department of Justice, “Cole Memorandum,” August 29, 2013.
³ 31 U.S.C. § 5311 et seq.
⁴ U.S. Department of the Treasury, Financial Crimes Enforcement Network, Guidance, February 14, 2014.
⁵ Their application for share credit insurance to the National Credit Union Administration (NCUA) was also denied, and Four Corners Credit Union filed a separate suit in federal district court.
⁶Fourth Corner Credit Union v. Federal Reserve Bank of Kansas City, 2016 US Dist. LEXIS 517 (D. Colo. January 5, 2016).
⁷ The related NCUA case is still in litigation before a different district judge.

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This article is reprinted with the permission of Kentucky Bankers Association, Kentucky Banker ^©2016