Marijuana hedge funds: An emerging conundrum for regulators?

Will the launching of new marijuana hedge funds seeking to profit from legal cannabis sales in the Canada and the United States constitute money laundering by the Financial Action Task Force and federally defined illegal drug acts?  

This is a big question for regulators a year after sales of medicinal and recreational marijuana were made legal. And as the top domicile for hedge funds, would the Cayman Islands Monetary Authority welcome such hedge funds into this jurisdiction?  

The marijuana market is increasingly attracting the attention of hedge funds and private investment firms. Several notable and influential investors have stepped into the ring to capitalize on this ballooning industry:  

Founders Fund – a venture capital firm co-launched by billionaire PayPal co-founder Peter Thiel with more than $2 billion in assets under management, whose investment portfolio includes Airbnb, Lyft, Facebook, SpaceX and other tech companies – has taken a multimillion-dollar stake in Privateer Holdings, a private equity firm that invests in the legal cannabis industry, the two businesses announced a few months ago.  

The investment was a significant one for both Privateer and the cannabis industry as it represents the first major institutional funding in a marijuana company. The move is also exceptional in that Founders isn’t shunning the publicity. Other firms have made substantial investments but have not publicized them. 

Pharma Can Capital, a group of former Toronto hedge fund and tech investors recently closed a $9 million investment round with the aim of becoming the preferred source of money for medical marijuana startups. 

Poseidon Asset Management founded by Morgan Paxhia, a former financial adviser with UBS, and his sister Emily Paxhia, has also launched a fund focused on investments in cannabis and hemp-related assets. 

Leslie Bocskor, a Las Vegas resident, is creating a hedge fund to invest in medical and recreational marijuana companies, and also a consulting firm to assist state governments in establishing regulatory guidelines for medical cannabis. 

The exchange of money is huge. The medical marijuana market in Canada is estimated at roughly C$120 million in its first year, according to industry analysts. The ArcView Group, a cannabis-focused investment firm that collects market research, predicts that the legal marijuana market will reach $2.6 billion in sales by the end of 2015, and could exceed $10 billion annually by 2018.  

The marijuana industry is growing daily, and could potentially rival that of the tobacco and alcohol industries in how it contributes to the economy. It’s no wonder then that hedge funds are viewing this industry intently.  

The investment possibilities range from companies linked with medicinal use in Canada, recreational use in Colorado and Washington state, to businesses catering to operations in 23 states and Washington, D.C., where medical use is allowed. 

However, marijuana is still listed by the U.S. Drug Enforcement Administration and its peers as a Schedule I drug, which is defined as a drug for which there is no currently accepted medical use and a high potential for abuse. As a consequence, large U.S. banks have shied away from doing business with the marijuana industry – even in states where the drug is legal for medical or recreational purposes – for fear of losing their federal insurance. 

Under the U.S. money laundering law, conducting transactions with the proceeds of the sale of controlled substances, or moving the proceeds internationally, is considered a “specified unlawful activity” and a “predicate” offense to a money laundering prosecution. 

In July 2014, the U.S. House of Representatives voted to forbid the Treasury Department from punishing financial institutions that conduct business with the marijuana industry. The Senate, however, is still sitting on the fence. Meanwhile, several federal regulators have published guidance on how banks can work with marijuana businesses without breaching federal laws. 

Still, the largest banks will likely continue to shun the cannabis industry until the federal government reclassifies marijuana from its current prohibited status. 

Other countries that have long been fighting the war on drugs are observing the U.S. intently. FATF has issued no guidance on how financial institutions can work with the cannabis industry as yet, so they would be breaching the FATF 40 + 9 Recommendations. Hence, regulators are stumped as to what to do. 

While consecutive British governments have spurned calls for legalization, it is believed that many politicians privately feel it would be the right move but are too scared of displeasing constituents and the media by ever recommending it. CLEAR, a cannabis law reform group, lately projected that the British economy would gain £6.7 billion (US$10.1 billion) were it to tax and regulate marijuana.  

Right now, financial institutions and designated non-financial businesses and institutions that conduct transactions, which includes taking funds that originate from legalized marijuana businesses, could be exposed to money laundering charges under U.S. and international laws. These offenses could result in huge criminal fines for the institution and prison sentences of up to 20 years or both, depending on the jurisdiction, for individuals who are convicted. 

So what will these new hedge funds be told if they try to register in Cayman? Currently, they will be turned away, since marijuana businesses that comply with the laws of a particular state are still breaking federal and international laws. Third parties that help the business operate, including bankers, investors, lawyers and accountants, are exposing themselves to risk of imprisonment, loss of money, and loss of professional licensing.  

Until international and federal laws are amended, financial institutions and designated non-financial businesses and institutions face a stark choice – continue to reject businesses associated with the marijuana industry, or risk prosecution and penalties from regulators for violating international and U.S. money laundering laws. 

Alternately, this may be an opportunity for Cayman’s leaders and financial industry gurus to take the lead and help devise solutions so that when the opportunity arises, Cayman can benefit from it. 

 

Gregg Anderson is managing director of VisionQuest Management Services Ltd., a boutique management consulting company.  

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Morgan Paxhia

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Leslie Bocskor

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