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The Department Of Justice’s Policy On Marijuana And Its Affects On Financing For Marijuana Related Businesses

As most readers of this blog are aware, marijuana is now legal in some form in half of the states, including Pennsylvania. Although legal in half of the states, marijuana related businesses remain subject to federal prosecution under the Controlled Substance Act (“CSA”) because it remains listed as a Schedule I drug. Until the DEA reclassifies marijuana, marijuana related businesses are subject to enforcement and prosecution under the CSA. The CSA specifically states that the federal law does not preempt state law on the same subject matter. How do marijuana related businesses and financial institutions resolve this conflict between state laws and federal law.

Initially, financial institutions wouldn’t go near marijuana related businesses.  The risk of federal prosecution was too much for banks even if the marijuana related business was in compliance with state laws.

Through a series of three internal memos authored by former Deputy Attorney General, James Cole, the DOJ outlined its policy on enforcement of federal law and prosecution of marijuana related businesses and helped to alleviate the concerns of financial institutions.

The first memo dated June 29, 2011, clarified the DOJ’s position after an earlier Ogden Memo. The Ogden Memo focused the DOJ’s enforcement and prosecutorial efforts on illegal enterprises, gangs and cartels and viewed the prosecution of those individuals taking medical marijuana pursuant to an applicable state law as an inefficient use of federal resources. The First Cole Memo seemingly contradicted this when it stated that the Ogden Memo was never intended to shield such activities from enforcement action and prosecution, even when those actions comport with state law. The First Cole Memo reinforced that state laws were not a defense to enforcement of federal law when such enforcement was consistent with resources and focus of the individual judicial districts. The First Cole Memo was a major blow to marijuana related business as banks were unwilling to provide financing given the threat of federal prosecution and forfeiture under the CSA.

The Second Cole Memo dated August 29, 2013, helped to ease these concerns and fears when it listed eight (8) priorities of the DOJ’s for enforcement of the CSA on marijuana related activities.

The Second Cole Memo priorities are as follows:

– 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 the 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.

The Second Cole Memo priorities provided some reassurance to marijuana related businesses that so long as they were in compliance with their respective state laws they were not likely to be the subject of federal action against them.

The Third Cole Memo, dated February 14, 2014, was issued concurrently with a memo from the Department of Treasury, Financial Crimes Enforcement Network (“FinCEN”) to provide guidance and clarification to marijuana related businesses and banks providing financing to those business. Essentially, the two memos were issued to guide banks and lending institutions financing marijuana related businesses with regards to the DOJ’s focus on financial crimes for which marijuana related conduct is a predicate. The memos stated that money laundering statutes, the unlicensed money remitter statute, and the Bank Secrecy Act remain in effect with respect marijuana related activities. However, the two memos provide guidance to banks on how they can provide services to marijuana related businesses and not run a foul of the DOJ and/or the Department of Treasury.

The FinCEN Memo, in particular, states that in assessing the risk of providing services to marijuana related businesses, a financial institution should perform customer due diligence that includes: (i) verifying with the appropriate state authorities whether the business is duly licensed and registered; (ii) reviewing the license application (and related documentation) submitted by the business for obtaining a state license to operate its marijuana-related business; (iii) requesting from state licensing and enforcement authorities available information about the business and related parties; (iv) developing an understanding of the normal and expected activity for the business, including the types of products to be sold and the type of customers to be served (e.g., medical versus recreational customers); (v) ongoing monitoring of publicly available sources for adverse information about the business and related parties; (vi) ongoing monitoring for suspicious activity, including for any of the red flags described in this guidance; and (vii) refreshing information obtained as part of customer due diligence on a periodic basis and commensurate with the risk.

The FinCEN Memo further states a financial institution may reasonably rely on the accuracy of information provided by state licensing authorities, where states make such information available.

In effect the memos provided a blue print for marijuana related businesses to follow when they attempt to obtain financing from a bank.

1. Make sure your marijuana related business is licensed under state law and has procedures in place to ensure ongoing compliance with state and local laws regulations, and ordnances;

2. Have a proper understanding of all state and federal law including the Cole Memo priorities;

3. Screen all employees and any other parties related to the business to confirm they are properly licensed, if required, and to verify that they have no previous criminal records, especially drug related criminal records;

4. Provide a business plan or model which includes information such as: 1) the type of activity the business will engage in (grower /processor, dispensary, etc.); 2) product being manufactured, grown or sold; 3) proposed number employees; 4) proposed location of business; and 6) list of assets, liabilities, and possible investors;

5. Have procedures in place to properly document all of the activities of your marijuana related business; and

6. Have a monitoring and security system in place to prevent adverse public information and suspicious activity.

Generally, operate a marijuana related business like a normal business but keep in mind it is subject to unique legal requirements and rules which require your knowledge, understanding, and compliance.

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Say What?!?! ATF Re-Opens Comment Period for ATF-4473

In an extremely unusual turn of event, yesterday, the Bureau of Alcohol, Tobacco, Firearms and Explosives (“ATF”) re-opened its comment period relative to its proposed changes to the ATF-4473 form, to provide an additional 30 days for comments.

Our readers probably remember our April blog entitled ATF Soliciting Comments on Proposed Revisions to the Firearms Transaction Record “4473”, where we alerted the Firearms Industry about ATF’s intent (seemingly in violation of the Administrative Procedures Act) to address, among other things, medical marijuana users.

Our friends at Cannabis Industry Law Group (“CILG”), a division of Civil Rights Defense Firm, P.C.,  filed a Comment in opposition to ATF’s proposed changes and pointing out that 27 C.F.R. 478.11 already acknowledges that the use of physician prescribed controlled substances does not result in a prohibition and that ATF is the incorrect federal administrative agency for determinations of prohibition under 18 U.S.C. 922(g). For those unaware, CILG’s stated purpose is to “protect, defend and assert the legal rights of businesses, professionals and individuals to operate lawful cannabis-related businesses and professions and to use cannabis medication without discrimination.”

Firearms Industry Consulting Group® (“FICG®”), a division of Prince Law Offices, P.C., also filed a Comment in opposition to ATF’s proposed changes, where we raised numerous issues, including that ATF cannot redefine a “fugitive from justice” in these proceedings and issues relating to the certification statement. FICG® also requested that ATF revise the 4473 Form, consistent with the ATF Form 1 and Form 4, whereby it would include fields for fictitious entities, instead of requiring FFLs to draft and attach a fictitious entity form as required by 27 C.F.R. 478.124(g), for which, ATF provides no sample form.

At the present time, it is unknown why ATF has elected to re-open the comment period and to provide an additional 30 days – unless it was at the behest of the National Firearms Act Trade and Collectors Association (“NFACTA”), which has become notorious in past several years in petitioning ATF to take regulatory action contrary to the Firearm Industry’s interest. Nevertheless, if you did not have opportunity to file a comment, we highly recommend that you do or at least file a statement supporting FICG’s and CILG’s Comments. If we learn anything more about ATF’s (nefarious) motives in re-opening the comment period, we will be sure to let our readers know.

If you are a Firearm Industry member and would like representation in drafting comments to federal rulemaking proposals, including in relation to the 4473, contact us at 888-313-0416 or info@princelaw.com and we’ll be happy to discuss how we can ensure that your issues and concerns are considered in the rulemaking process.

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Governor Wolf passes new law allowing research into industrial hemp.

Pennsylvania has taken another step forward in legitimizing the production of Cannabis. In this instance, it’s industrial hemp. On July 19, 2016, Governor Tom Wolf signed a new law providing for industrial hemp research. House Bill No. 967, now Act 92 was approved by Governor Wolf and amends Title 3 (Agriculture) of the Pennsylvania Consolidated Statutes, providing for industrial hemp research; imposing powers and duties on the Department of Agriculture and the Legislative Reference Bureau; and imposing civil and criminal penalties.

Industrial hemp is a variety of the Cannabis sativa plant species grown specifically for the industrial uses of its derived products. Industrial hemp was one of the first plants to be spun into usable fiber 10,000 years ago. Industrial hemp can be refined into a variety of commercial items including paper, textiles, clothing, biodegradable plastics, paint, insulation, biofuel, food, and animal feed.

Industrial hemp grows in a variety of climates and soil types, is naturally resistant to most pests, and grows very tightly spaced allowing it to outcompete most weeds. Industrial hemp is a natural substitute for cotton and wood fiber.

Under the law “Industrial hemp” is define as “the plant Cannabis sativa L and any part of the plant, whether growing or not, with a delta-9 24 tetrahydrocannabinol (THC) concentration of not more than 0.3% on a 25 dry-weight basis. Both recreational marijuana and industrial hemp are derived from the Cannabis sativa plant but they are distinct strains with unique biochemical compositions and uses. Industrial hemp has lower concentrations of THC and higher concentrations of cannabidiol (CBD), which decreases or eliminates its psychoactive effects. Industrial hemp has absolutely no value as a recreational drug.

“William Penn himself was an advocate of hemp growth, and in 1683, one of the first laws passed by the General Assembly in Pennsylvania was a law to encourage every farmer to grow hemp,” said Governor Wolf.

The new law authorizes industrial hemp to be grown or cultivated by the Department of Agriculture or an institution of higher education for the purposes of research conducted under an agricultural pilot program. The law authorizes the Department and/or institutions of higher education to begin cultivating hemp for research purposes, either by themselves or via independent contractors.

The new law is another step forward in creating new business opportunities for cannabis growers in Pennsylvania.

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DDTC Issues Guidance on ITAR Registration

DDTC

On Friday July 22, 2016, the Directorate of Defense Trade Controls (“DDTC”) released a letter issuing guidance on the requirement of firearm manufacturers and gunsmiths to register with DDTC under the International Traffic in Arms Regulations (“ITAR”).

There has been constant discussion on the internet regarding whether an individual who has obtained a federal firearms license (“FFL”) is required to register for ITAR. Some of the Industry Operations Inspectors (“IOIs”) have taken it upon themselves to inform Type 07 FFLs that they must register for ITAR without any guidance from DDTC. There are certain instances where an FFL does not need to register for ITAR.

22 C.F.R. § 122.1 discusses the registration requirements for ITAR.

(a) Any person who engages in the United States in the business of manufacturing or exporting or temporarily importing defense articles, or furnishing defense services, is required to register with the Directorate of Defense Trade Controls under § 122.2. For the purpose of this subchapter, engaging in such a business requires only one occasion of manufacturing or exporting or temporarily importing a defense article or furnishing a defense service. A manufacturer who does not engage in exporting must nevertheless register.

The crux of the registration for ITAR (for most FFLs) lies within the definition of manufacturing. DDTC has not promulgated a definition for manufacturing which is the source of a lot of confusion and misinformation.

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DDTC’s letter states that individuals who “do not actually manufacture ITAR-controlled firearms (including by engaging in the activities described below, which DDTC has found in specific cases to constitute manufacturing) need not register with DDTC – even if they have an FFL from ATF.” This is because the requirements for obtaining an FFL are separate and distinct of the requirements for registering under ITAR.

As DDTC does not have a definition for the term “manufacturing”, it relies on “the ordinary, contemporary, common meaning of the term.”

DDTC’s guidance is only in relation to “domestic (U.S.) activities involving firearms (as defined in Category I(j)(1) of the United States Munitions List (USML) (22 CFR § 121.1)) and related ammunition that are .50 caliber (12.7 mm) or smaller – i.e., firearms in Category I, paragraphs (a) and (b), related items in paragraphs (e)-(h), and ammunition in Category III(a) for those firearms. Activities involving items elsewhere on the USML, including Category I, paragraphs (c) and (d), are not included in the scope of this guidance.”

DDTC has found that the following instances do not require registration.

a)  Occasional assembly of firearm parts and kits that do not require cutting, drilling, or machining;

b)  Firearm repairs involving one-for-one drop-in replacement parts that do not require any cutting, drilling, or machining for installation;

c)  Repairs involving replacement parts that do not improve the accuracy, caliber, or other aspects of firearm operation;

d)  Hydrographic paint or Cerakote application or bluing treatments for a firearm;

e)  Attachment of accessories to a completed firearm without drilling, cutting, or machining—such as attaching a scope, sling, or light to existing mounts or hooks, or attaching a flash suppressor, sound suppressor, muzzle brake, or similar item to a pre- threaded muzzle;

f)  Cosmetic additions and alterations (including engraving) that do not improve the accuracy, caliber, or other aspects of firearm operation beyond its original capabilities;

g)  Machining new dovetails or drilling and tapping new holes for the installation of sights which do not improve the accuracy or operation of the firearm beyond its original capabilities; and

h)  Manual loading or reloading of ammunition of .50 caliber or smaller.

The guidance goes on to clarify that “[a]ctivities limited to the domestic sale or resale of firearms, the occasional assembly of firearms without drilling, cutting, or machining, and/or specific gunsmithing activities that do not improve the accuracy, caliber, or operations of the firearm beyond its original capabilities (as described above) are not manufacturing within the context of the ITAR. If you are not manufacturing, exporting, temporarily importing or brokering defense articles or services, you are not required to register with DDTC.”

Which then begs the question, what does DDTC require the registration under ITAR for?

DDTC states that if you are engaged in any of the following you are required to register for under ITAR.

a)  Use of any special tooling or equipment upgrading in order to improve the capability of assembled or repaired firearms;

b)  Modifications to a firearm that change round capacity;

c)  The production of firearm parts (including, but not limited to, barrels, stocks, cylinders, breech mechanisms, triggers, silencers, or suppressors);

d)  The systemized production of ammunition, including the automated loading or reloading of ammunition;

e)  The machining or cutting of firearms, e.g., threading of muzzles or muzzle brake installation requiring machining, that results in an enhanced capability;

f)  Rechambering firearms through machining, cutting, or drilling;

g)  Chambering, cutting, or threading barrel blanks; and

h)  Blueprinting firearms by machining the barrel.

Of particular interest is the guidance that now offering barrel threading services will result in an FFL being required to register for ITAR. This will certainly put a financial burden on the smaller gunsmiths who are threading barrels as registration for ITAR is $2,250 a year.

tenon_threading

Additionally, the penalties for violating ITAR are significant and able to be applied retroactively. Penalties for each violation of ITAR can result in up to $1,000,000 in fines and 20 years imprisonment. 22 U.S.C. § 2778(c)

DDTC does allow for voluntary disclosures of violations.

“The Department may consider a voluntary disclosure as a mitigating factor in determining the administrative penalties, if any, that should be imposed. Failure to report a violation may result in circumstances detrimental to U.S. national security and foreign policy interests, and will be an adverse factor in determining the appropriate disposition of such violations.” 22 C.F.R. § 127.12.

Lastly, DDTC does have a mechanism for an individual or company to inquire whether the activity they are engaging in requires registration under ITAR. This is an area that myself and Attorney Joshua Prince have experience in. It is certainly advised that a determination from DDTC is sought prior to engaging in the activity (if it is unknown or questionable whether it would require registration under ITAR) in order to mitigate any potential penalties.

 

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IRS unfairly taxes Legal Marijuana Businesses.

For those who wish to get involved in the now legitimate Pennsylvania business of medical marijuana, be prepared to be unfairly taxed by the IRS. While medical marijuana is now legal in Pennsylvania, as well as 24 other states, it remains classified as schedule I drug under the Federal Controlled Substance Act. This allows the Federal government to unreasonable tax gross revenue or income from the operation of any marijuana business under section 280E of the Internal Revenue Code. Section 280E does not allow a business to deduct otherwise ordinary business expenses from gross income generated from the trafficking of Schedule I or Schedule II substances.

Section 280E states:

  •  No deduction or credit shall be allowed for any amount paid or incurred during the       taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

Section 280E was originally enacted in 1982 in response to a Minneapolis drug dealer arguing in Court that he should be allowed to write off expenses related to his business under the Federal tax law. Congress enacted section 280E to prevent other illegal drug dealers from following suit.

While section 280E has been around since 1982, in January of 2015, the IRS issued an internal memorandum rejecting many of the tax deductions utilized by legal marijuana businesses and requiring strict interpretation of Section 280E. Under 280E, standard business deductions such as employee salaries, utility costs, internet, telephone, insurance, advertising costs, repairs and maintenance fees, and rental fees will be scrutinized and likely denied.

Since marijuana remains illegal and classified as a Schedule I drug, small businesses cannot deduct ordinary business expenses on their Federal Income Tax. The effective tax rate for a small marijuana business can exceed 70% of the gross revenue as result. Getting taxed at a rate of 70% of your gross revenue will destroy even the most efficient business.

In other words, if a legal marijuana business had gross revenue or income of $1,000,000.00 for 2016 and $600,000.00 in standard deductions, that business could not deduct the $600,000.00. Instead of being taxed on $400,000.00 (or whatever the net income was after all other deductions), the legal marijuana business net income would include those deductions and it would be taxed on the full $1,000,000.00.

Legal marijuana businesses can deduct the Cost of Goods Sold under the internal revenue code. Through creative setup or accounting, legal marijuana business can try to attribute deductions to non-marijuana aspects of their business. Indirect costs may also be deductible under section 263A of the Internal Revenue Code.

The easiest way to fix this problem is to reclassify marijuana as Schedule III drug under the CSA. While the DEA is considering that, there is no idea when and if that will happen.

Last year, the Small Business Tax Equity Act was introduced in the U.S. Senate and the U.S. House which would amend the Internal Revenue Code of 1986 to allow deductions and credits relating to expenditures in connection with marijuana sales conducted in compliance with State law.

Section 280E is an outdated provision of the Internal Revenue Code which was enacted to keep drug dealers from benefitted from the illegal drug business. With the change in state drug laws allowing legal marijuana businesses, 280E’s application to those legal marijuana businesses will only punish and destroy otherwise legal job creating businesses.

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Monumental Decision from the Middle District Court of Pennsylvania Regarding Mental Health Commitments and the Second Amendment

Today, Judge John E. Jones, III. of the United States District Court for the Middle District of Pennsylvania held in Keyes, et al. v. Loretta Lynch, et al. that an individual, who was involuntarily committed on a single-isolated occasion, can successfully challenge a prohibition under 18 U.S.C. § 922(g)(4).

In this case, both Mr. Keyes and Mr. Yox challenged, inter alia, whether 18 U.S.C. § 922(g)(4) violated their Second Amendment rights, as-applied to their specific factual scenarios. Unfortunately, although Mr. Keyes and Mr. Yox’s factual backgrounds were extremely similar, the reason Mr. Keyes was denied the same outcome as Mr. Yox was due to the PA Superior Court’s previous incorrect analysis in In re Keyes, which Judge Jones felt precluded him from addressing Mr. Keyes’ Second Amendment as-applied challenge.

In addressing Mr. Yox’s challenge, the court declared:

Notably, Defendants hardly mention at all in their briefing, much less challenge, the specific facts of Mr. Yox’ case. Defendants reference Mr. Yox’s possession and use of firearms as a member of the military and as a correctional officer only to argue that there is no legal support for the position that his Second Amendment right can be restored “merely by virtue of his employment history.” (Doc. 46, p. 4). That this dismissive treatment of Mr. Yox’s public service [as] ungracious is clear. But more importantly, Defendants avoid addressing the clear irony of Mr. Yox’s situation. It requires a suspension of logic to believe that Mr. Yox is mentally stable enough to possess and use various types of firearms in his professional capacity, including putting his life on the line for his country while on active military duty, but is not mentally stable enough to possess a firearm for self protection in his home.

The court then went on to declare:

Indeed, Mr. Yox provides the perfect test case to challenge § 922(g)(4), as the illogical contradiction of being able to possess firearms in his professional capacities but not being able to possess a firearm for protection in his own home puts in relief a factual scenario where an as-applied Second Amendment challenge to this statute may succeed.

Indeed, if Mr. Yox were not to succeed on his as-applied challenge, we cannot imagine that there exists any person who could.

I must admit that it is extremely refreshing to see Judge Jones acknowledge that those who “are mentally ill” is a distinct and separate category from those who had an single-isolated mental health commitment over a decade ago. I believe we will see a number of federal challenges, some already pending in Pennsylvania, in relation to whether mental health commitments can strip an individual of a constitutional right, especially under Section 302 of the Mental Health and Procedures Act, as it does not provide any form of due process.

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Bi-partisan support for marijuana.

On July 9, 2016, the Democratic Party endorsed as part of its official platform a “reasoned pathway to future legalization” of marijuana and called for the drug to be downgraded in the Controlled Substances Act (“CSA”). On Saturday afternoon, the democratic platform committee introduce an amendment that would have removed Marijuana from the CSA entirely. After argument, a rival amendment was introduced which proposed downgrading marijuana from a Schedule I of the CSA to Schedule 2.

Schedule I drugs are defined as drugs with no currently accepted medical use and a high potential for abuse. Schedule I drugs include heroin, LSD, ecstasy, methaqualone, and peyote. Schedule II drugs, substances, or chemicals are defined as drugs with a high potential for abuse, with use potentially leading to severe psychological or physical dependence. Some examples of Schedule II drugs include Vicodin, cocaine, methamphetamine, methadone, hydromorphone (Dilaudid), meperidine (Demerol), oxycodone (OxyContin), fentanyl, Dexedrine, Adderall, and Ritalin.

The text of the amendment to the Democratic Party’s platform reads as follows:

“Because of conflicting laws concerning marijuana, both on the federal and state levels, we encourage the federal government to remove marijuana from its list as a Class 1 Federal Controlled Substance, providing a reasoned pathway for future legalization.”

Back in April of this year, the DEA sent a letter to lawmakers indicating that it will consider in the upcoming months reclassifying marijuana as a Schedule II drug to help researchers better study its uses and benefits.

Democratic Presidential candidate, Hillary Clinton, has stated that she supports medical marijuana research and the reclassification of marijuana from Schedule I to Schedule II. Republican Presidential Candidate, Donald Trump states that cannabis is a decision to be left up to the individual states.

In May of this year, Republican House Speaker Paul Ryan, stated that he believes that a measure for the legalization of Cannabidiol (CBD) can pass the Republican dominated House of Representatives.

Updated July 12, 2016.  Despite vigorous debate, Republican delegates voted not to  endorse medical marijuana as part of the Republican Party’s official platform. 

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