The Evolving Landscape of Merchant Processing and Cannabis Sales

Introduction

Title II of the Comprehensive Drug Abuse Prevention and Control Act of 1970, commonly known as the Controlled Substances Act (“CSA”), divides controlled substances into five levels of “schedules,” which are based on the drug’s potential for abuse, whether the drug has a currently accepted medicinal use, and whether there is a lack of accepted safety for the use of the drug under medical supervision or the level of psychological or physical dependent that could result from abuse of the drug.

After much anticipation and comments from some Senators, on May 16, 2024, the United States Department of Justice (the “DOJ”) began formal proceedings to reschedule marijuana as a less dangerous drug, and on May 21, 2024, the DOJ published a notice of proposed rulemaking (“NPRM”) to reschedule marijuana (cannabis) from a Schedule I controlled substance to a Schedule III. Although the reclassification process will take months before it is finalized and public comments to the DOJ are open until July 22, 2024, this NPRM could have far-reaching impacts on the cannabis, pharmaceutical, banking, and electronic payments industries.

Background

Under the CSA, 21 U.S.C. § 811 enumerates the rules and factors that the Attorney General shall use to determine classifying the control and enforcement of drugs in America. And subsection (c) lists eight (8) factors “determinative of control or removal from schedules.” Those factors listed in subsection (c) include inter alia, “its actual or relative potential for abuse,” “scientific evidence of its pharmacological effect, if known,” the state of the current scientific knowledge regarding the drug or other substance,” “its history and current pattern of abuse,” and “whether the substance is an immediate precursor of a substance already controlled.”  Currently, marijuana is classified as a Schedule I drug under the CSA, which means that it is treated as a “highly addictive” drug lacking medical value. Comparatively speaking, other drugs classified as Schedule I drugs include heroin and peyote.

However, the DOJ’s NPRM seeks to reclassify marijuana as a Schedule III drug, which could have a significant impact on the banking and payment processing industry because a Schedule I rescheduling would place marijuana on the same Schedule as many prescription drugs (e.g., acetaminophen with codeine) and indicates a moderate to low risk of dependency. Notably, neither recreational marijuana dispensaries nor medical marijuana dispensaries can currently process credit card transactions because of the Schedule I classification, and both often face significant barriers in opening bank accounts for that reason as well. Though this change will not legalize marijuana at the federal level, it marks a significant shift in the way the drug should and would be treated—assuming the reclassification passes. The shift also means that the federal government is formally recognizing that marijuana has potential therapeutic and medical benefits.

For many advocates, this has been a long-awaited and speculated shift in the federal government’s treatment of marijuana that first started with the Ogden Memo in 2009, wherein Deputy Attorney General David Ogden published formal guidelines for federal prosecutors to use their prosecutorial discretion consistent with the DOJ’s priorities in states authorizing the medical use of marijuana. The Ogden Memo was of significant importance as it was the first time that the federal government issued an opinion acknowledging the potential medical benefits of marijuana, albeit marijuana remained a Schedule III drug.

In fact, in 2013 and 2014, three separate reported opinions challenged the federal treatment of marijuana.[1] However, each court rejected arguments advanced related to the proposed rescheduling of marijuana, the de facto rescheduling of marijuana due to the Ogden memo, and that the current scheduling of marijuana violated the Constitution. Consequently, there were not any significant changes in the federal treatment of marijuana or its derivatives until the Agricultural Act of 2014 (the “2014 Farm Bill”). Under Section 7606 of the 2014 Farm Bill, producers were allowed to grow hemp so long as it met the university research pilot program requirements prescribed thereunder. Thereafter, the Agricultural Improvement Act of 2018 (the “2018 Farm Bill”) authorized the production of hemp and removed hemp and hemp seeds from the Drug Enforcement Administration’s (“DEA”) schedule of Controlled Substances.

In the banking and payment processing industry, the 2018 Farm Bill had far-reaching implications as it created a “gray area” in the world of marijuana derivatives and those companies’ ability to process compliant payments on the payment networks of the major credit card brands (e.g., Visa, Mastercard, Discover, and American Express. Collectively, the “Card Brands”). Because the 2018 Farm Bill defined “hemp” as Cannabis sativa L. and “any part of the plant, including the seeds thereof and all derivative, extracts, cannabinoids, isomers, acids, salts, and salts of isomers,” with no more than a 0.3 percent concentration of THC “hemp” companies and/or producers saw a significant reduction in the barriers related to opening bank accounts subject to federal law. And although doing so required heightened underwriting and risk management to ensure the products complied with the federal definition of “hemp,” so long as their products met the federal definition of “hemp,” companies and/or producers were also allowed to accept credit cards as a form of payment for their products.

Analysis

The proposed rescheduling of marijuana from Schedule I to Schedule III will have significant regulatory implications for cannabis businesses and will likely have far-reaching implications for the baking and electronic payments industries in the form of financial and tax implications for cannabis businesses, risk tolerance shifts for traditional banking, and risk tolerance shifts for acquirers and their independent sales organizations (“ISOs”) in the electronic payments industry.

A. Regulatory Implications for Cannabis Businesses

Rescheduling marijuana from Schedule I to Schedule III would subject marijuana to the same regulatory scheme applicable to Schedule III substances. As a threshold issue, this means marijuana would remain subject to the applicable provisions of the federal Food, Drug, and Cosmetic Act (the “FDCA”), which is under the jurisdiction of the Food and Drug Administration (the “FDA”). Under the NPRM, the DOJ explicitly notes that any drug containing a substance within the CSA’s definition of marijuana would need FDA approval to be lawfully “introduce[ed] or deliver[ed] for introduction into interstate commerce.” The only exception to that rule is where an Investigational New Drug (“IND”) is in effect for that drug.

The Schedule I classification of marijuana has also prevented or, at least, inhibited those seeking federal funding for research, which could help reclassify cannabis as a Generally Recognized as a Safe Ingredient by the FDA. As noted above and in the NPRM, the FDA would require approval of any drug products containing marijuana, ensuring those products meet safety and efficacy standards before entering interstate commerce. This proposed rescheduling of marijuana to Schedule III would likely result in more research, which would lead to pharmaceutical companies submitting INDs and, ultimately, New Drug Applications (“NDAs”) for marijuana-derived drugs to establish their safety, efficacy, and manufacturing quality.

In addition to the expected funding for research, submissions of INDs, and submissions of NDAs in the frug developmental and approval process, the regulatory process for the sale and distribution would also be subject to the same hurdles as other Schedule III drugs. While this process is likely familiar to many more established drug manufacturing companies, businesses newly engaging in the cannabis industry should be mindful that the DEA also has registration requirements after the proposed language is finalized at the FDA stage. Specifically, the DEA requires registration to permit businesses and/or individuals to manufacture, import, export, distribute, and dispense controlled substances.

B. Financial and Tax Implications for Cannabis Businesses

The proposed rescheduling of cannabis is also likely to alleviate financial burdens for cannabis-based businesses. Under the current iteration of the Internal Revenue Code, cannabis businesses face prohibitive tax burdens due to Section 280E, which disallows specific deductions for businesses trafficking Schedule I or II drugs. Due to Section 280E, cannabis businesses have historically suffered from higher income tax rates and have often encountered higher costs, as well as less favorable terms for loans and insurance policies due to the risks associated with Schedule I substances. The removal from Schedule I and rescheduling to Schedule III is likely to significantly reduce these tax burdens, financial challenges, and operational hurdles for those in the cannabis industry.

C. Risk Tolerance Shifts for Traditional Banking

Due to the current cannabis’s current Schedule I status, cannabis-related businesses also often struggle to find financial institutions to service their basic deposit needs. Rescheduling marijuana from Schedule I to Schedule III has the potential to impact the regulatory and legal risks associated with providing financial services to cannabis-related businesses. The current Schedule I status of marijuana means that it is classified as a substance with no accepted medical use and a high potential for abuse, which means that under the current scheme, banks face significant legal risks in providing services to cannabis-related businesses and could be accused of money laundering or aiding and abetting criminal activity.

Conversely, rescheduling marijuana to Schedule III would significantly minimize the risks banks face of potentially being accused of money laundering or aiding and abetting criminal activity. Furthermore, rescheduling marijuana to Schedule III is likely to prompt federal regulatory agencies to issue updated guidance on banking for cannabis-related businesses. For example, the Financial Enforcement Network (“FinCEN”) is likely to provide banks with a clearer framework for legal compliance and risk management, and there could even be amendments to major banking acts, such as the Bank Secrecy Act. Banks who seek to take on cannabis-related businesses as clients should be sure to have an in-depth understanding of money laundering laws, money transmitter laws, and any current or recently issued guidance from the DOJ and FinCEN.

D. Risk Tolerance Shifts for the Electronic Payments Industry

On a related note, the electronic payments industry is guided, in part, by federal and state banking laws. However, because the Card Brands own the networks that process credit card transactions, the electronic payments industry is also subject to each Card Brand’s private rules and regulations. For example, acquirers, who are the banks that process and settle credit card transactions for merchants, are held responsible for all the transactions accepted by their merchants, even if they use a payment processor and/or an ISO. Likewise, all credit card transactions must comply with federal, state, and local laws. Due to these rules and regulations, some of the Card Brands, such as Visa and Mastercard, also have rules and regulations associated with merchant underwriting, reserves and funding, and merchant risk monitoring for using their respective networks.

Furthermore, the Electronic Transactions Association (“ETA”) is the largest trade organization in electronic payments, which publishes suggested underwriting and risk management practices for acquirers and their ISOs (the “ETA Guidelines”). Of particular importance, Section 3.6.1 of the ETA Guidelines identifies specific categories of merchants from which the ETA suggests acquirers should require their ISO’s attestation of compliance with the law. Included in the current list are “CBD based or derived products,” and the rescheduling of marijuana from Schedule I to Schedule III would likely result in an amendment to the ETA Guidelines with cannabis-related businesses being added to that list.

Conclusion

Similar to how the ETA and the Card Brands currently treat CBD or pharmaceutical products, cannabis-related businesses will require proofing during the underwriting process, which will require each of the respective licenses and registrations discussed above and could also require a legal opinion letter before the bank approves the cannabis-related business for payment processing. However, because the rescheduling of marijuana from Schedule I to Schedule III will not result in full federal legalization of marijuana, the important distinction to make is that recreational marijuana products still will not be able to be purchased with credit cards. Like other Schedule III drugs, only approved medical marijuana and approved marijuana-derived products are likely to be allowed to be purchased using credit cards.

— Written by Matt Luciani

Sources

[1] See, e.g., Americans for Safe Access v. Drug Enforcement Admin., 706 F.3d 438 (D.C. Cir. 2013) (denying a petition to initiate proceedings to reschedule marijuana under the CSA); U.S. v. Canori, 737 F.3d 181 (2013) (holding that the Ogden Memo did not create a de facto rescheduling of marijuana); U.S. v. Wilde, 74 F. Supp.3d 1092 (N.D. Cal. 2014) (holding that Congress’s classification of marijuana as a Schedule I controlled substance satisfied traditional rational basis review).