Washington faces marijuana legalization roadblocks

When more than 1.7 million Washington residents voted to make marijuana legal for adults last November, most probably didn’t give much thought to how that would work.

Some may have wondered who would grow it and who would sell it. A few may have questioned how those businesses would set up and operate.

But the discussions likely tended more toward Cheech & Chong than Dun & Bradstreet.

As the state tries to create a legal industry that hasn’t existed before, it finds more questions than answers: How will legal marijuana grown in Washington be tracked and kept from “leaking” into the black markets in surrounding states? How will its chemical content be tested and labeled? How will it be packaged to discourage use by children?

Among the biggest questions: How will those new businesses finance their operations or pay their bills with money that might have to be kept out of the national banking system?

Several federal laws, including the Bank Secrecy Act and the Patriot Act, have severe restrictions about accepting money from drug operations.

“You can’t transact financial matters with marijuana proceeds,” said Scott Jarvis, director of the Washington Department of Financial Institutions.

Currently, medical marijuana operations in the state are having increasing trouble establishing or keeping bank accounts, said Ezra Eickmeyer of the Washington Cannabis Association.

No bank account means no credit, debit or check purchases by customers and no checks or electronic transfers to pay state taxes or fees. Legal marijuana, like its black-market counterpart, could be an all-cash business.

$40,000 brought to Revenue office

The prospect of large sums of cash on site raises major security concerns, both at the marijuana businesses and at Department of Revenue offices where business owners might go to pay their taxes.

Earlier this month, for example, the Have a Heart medical marijuana dispensary in Seattle took $40,000 in cash to a local Revenue office to pay its tax bill. Owners stacked the bills on the counter, which were then hand-counted by department staff for about two hours while other taxpayers came in to make payments.

The department is reviewing its procedures and security at offices around the state in advance of the recreational marijuana businesses opening, Revenue spokeswoman Kim Schmanke said. Right now, about 2.2 percent of all taxes the state collects are paid in cash, but that could change, she said. “We do anticipate … we might have people coming in with piles of cash.”

The state currently deposits taxes from medical marijuana operations like any other taxes paid, Schmanke said, and has no plans to do anything different for recreational marijuana businesses.

It might have to, said Jarvis, of the Department of Financial Institutions. The strictest interpretation of federal banking laws would forbid commingling money the state collects from marijuana businesses with other tax collections, said Chris Marr, a member of the Liquor Control Board, which is in charge of writing Washington’s legal marijuana rules. If not, and the federal government moves to seize tax revenue from marijuana businesses, the state could risk forfeiture of the non-drug money in the account.

“This is the Rubik’s Cube that is the most challenging to solve,” said Marr, a former Spokane state senator. “There’s no elegant way to get around it.”

Company told to take banking business elsewhere

“Everything in this industry is harder than we imagined – exponentially harder,” said Brendan Kennedy, one of the founding partners of Privateer Holdings, a Seattle-based company that invests in services, products and infrastructure for the marijuana industry.

Even though the company was started by three experienced venture capitalists and invests only in businesses with indirect connections to the industry – no growers, processors or retailers – it struggled to find legal, accounting and payroll firms to take its business. Earlier this year it had to move its multimillion-dollar account when a bank told them to take their money elsewhere, Kennedy said. Privateer Holdings is on its third bank in three years.

“Banking is a significant issue,” Kennedy said. “Only in the United States do you see this mess where the federal government wants their taxes … but they also drive the industry underground with all-cash.”

The state is getting little or no assistance from federal officials in solving the problem, Jarvis said. While visiting with Federal Reserve and Federal Deposit Insurance Corp. officials earlier this year, he said he explained the state was working to set up regulations for legalized marijuana and asked for advice.

“They looked at me like I was pitching a TV reality series,” Jarvis recalled.

U.S. Rep. Denny Heck, D-Wash., recently co-sponsored a bill to give licensed recreational and medical marijuana businesses access to the federal banking system if they’re in states where that’s legal. Operating businesses strictly on cash raises questions about accounting and tax compliance as well as security, he said.

“It’s a bit like putting out the welcome mat to come out here and rob us,” Heck said last week. “My point is that it’s a legitimate business, and the size of that part of the economy is only going to grow.”

The bill, drafted by Rep. Ed Perlmutter, D-Colo., has attracted a handful of co-sponsors, mainly from states that have some form of legalized marijuana. But it hasn’t been scheduled for a hearing.

The chances of something passing before next spring, when the Liquor Control Board expects licensed recreational marijuana to be operating in the state?

“Slim and none, and none just left the room,” Heck said. “But we don’t ever get there if we don’t begin the process.”

‘Seed-to-sale’ tracking

The financial challenges of setting up a new industry aren’t the only problems the state faces as it works toward a legalized marijuana industry.

Gov. Jay Inslee said one of the federal government’s main concerns about making the drug legal in Washington is “leakage” – that is, marijuana grown legally here could be siphoned off to the black market and sold illegally in other states.

To allay these concerns, the Liquor Control Board will require a “seed-to-sale” tracking system, probably with growers assigning each plant a bar code that allows them and the state to follow that plant’s produce and waste. Seed-to-sale is a bit of a misnomer because most marijuana is not grown from seed but from “clones,” cuttings taken at a certain stage of a plant’s development that are dipped in a rooting compound and then planted.

This process has the Washington Cannabis Association asking the Liquor Control Board to change its proposed rules that require organic compounds be used on the plants, Eickmeyer said. The rooting chemicals are well-established after years of cultivation for medical marijuana, he said; they’re safe, but they aren’t organic.

Mike Steenhout, who heads up the liquor board’s research for marijuana, said that might be a relatively easy fix. The liquor board is concerned about chemicals that touch parts of the plant that are smoked or are processed to remove tetrahydrocannabinol, or THC, the chemical producing the euphoric “high.” The regulations may need a slight revision to make clear that chemicals on the roots don’t have to be organic, he said.

Testing for purity and potency

Legal recreational marijuana will have to be tested to ensure it is free of most pesticides, mold, mildew and insects, Steenhout said. It won’t be labeled organic, even with the requirements to use mainly organic chemicals. The federal government controls organic labeling rules and it has no standards for marijuana, which it still lists as a Schedule I drug, illegal for all uses.

The THC potency of recreational marijuana products sold under Initiative 502 will have to be clearly marked on the package, Steenholt said, and based on standardized testing. Setting those standards was another challenge the liquor board discovered in developing regulations. There were a wide array of laboratories with varying degrees of reliability testing medical marijuana products, as well as some “armchair chemists.”

The federal government has no testing standards to determine THC content, so the liquor board held a “summit” with representatives of the industry and faculty from universities in Washington and British Columbia to set its own.

“The percentage of THC is what sells,” Steenhout said. Medical marijuana products market that to consumers who have not established a particular brand loyalty and for “edibles,” food with marijuana baked or otherwise infused into it. “There’s kind of a nuclear arms race to see who can make the strongest edible.”

Some THC-infused baked goods have as much as 400 milligrams. The state’s recommended individual dose is 10 milligrams. Because distinguishing those products from regular cookies or brownies can be difficult, 502-infused products will have strict child-proof packaging requirements.

The diversity of infused products surprised Steenhout when he began his research. “There’s marijuana-infused coffee and marijuana-infused ice cream,” he said. There’s also hash oil, waxes and “budder,” which extracts the THC from the plant through a chemical process that can involve highly flammable butane.

Manufacturing such products will be allowed under state regulations, but only in state licensed and inspected facilities. Some processors now do it in their homes or backyards, which occasionally results in a fire or explosion.

“We’re going to take it out of the kitchen and into a state-sanctioned system,” the liquor board’s Brian Smith said.

Although the liquor board is open to current marijuana growers receiving licenses if they have relatively clean criminal records – current rules would allow some minor possession charges but no drug trafficking felonies – most will have to invest in more security, spend more on testing the chemical content and purity of their plants as well as keep extensive records.

Will small operations survive?

Marr, the Liquor Control Board member, said the system may favor larger, well-capitalized operations, but the state will try to give small operators like medical marijuana growers a chance to enter the new industry. Current plans are to “throw the doors open for 30 days” for anyone seeking a license to grow or process marijuana, providing they pass background checks and have a business plan that includes required security and testing standards, and are current on their taxes. The number of retail stores will be set based on population and research into current consumption.

There may be a high failure rate for small operators, but it’s something the state and the industry will have to deal with, Marr said.

Sean Green, who operates the Pacific Northwest Medical marijuana cooperative in Spokane and Shoreline, plans to set up a separate company and apply for a recreational marijuana grower’s license despite the challenges of banking and the costs of security, testing and other regulations.

Like any other business, the laws of supply and demand will allow some or all costs of testing and tracking to be passed on to the retailers, who will pass them on to the customers, he said. “The biggest concern is whether (legal marijuana) gets so expensive that the consumer doesn’t purchase it.”

Bigger companies might have an advantage for growing in outdoor fields, which would be the likely source of lower-priced, lower-potency products, said Green, a former real estate appraiser. Smaller operators who control their indoor environments might compete for the high-quality market, he said.

Marijuana purchasers may respond to variety the way consumers in other markets do, he said. “Some people buy a Lexus, some buy a Toyota.” The Liquor Control Board often uses the analogy of microbreweries or craft distilleries competing for a niche against mass-produced beer or liquor.

That variety, coupled with quality assurance, could cut into illegal sales even if the price of illegal marijuana remains significantly below the price of 502 products, liquor board officials say.

“There’s something to be said for knowing what you’re getting,” said Smith, of the liquor board.

The board’s members and staff are keenly aware that if Washington finds ways to solve the banking, testing and tracking problems, its system could end up being the model for other states that decide to legalize recreational marijuana.

Kennedy, with Privateer Holdings, said it’s “vitally important” that Washington and Colorado get the big things right, but they can’t expect immediate perfection. “There are going to be small parts that won’t be right at the get-go. In the next three years, there will be small tweaks to continually perfect the system.”