Bradley & RiskScout: Smokable Hemp Bans
Authors: Hunter Robinson, Connor Rose, Jake Fanella, Jessica Caballero
This article provides an overview of some states’ smokable hemp bans and discusses practical considerations for hemp companies and the financial institutions that serve them. This article was originally published in the Cannabis Law Journal.
Smokable Hemp Bans
Numerous states, including Iowa, Indiana, Louisiana, Kentucky, and Texas, either ban or severely restrict smokable hemp. The scope of these bans varies based on the language of the applicable statute or regulation, with important consequences for industry participants.
For example, Texas initially prohibited “the processing or manufacturing of a consumable hemp product for smoking” in a statute enacted on June 10, 2019. Since the statute was silent as to whether smokable hemp could be sold or consumed, many Texas businesses imported smokable flower from other states to sell in Texas. But on July 24, 2020, the Texas Department of State Health Services promulgated a regulation that prohibits the “the retail sale of consumable hemp products for smoking.” The regulation does not ban the consumption of smokable hemp, however, and thus invites Texas consumers to purchase smokable hemp from non-Texas retailers, to the detriment of Texas-based retailers (and Texas’s tax revenue).
Other states have enacted a total ban on smokable hemp. Iowa bans the production, sale, transportation, and consumption of “harvested hemp or hemp product[s]” if their “intended use … is introduction into the body … by any method of inhalation.” Indiana goes further in some respects, prohibiting not only the manufacture, delivery, or possession of smokable hemp, but also the financing of such activities. However, the financing ban does not apply to “financial institution[s].” Nor does the ban “apply to the shipment of smokable hemp from a licensed producer in another state in continuous transit through Indiana to a licensed handler in any state.”
Hemp advocates have pushed back on these bans through lobbying campaigns and litigation, but the results have been mixed thus far. The industry scored an initial victory in C.Y. Wholesale, Inc. v. Holcomb, where a federal district court issued a preliminary injunction that blocked large portions of Indiana’s smokable hemp ban. The district court found the hemp-industry plaintiffs had shown a strong likelihood of success on their contention that Indiana’s ban was preempted by the 2018 Farm Bill because it put those transporting smokable hemp through Indiana at risk of criminal prosecution. But this industry victory was short lived, as the Seventh Circuit reversed the injunction. While the Seventh Circuit recognized the 2018 Farm Bill “unequivocally” preempts any state law that interferes with the “interstate transportation of smokable hemp,” it does not preempt state laws that “prohibit the cultivation or production of industrial hemp.” Since the district court enjoined the manufacture and possession of smokable hemp, the Seventh Circuit held the injunction “swept too broadly.”
Soon after the Seventh Circuit issued its decision in Holcomb, the hemp industry scored a victory in Texas when a state court issued a temporary restraining order that enjoins the state from enforcing its ban on the sale of smokable hemp. The temporary restraining order expires on September 2, 2020, when the court will conduct a hearing on the hemp-industry plaintiffs’ request for a preliminary injunction.
As these lawsuits show, smokable hemp bans are subject to attack on various legal grounds, and their staying power is up in the air. But while such bans are in effect, hemp companies and the financial institutions that serve the industry must learn to live with them.
Smokable hemp bans will have differing effects on and raise differing compliance concerns for hemp companies depending on the company’s geographic location, place in the supply chain, and distribution model, as well as the specific scope of the applicable bans.
For large cultivators and processors located in states that ban manufacturing smokable hemp, the best option may be relocating to a more welcoming state. Indeed, Crown Distributing LLC, the lead plaintiff in the Texas lawsuit discussed above, stated that it was considering moving to Oklahoma if Texas’s ban was not struck down, noting that the ban could cause $50 million in lost revenue over the next five years.
For local retailers, a ban on the sale of smokable hemp may be an existential threat. Retailers with enough product offerings to survive without the sale of smokable hemp must ensure they are neither selling products labeled as smokable hemp nor marketing other flower products, like tea, as smokable.
Multistate operators and large single-state businesses that distribute interstate will need to understand the scope of the smokable hemp bans in states to which they distribute. These companies may need to take steps to prevent sales to customers in states that ban the consumption of smokable hemp. This may require updates to product skus and software related to inventory and sales. Further, these companies should take care when shipping smokable hemp through a state in which it is banned. While companies should always include with hemp shipments documents showing the product is hemp, not marijuana, and ensure their shipping contracts properly allocate risks of loss, this is especially so when a smokable hemp shipment goes through a state that bans possession of the product.
Navigating the complex and dynamic legal landscape of hemp has always been a challenge for financial institutions seeking to serve the industry. The patchwork of state laws regarding the legality of smokable hemp adds another layer of complexity.
Institutions must ensure their hemp customers are operating lawfully to stay in compliance with their Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) obligations. Broadly speaking, the BSA requires that a financial institution establish an effective “AML Compliance Program,” comply with customer due diligence (“CDD”) and customer identification program (“CIP”) obligations, report certain currency transactions, and file a “Suspicious Activity Report” (“SAR”) when it detects a “known or suspected violation of Federal law or a suspicious transaction related to a money laundering activity or a violation of the [BSA].” An institution’s interwoven CIP and CDD procedures assist in determining a customer’s true identity, understanding the types of activities in which the customer is likely to engage, and identifying and reporting potential suspicious activities based on the use of the customer’s account. An AML Compliance Program must also include “[a]ppropriate risk-based procedures for conducting ongoing customer due diligence,” which includes the development of a “customer risk profile.” The most recent BSA/AML guidance from the Financial Crimes Enforcement Network (“FinCEN”) makes clear that financial institutions must tailor the risk profiles of and due diligence for their hemp customers to reflect the unique aspects of the hemp industry and the level of risk posed by each customer.
To properly tailor their CDD procedures, financial institutions will need to understand smokable hemp bans. For hemp customers operating in states with smokable hemp bans, financial institutions would be wise to document their customer’s compliance with the ban. For hemp customers that distribute interstate, the institution should inquire into which geographic areas the customer distributes and document that such distribution does not violate any smokable hemp bans in that area. Further, some states, like Vermont, do not ban smokable hemp, but do require additional licensing for a cultivator seeking to sell it. Institutions must be aware of these nuances to obtain the proper licensing documentation from their hemp customers.
Like most things cannabis, smokable hemp bans are a moving target. Industry organizations are mounting lobbying campaigns to stop the spread of these bans and litigating the legality of bans already in effect, but unless and until the bans disappear, hemp companies must comply with them. And financial institutions must stay abreast of this shifting legal landscape and gain an accurate understanding of their hemp customers’ businesses to properly manage the risks of serving the hemp industry.
Hunter Robinson represents clients in commercial litigation and compliance-related matters across the country. His litigation practice focuses on representing financial institutions in lender liability, title, and business disputes, including class actions.
Hunter leverages his experience representing these highly regulated businesses to solve problems for cannabis companies and the vendors that serve them. In this role, he provides compliance advice to financial institutions regarding the complex laws governing the provision of financial services to cannabis companies, including the Bank Secrecy Act and related Anti-Money Laundering statutes and regulations. Hunter also assists hemp and CBD companies with a variety of issues, including entity formation and structuring, raising capital, regulatory compliance, and business disputes.
Connor Rose is an associate in Bradley’s litigation and construction practice groups. Connor represents clients in both state and federal courts in a broad range of commercial, construction, and product liability litigation matters.
Connor also advises financial institutions that service cannabis companies in Canada and states that have legalized cannabis under state law on how to navigate the complex state and federal laws regulating the provision of financial services to cannabis companies.
Jessica Caballero began her career as an examiner for the Office of the Comptroller of the Currency (OCC). After leaving the agency, she worked as both a banker and a consultant focused mainly on compliance and risk management in the wake of the Global Financial Crisis. Jessica joined the RegTech space in 2015 working in various roles as a subject matter expert at a large company. Jessica assisted product and R&D create technology solutions that address the evolving needs of the financial industry.
Jessica is now the Head of Compliance & Strategy for RiskScout, a RegTech company focused on bringing efficiencies and automation to cannabis and hemp banking. She is passionate about helping community financial institutions accurately interpret regulation and guidance through web-trainings, whitepapers, workshops and conferences. Jessica earned her bachelor’s degree in business economics from Texas State University in 2008, and has achieved the Certified Enterprise Risk Professional (CERP) and Certified Regulatory Compliance Manager (CRCM) designations from the American Banker Association (ABA).
Jake Fanella is a sales and marketing executive for RiskScout, a RegTech company focused on bringing efficiencies and automation to cannabis and hemp banking. Jake started his career in sales at Oracle where he focused on helping small businesses across the country migrate to the cloud. After leaving Oracle, Jake took a role as a sales and marketing executive for a student loan benefits startup where he met RiskScout Co-Founders, Justin Fischer and Josh Keys. Jake is passionate about helping small businesses and community financial institutions service the needs of their customers and capitalize on emerging markets. Jake earned his bachelor’s degree in business management and entrepreneurial leadership from the University of Iowa Tippie College of Business in 2016.
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