On July 3, the New York Department of Financial Services (“DFS”) issued its “Guidance on Provision of Financial Services to Medical Marijuana & Industrial Hemp-Related Businesses in New York State (PDF).” In the memorandum, DFS Superintendent Maria T. Vullo examines the current banking issues facing the state-legal marijuana businesses and states (in our view correctly) that:

Forcing medical marijuana and industrial hemp businesses to operate solely with cash creates a public safety issue, as cash intensive businesses and their suppliers, employees and customers become targets for criminals. Large amounts of cash distributed outside the regulated banking system is unacceptable and creates risks to the companies, and their employees and business partners. Further, large scale cash operations impede tracking funds for tax and anti-money laundering purposes. None of this is necessary. Positions taken by the federal government are only exacerbating these problems, rather than remedying them. New York must act.

Notwithstanding DFS’ guidance (including its reference and reliance on the rescinded Cole Memo), banks are likely to be reluctant to respond to the Superintendent’s encouragement for “New York State chartered banks and credit unions to consider establishing banking relations with [New York state sanctioned] marijuana-related business.” Most banks continue to have concerns that the federal regulators, including the FDIC, will not sanction this activity. This is evident in states that have enacted recreational-marijuana programs, where concerns about federal regulators and burdensome compliance requirements limit options to a handful of banks charging onerous rates for basic services. In any event, this memo represents a significant marijuana banking “shot across the bow” to federal banking regulators by the principal bank regulator of the state that serves as the center of the country’s banking business.

As our regular readers are aware, Senators Warren and Gardner introduced a bi-partisan bill in the Senate for the federal government: (1) to generally defer to state laws legalizing marijuana and (2) to effectively allow all banks to provide services to legal cannabis businesses in the same way that they treat other legal businesses (STATES Act, S. 3032). S. 3032 has been read twice and was referred to the Senate’s Judiciary Committee when it was introduced on June 7. An identical bill was introduced in the House (H.R. 6043), also on June 7, and was referred to the House’s Judiciary and Energy and Commerce Committees on the same day. No action has been taken on either bill since they were introduced.

Earlier this month, Congress continued to avoid providing bank access to state-legal cannabis businesses by voting against measures in appropriations bills that would have prohibited bank regulators from using federal funds to punish banks that provide bank services to state-legal cannabis businesses. This failure by Congress to allow cannabis business access to the banking system continues to cause serious business and safety problems for state-legal cannabis businesses.

With the midterm elections now coming into clear view, and with dramatic divisions in both houses of Congress, it appears unlikely — at the present time — that Congress will take any steps to solve this cannabis banking problem. It also remains unclear if, without Congressional action, the federal banking regulators will take any useful steps in the area, especially in light of the rescission of the Cole memo by Attorney General Sessions.

We will continue to follow and report on this, but unless an imaginative and scalable solution is found, the risks (including to public safety) and difficulties in dealing in an all-cash business is likely to be a significant hurdle for state-licensed  cannabis businesses.

Due to some interesting developments in health science, the future of the industrial hemp industry may be in the hands of the DEA once again.

For the first time ever, the FDA approved a drug derived from marijuana. The active ingredient in Epidolex, which in clinical trials reduced the frequency of seizures in people with certain forms of epilepsy, is cannabis-derived cannabidiol. Cannabidiol, commonly known as CBD, is used to (questionably?) treat a host of conditions, including anxiety, insomnia, chronic pain, and various neurological disorders such as seizures. Now, following a successful clinical trial, anecdotal claims of CBD’s efficacy, at least as they relate to epilepsy, have been given some scientific substance. While Epidolex is not the first approved drug based on compounds found in cannabis, the others (Marinol, Syndros, and Cesamet) contain synthetic versions of cannabinoids or cannabinoid analogues, whereas Epidolex is made from Cannabis Sativa L. itself.

The FDA’s blessing puts the DEA in an interesting position. CBD — along with every other compound extracted from the naughty parts of Cannabis Sativa L. — sits on Schedule I of the Controlled Substances Act, due in part to the DEA’s determination and Schedule I requirement that it has “no currently accepted medical use in treatment.” In response to the FDA’s determination that CBD does, in fact, have medical uses, the DEA is expected to reschedule CBD within the next 90 days.

That rustling sound you hear is industrial hemp growers shifting uneasily in their seats. Over the past few months, we’ve written about the growing legitimacy of the industrial hemp industry. Current internal DEA guidance differentiates cannabinoids sourced from marijuana and cannabinoids from industrial hemp, and there is active and increasing congressional support for the industrial hemp industry.  Interest in industrial hemp is driven in large part by the fact that some industrial hemp-derived CBD is not currently (at least not clearly) restricted by the CSA, and thus can be sold freely in the United States except in those few states with explicit prohibitions. If the DEA reschedules only cannabis-derived CBD, hopefully they will acknowledge that the reason for such limited release is that industrial hemp-derived CBD is already exempted by the 2014 Farm Bill. Otherwise, the DEA will disrupt a market and continue to obfuscate the law to promote political objectives.  (See this great Leafly article for more info on the topic.) We will be monitoring the DEA’s actions closely, and will post updates here when further information is available.

On June 13, the U.S. Tax Court issued Tax Court Memo 2018-83, Alterman and Gibson v. Comm’r. Based on the way this case is being reported in the trade press, one might think that this decision portends doom and gloom for taxpayers in the cannabis industry. Such fears are not justified for anyone who maintains good records and does even basic tax planning.

The Alterman Tax Court held:

  • Taxpayers selling both cannabis and paraphernalia were not carrying on a separate non-trafficking business and, therefore, could not allocate expenses between trafficking and non-trafficking businesses;
  • Taxpayers failed to substantiate amounts allocable to cost of goods sold (COGS); and
  • Taxpayers were subject to 20 percent accuracy-related penalties.

The doom and gloom of the holdings fade once you appreciate the relevant facts:

  • Taxpayers’ non-trafficking business was limited to selling products that contained no cannabis (e.g., pipes, papers and other consumption-related items) and represented less than 5 percent of total revenue;
  • Taxpayers’ kept very poor books and records;
  • Taxpayers’ filed tax returns, which included facially “questionable” amounts for beginning and ending inventory, and which could not be traced to the balance sheet or general ledger;
  • Taxpayers’ accountant prepared a profit and loss statement, but failed to produce supporting work-papers; and
  • “The 2011 general ledger bizarrely recorded that ‘Total Inventory’ was $12,279, which was the same dollar amount recorded in the ‘Total Inventory’ entry in the 2010 ledger.”

The last point is an actual quote from the Tax Court’s findings of facts. Bad facts often result in bad law, especially when jurisprudence is summarized in the trade press where headlines attract readers and clicks. However, bad facts provide opportunities to distinguish yourself with good (or at least better) facts. So here are the key takeaways from the Aterman case that are worthy of attention:

  • Taxpayers should maintain true, accurate and complete books and records; this taxpayer lost because of bad records not because the court overreached or applied Internal Revenue Code Section 280E in a particularly egregious manner;
  • Alterman is a memorandum opinion that does not create new law or alter existing law;
  • Taxpayers should identify and follow an inventory costing method that maximizes COGS;
  • Taxpayers using a CHAMPS strategy to allocate non-COGS items between trafficking and non-trafficking businesses arguably requires some level of substance and recordkeeping — we generally recommend that clients conduct non-trafficking businesses in a separate legal entity and report on a separate income tax return;
  • Taxpayers should engage competent accountants, bookkeepers and tax return preparers that understand applicable accounting methods and tax planning strategies; and
  • Failing to keep accurate books and records may result in significant tax exposure and penalties.

With a little bit of luck, legislation pending in Congress will soon be enacted and henceforth relieve the state-legal industry of the unfair burden imposed by IRC Section 280E. But we can promise that no legislation will help taxpayers with shoddy record keeping.

Right on schedule, the Agricultural Improvement Act of 2018 (i.e., the Senate’s version of the Farm Bill) was announced on Friday, and brings with it some good news for the U.S. hemp industry. As we predicted last month, hemp supporters in the Senate worked successfully to include the Hemp Farming Act (the “Act”) in this version of the Farm Bill.

The Act, sponsored by Senators McConnell (R-KY), Paul (R-KY), Merkley (D-OR) and Wyden (D-OR), gives states and Indian tribes the opportunity to have “primary regulatory authority” over the production of hemp with that state or on tribal land by submitting a control plan to the Secretary of Agriculture for approval. The plan is required to include, at a minimum:

  • Legal descriptions of land on which hemp is produced in the state or territory;
  • Procedures for testing to ensure compliance with federal restrictions on the THC content of industrial hemp;
  • Procedures for disposal of non-conforming hemp; and
  • Procedures for enforcement of the Act’s requirements.

Department of Agriculture oversight is significant in that the Farm Bill of 2014, on which current state programs are based, did not name a responsible federal agency. This framework will also shape changes to current state applications for licenses to produce industrial hemp and to state rules to the extent that they do not currently address the above requirements.

Another welcome effect of the Act is the specific exclusions of industrial hemp from the Controlled Substances Act (CSA). The CSA’s applicability to industrial hemp is currently murky at best, and while states and various federal agencies have indicated that it is excluded, clarity in this area will be of huge benefit to the industry. In addition, as we wrote about last week regarding the STATES Act, exclusion from the CSA also confers benefits with respect to banking and tax.

The Act further provides for easier funding for industrial hemp research, makes crop insurance available to the industry, and states that the Act, in and of itself, may not be construed to authorize the federal government to interfere with the interstate commerce of industrial hemp.

Nothing is certain in Washington, D.C. these days, but consensus seems to be that the Senate’s Farm Bill has bipartisan support and a much greater chance of success than the House version, which failed to pass in May. If it becomes law, the U.S. hemp industry will be on much stronger footing.

Last month, we wrote about draft legislation out of the U.S. Senate that aimed to end the tension between the Controlled Substances Act (CSA) and state laws legalizing cannabis. Today, Senators Elizabeth Warren (D-MA) and Cory Gardner (R-CO) introduced the excellently-named Strengthening the Tenth Amendment Through Entrusting States (STATES) Act, which amends the CSA to carve out an exception to the federal prohibition on trafficking marijuana for persons acting in compliance with the laws of their particular state.

As we noted previously, that draft of the Act showed promise to the extent that many of the most serious issues facing the cannabis industry (access to banking, disparate tax treatment, and your business plan involving federal crimes) are consequences of the CSA. Creating an exception to the CSA for state law-compliant marijuana business would significantly lessen the impact of banking, taxes, and prohibition.

The text of the Act introduced today tracks closely to the previous draft, and contains some exciting developments. In short, the Act:

  • Clarifies its applicability to federally-recognized Indian tribes operating within Indian Country,
  • Creates a specific exception for the distribution of medicinal marijuana to persons under the age of 21 (likely to account for the federal enforcement guidelines in the late Cole Memo), and
  • Specifies that proceeds from any transaction in compliance with the Act will not be deemed “the proceeds of an unlawful transaction,” which prevents the seizure of cannabis industry in a civil asset forfeiture action.

The Act also amends the CSA’s definition of “marihuana” to specifically exclude “industrial hemp.” At a glance, this might read like the legislative equivalent of a double negative (legalizing the trafficking of marijuana while also excluding industrial hemp from the CSA’s definition of marijuana), but it would actually provide some needed clarity regarding the applicability of the CSA to industrial hemp. Further, while the Act’s benefits apply only to states that have an existing marijuana regulatory regime, excluding industrial hemp from the CSA altogether means that even states that have not legalized marijuana can adopt industrial hemp programs with less uncertainty.

Citing an unmanageable backlog of recreational marijuana license applications and difficulty meeting its responsibilities to existing licensees, the Oregon Liquor Control Commission (OLCC) announced today that it will “pause” review of new recreational license applications effective June 15, 2018. The OLCC will also reallocate staff from licensing review to compliance and enforcement, focusing on the fall 2018 recreational outdoor harvest and registration of medical marijuana sites with the state’s Cannabis Tracking System (CTS), which registration is required by July 1, 2018.

This OLCC action presumably responds to the Williams Memo, explained in a previous post, which called out overproduction and interstate trafficking of Oregon cannabis as top federal enforcement priorities. The OLCC, however, cannot unreasonably delay review of license applications (see ORS 475B.060). Although the OLCC lacks authority to unreasonably delay license review, and certainly has no authority to limit the number of licensees, it does have broad authority to carry out the intent of the applicable statutes (see ORS 475B.025).

Given ongoing frustration from applicants and licensees at the OLCC’s lengthy wait times and the well-publicized over-production issue and its consequences for both intrastate wholesale prices and the black market, today’s OLCC decision appears a prudent reallocation of resources. We reserve the right to adjust our opinion if the “temporary suspension” continues indefinitely.

Earlier this year, we outlined a potential argument concerning hemp-derived CBD oil and its status under the Controlled Substances Act (CSA). Our argument focused on the CSA’s definition of the term “marihuana,” which excludes mature stalks, oil or cake made from seeds from the list of controlled substances. Last week, the DEA agreed and issued an internal directive with the following key statement:

Products and materials that are made from the cannabis plant and which fall outside the CSA definition of marijuana (such as sterilized seeds, oil or cake made from the seeds, and mature stalks) are not controlled under the CSA. Such products may accordingly be sold and otherwise distributed throughout the United States without restriction under the CSA or its implementing regulations. The mere presence of cannabinoids is not itself dispositive as to whether a substance is within the scope of the CSA; the dispositive question is whether the substance falls within the CSA definition of marijuana.

The CSA exception extends to oils derived from marihuana but not to “resin” derived from marihuana. The DEA’s internal directive does not alter previous statements regarding their coding for marihuana extracts, but notes the drug code for marihuana extract “extends no further than the CSA does.”

The takeaway? As we have previously suggested, CBD oil (but not the resin) derived from the excepted parts of marihuana plants falls outside the scope of the CSA. The fact that CBD oil produced from excepted parts of the plant will be chemically similar to CBD oil produced from non-excepted parts (or the resin of excepted parts) may not be logical but it is driven from the statutory definition. Nevertheless, the logical and scientific inconsistency puts the DEA and purveyors of CBD goods in a precarious position: how will they determine which CBD products are subject to the CSA and will people really be prosecuted for trafficking a Schedule I controlled substance where the substance is chemically indistinguishable from one that is not prohibited by the CSA? We anticipate that at least one outcome will be buyers insisting on statements or warrantees from sellers, and buyer quality control due diligence, that their CBD products contain only excepted marihuana oil.

One further complication: some state prohibitions have different (sometimes broader) definitions or interpretations of what constitutes a controlled substance.

Lost in the rubble left by last week’s noisy collapse of H.R. 2 (the Agriculture and Nutrition Act, commonly known as the Farm Bill) are some significant developments in the United States’ progress towards legalizing the cultivation of industrial hemp. Industrial hemp is the same species as its THC-laden cousin marijuana, Cannabis Sativa L., but is cultivated differently to produce long, fibrous stalks suitable for industrial use, and to minimize the production of the characteristic flowers commonly associated with marijuana. Industrial hemp production is legal in the United States to the extent allowed by Section 7606 of the Agricultural Act of 2014 (the Farm Bill of 2014), which authorizes state departments of agriculture and educational institutions to regulate research and pilot programs to determine the viability of hemp as an industrial crop.

Since 2014, at least 35 states have implemented some kind of legislation regulating the production of industrial hemp. As with state marijuana laws, the result is an inconsistent patchwork of state regulatory systems. In contrast to marijuana, industrial hemp cultivation pursuant to a state’s pilot program has the qualified blessing of the federal government, which would seem to make it a more attractive opportunity than marijuana. Practically speaking, however, the current business climate for industrial hemp production is fraught with uncertainty and lacking basic business services like banking and insurance. This is due to a vague federal mandate combined with state regulatory frameworks that are much less rigorous as compared to those governing marijuana.

Leading up to the 2018 Farm Bill, this state of affairs seemed poised to change. Broad bipartisan support for industrial hemp resulted in a number of proposed amendments that would have:

  • Legalized industrial hemp and made crop insurance available,
  • Explicitly excluded industrial hemp from the Controlled Substances Act, and
  • Opened up banking for pilot program participants.

However, prior to the final vote on the 2018, Republicans on the House Rules Committee led by Pete Sessions (R-TX) (no, the other anti-cannabis Sessions) blocked consideration of these amendments. None of them made it into the final version of H.R. 2, which ended up failing amidst partisan wrangling over the content of the Farm Bill itself as well as some good old-fashioned hostage taking by conservatives over immigration issues.

All is not lost, however, as industrial hemp continues to gather bipartisan supporters, including Mitch McConnell (R-KY) himself, a champion of Kentucky’s early and successful pilot program. As the Senate considers its own version of the Farm Bill, expected to arrive with less controversy in June, look for hemp-focused fixes that may bring some needed clarity to a growing but uncertain industry.

Much has recently been discussed about the potential value to the cannabis industry of last Monday’s decision by the U.S. Supreme Court concerning states authorizing sports betting. Murphy v. NCAA, No. 16-476 (U.S., May 14, 2018).  For example, see “The Implications of Murphy v. NCAA for State Marijuana Reforms,” authored by Vanderbilt University Law School Professor Robert Mikos.

While some of the arguments are interesting, caution should be exercised here. The law at issue in the Murphy case, the Professional and Amateur Sports Protection Act, did “not make sports gambling a federal crime … Instead, [it] allow[ed] the Attorney General … to bring civil actions to enjoin violations.” (Slip Op., at 5.)  In contrast, federal law makes it a crime to possess, sell or manufacture marijuana, or to aid or abet others in doing so (12 U.S.C. § 841(a)(1) and 18 U.S.C. § 2). Judge Alito, in the majority opinion, supported the so-called “anticommandeering” doctrine as part of the Constitutional mandate “to withhold from Congress the power to issue orders directly to the States.”  However, he also reiterated that “when federal and state law conflict, federal law prevails and state law is preempted” (Slip Op., at 14-15).

While Murphy is an important decision, time will tell as to what — if any — effect it may have concerning the state laws permitting medical, and especially recreational, marijuana use.