Article – Faegre Baker Daniels: Key Considerations for U.K. Investment in the Legal Cannabis Industry Abroad

Faegre Baker Daniels

 

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U.K. investors in cannabis-related entities, where the activity is legal in its jurisdiction but not legal in the U.K., risk committing money laundering offences under the Proceeds of Crime Act 2002 (POCA). However:

  • Various defences may be available under POCA (as set out below).
  • The legality of the investment can be safeguarded by making an authorised disclosure to the National Crime Agency (NCA) and receiving consent to proceed with the specific proposed activity (be it selling existing investments, holding them and receiving dividends, or making new investments).
  • Correct structuring of an investment is key to ensuring that the investment can be made lawfully.

That said, the legal position is not clear cut. There is very little guidance for U.K. businesses with regards to cannabis-related activity and significant discrepancy in opinion within the U.K. investment community as to the boundaries of legal risk and compliance. The position of the NCA and other regulators is not clear, whilst Lloyd’s of London guidance varies by jurisdiction, as outlined below. On 18 June 2019, the U.K. Law Commission published a report, “Anti-money laundering: the SARs regime”, highlighting the need for guidance on transactions involving the legal cannabis industry in Canada and elsewhere.

In the meantime, U.K. investors will need to remain alive to the risk that returns from the Canadian or U.S. cannabis industries may be considered proceeds of crime and conduct appropriate due diligence (and make disclosures if necessary) in accordance with their risk appetite.

Legal Status of Cannabis in the U.K., U.S. and Canada

U.K.

In the U.K., cannabis is illegal for recreational use and is classified as a Class B drug under the Misuse of Drugs Act 1971. Medical use of cannabis when prescribed by a registered specialist doctor was legalised in November 2018. The possession of cannabis carries a sentence of up to 5 years in prison, an unlimited fine or both, and the supply and production of cannabis carries a sentence of up to 14 years in prison, an unlimited fine or both.

U.S.

In the U.S., the use and possession of cannabis over 0.3% THC (legal term “marijuana”) is classified as a Schedule 1 drug and is illegal under federal law for any purpose (with the exception of FDA-approved research programs) by way of the Controlled Substances Act 1970.

However, individual states have enacted legislation permitting exemptions for various uses, mainly for medical and industrial use but also recreational use. This has not changed federal law; the Department of Justice has instructed prosecutors to refrain from prosecuting by way of the Cole Memorandum, issued in August 2013 to all U.S. Attorneys, governing federal prosecution of offenses related to marijuana. The memo stated that given its limited resources, the Department of Justice would not enforce the federal marijuana prohibition in states that “legalized marijuana in some form and … implemented strong and effective regulatory and enforcement systems to control the cultivation, distribution, sale, and possession of marijuana,” except where a lack of federal enforcement would undermine federal priorities (such as preventing violence in marijuana cultivation and distribution, preventing cannabis impaired driving, and preventing marijuana revenues from going to gangs and cartels).

Canada

Since 17 October 2018, it has been legal to produce, distribute, sell and possess cannabis in Canada (for all purposes including medical and recreational), subject to complying with the provisions of the Canadian Cannabis Act.

Relevant U.K. Statute

POCA

POCA contains various money laundering offences relating to the direct handling of the proceeds of crime. A person commits an offence if he or she:

  • Conceals, disguises, converts, transfers the proceeds of crime or removes criminal property from the jurisdiction of England and Wales (s327) (the basic money laundering offence).
  • Enters into or becomes concerned in an arrangement which he or she knows or suspects facilitates the acquisition, retention, use or control of criminal property by or on behalf of another person (s328) (the aiding and abetting offence).
  • Acquires, uses or possesses criminal property (s329) (the handling stolen goods offence).

“Criminal property” is defined in s340(3) and s413(1) of POCA as property which constitutes a person’s benefit from criminal conduct or which represents such a benefit (in whole or in part and whether directly or indirectly).

“Criminal conduct”, under s340(2) of POCA, is conduct which constitutes an offence in any part of the U.K. or would constitute an offence in any part of the U.K. if it occurred there.

The above definitions bring cannabis, including cannabis grown and distributed legally abroad, within the scope of POCA, thereby creating an issue for U.K. investors.

The SOCPA or “Spanish Bullfighter” Exception

The Serious Organised Crime and Police Act 2005 (SOCPA) provides an exception to the above offences (the “Spanish bullfighter” exception) in relation to conduct that is legal in other jurisdictions. A person does not commit an offence if:

  • They know or believe, on reasonable grounds, that the relevant criminal conduct occurred outside the U.K.,
  • The relevant criminal conduct was not, at the time it occurred, unlawful under the criminal law then applying in that territory, and
  • The relevant criminal conduct is not of a description prescribed by an order made by the Secretary of State.

For example, a bullfighter from certain parts of Spain (where the practice is legal) could come to the U.K. (where it is not) and spend his earnings without fear of committing an offence under POCA.

However, the above exception regarding orders made by the Secretary of State brings cannabis-related businesses back within the scope of POCA; the Proceeds of Crime Act 2002 (Money Laundering: Exceptions to Overseas Conduct Defence) Order 2006 provides that conduct which would constitute an offence punishable by imprisonment for a maximum term in excess of 12 months in any part of the U.K. does not form part of the Spanish bullfighter exception. The cultivation, possession, distribution (etc.) of cannabis all carry sentences of greater than 12 months.

Defences and Safeguards

Adequate Consideration

Section 329(2)(c) POCA contains a specific defence to the offence of acquiring, using or possessing criminal property, which is that a person does not commit an offence if they acquired their property for “adequate consideration”. Consideration would be “inadequate” for these purposes if it was significantly less than the value of the relevant property. Therefore, shares purchased in a public company for market value would not constitute criminal property. The right to the benefits derived from those shares, such as dividends and capital growth, should also be considered to have been purchased for adequate consideration, albeit this position has not been tested and confirmed in the U.K. courts.

U.K. shareholders should therefore be entitled to rely on the adequate consideration defence to permit them to (i) purchase shares in companies exposed to the cannabis industry, (ii) receive dividends paid on those shares, and (iii) sell those shares for a profit if the share price has risen since they were acquired, in each case without such conduct constituting an offence under s329. It must be noted, however, that in relation to points (i) and (iii), offences under s328 and s327 POCA (respectively) may still be committed. It is therefore imperative to ask when the relevant activity took place and consider any available defences accordingly.

Authorised Disclosure

POCA also specifies a method to ensure that the various money laundering offences would not be committed; under s327(2), s328(2) and s329(2), a person does not commit an offence if they make an “authorised disclosure” and obtain the appropriate consent. This “authorised disclosure” takes the form of a suspicious activity report (SAR) that is typically submitted to the NCA.

The NCA may give “active” consent (i.e. respond saying that consent is granted), or, if the NCA does not respond to an SAR within seven working days from the first working day after submission, then they are deemed to have given consent and the person may proceed (s335(5) POCA).

Note, however, that an SAR cannot be used to obtain “blanket” permission. To adhere to the SAR regime, an investor would technically have to submit an SAR each time they decide to take any action in respect of their “criminal property”, e.g. purchasing shares, receiving dividends or selling shares. Investors might therefore burden themselves with various reporting obligations as well as the NCA with excessive numbers of reports to process.

U.K. Public Policy

This type of activity is not what POCA was designed to criminalise, and it is considered unlikely that the U.K. authorities would actively seek to prosecute for it. Moreover, the SOCPA exception indicates that U.K. legislation has been narrowed to avoid unintended consequences.

Timing of the Investment

According to the English cases of R v Loizou [2004], R v Geary [2010] and GH [2015], property must be “criminal property” at the time the alleged criminal activity was undertaken. Therefore, individuals who invest in companies that do not have a connection to the cannabis industry but subsequently change their business to include cannabis-related activity will not commit an offence until they begin to receive proceeds generated by that activity.

In R v Geary, the Court of Appeal held that “property becomes criminal property only when a person obtains an interest in it as a result of, or in connection with, criminal conduct, that is, conduct which constitutes a criminal offence” and “criminal property must already have come into existence in order for an offence to be committed under section 328 or 329”. This means that a U.K. company or individual investing lawful money into a new cannabis venture would not be committing an offence under s328.

Territoriality

Whilst English law presumes that English criminal statutes do not extend to acts wholly undertaken outside the U.K., the Court of Appeal decision R v Rogers [2014] significantly (and somewhat surprisingly) extended the scope of POCA to conduct that occurs entirely outside the U.K., subject to the restriction that a significant part of the underlying criminality must have taken place in the U.K. and it had harmful consequences in the U.K..

Rogers, a U.K. citizen resident in Spain, permitted money from a fraudulent scheme in the U.K. to be paid into his Spanish bank account and allowed the fraudsters to withdraw money from that account. He was convicted of converting criminal property. The Court of Appeal upheld the conviction because a significant part of the underlying criminality took place in the U.K. and it had harmful consequences in the U.K.

The effect of this is that, provided all actions are undertaken outside the U.K., the sale of shares or assets and collection of dividends outside the U.K. would not constitute a crime in the U.K.

However, were investors to move their returns into the U.K. they could be guilty of converting or transferring criminal property under s327 POCA, because the returns arise from an activity that, had it taken place in the U.K., would have been a criminal offence.

Therefore, the investment itself, the mere holding of the shares and the receipt of proceeds outside the U.K. would not constitute offences under English Law.

Note however, that the position regarding a U.S. cannabis-related entity (as opposed to Canadian) is more complex due to the status of federal law on marijuana, which provides for nonenforcement in respect of certain activities which remain illegal under federal law.

Lloyd’s of London Commentary

Lloyd’s of London Market Bulletins are the formal means of advising the Lloyd’s market of business-critical issues.

Canada

In its Market Bulletin of 30 August 2018, Lloyd’s stated that its underwriters are well-positioned to write Canadian cannabis business subject to compliance with local Canadian requirements:

“Having taken advice from specialist Leading and Junior Counsel, Lloyd’s is satisfied that:

  • Providing insurance for Canadian cannabis risks would not amount, in the circumstances under consideration, to entering into, or becoming concerned in, an arrangement which facilitates the acquisition, retention, use or control of criminal property by another person thereby breaching section 328 POCA.
  • That neither POCA – nor any of its statutory predecessors – was designed to bring wholly lawful conduct such as the provision of insurance of business activity carefully legalised in another country, into its scope.
  • This view is consistent with the Explanatory Notes to POCA, including for example paragraph 6 which states that the statute’s purpose was to criminalise money laundering in its broadest form which “is the process by which the proceeds of crime are converted into assets which appear to have a legitimate origin so that they can be retained permanently or recycled into further criminal enterprises” – this is far removed from Lloyd’s underwriters openly and properly providing businesses in Canada with insurance against a conventionally covered ascertainable external event”.

U.S.

In its Market Bulletin of 25 May 2016, Lloyd’s stated that:

“Based upon a thorough review of all positions, unless and until the sale of either medicinal or recreational marijuana is formally recognized by the Federal government as legal (as opposed to subject to non-enforcement directives), underwriters should not insure such operations in any form (including crop, property, or liability cover for those who grow, distribute or sell any form of marijuana or cover for the provision of banking or related services to these operations) in the United States.

Coverage may be provided to non-marijuana-related businesses with incidental marijuana exposures (e.g. a pharmacy or physician where a small amount of their business may include marijuana products or prescriptions) if losses arising from such exposures are expressly excluded from cover”.

Other Commercial Considerations (U.S.)

In the U.S., because of the status of federal law, state-legal marijuana businesses often have difficulty accessing the banking and accounting industries due to the extensive and onerous due diligence and filing obligations imposed on financial institutions providing them services.

The U.S. Financial Crimes Enforcement Network Guidance on Bank Secrecy Act Expectations Regarding Marijuana-Related Businesses requires financial institutions to conduct extensive and ongoing due diligence on cannabis-related entities they may provide services to, particularly in relation to breaching the federal priorities outlined in the Cole Memorandum.

In addition, financial institutions that subsequently decide to provide services to any marijuana-related business are required to file an SAR in relation to that business, including where it is duly licensed under state law. The SAR will be titled (i) “Marijuana Limited” where, based on the due diligence conducted, no suspicious activity has been identified, (ii) “Marijuana Priority” where, based on the due diligence conducted, the marijuana-related business implicates one of the Cole Memorandum priorities or violates state law, or (iii) “Marijuana Termination” where a financial institution deems it necessary to terminate its relationship with a marijuana-related business in order to maintain an effective anti-money laundering compliance program.

The law is stated as of July 2019 and is continually evolving.

Source: https://www.jdsupra.com/legalnews/key-considerations-for-u-k-investment-10413/

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Author: Sean Hocking
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