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Nov 04, 2019

Strange Bedfellows: Dissecting the CPA/Cannabis Industry Business Relationship

Cannabis is still illegal on the federal level, but its use is gaining wider acceptance among state governments for both medical and recreational purposes. This adds up to a sticky situation for CPAs who may be deciding on establishing a business relationship with those in the marijuana industry. To discuss the status of cannabis legalization in Pennsylvania, as well as the ethics and risk management considerations for CPAs, we are joined by Stan Sterna, vice president of Aon Insurance and a licensed attorney, who has provided risk consulting advice to accounting firms for over 20 years. For more on this topic, make sure to check out the agenda for the Nov. 18 PICPA Valuation & Forensic Accounting Conference.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

 


 

Podcast Transcript

While cannabis is still technically illegal on the federal level, on the state level, cannabis has been legalized in many places throughout the United States for both medical and recreational purposes. Wherever your opinion falls on this complicated issue, one fact is without argument: opportunity is knocking for CPAs to work with cannabis businesses in several capacities. In today's episode, we are talking to Stan Sterna, vice president of Aon Insurance Services. He is a licensed attorney who has provided risk consulting and advice for accounting firms for the last 20 years. We'll be talking about the status of cannabis legalization in Pennsylvania plus the ethics and risk management considerations of working with marijuana companies.

What is the current status of cannabis legalization on the federal and Pennsylvania state level?

[Sterna] For medical marijuana, Pennsylvania does allow the purchase and sale of marijuana or cannabis for medicinal purposes for certain designated illnesses, but it is still illegal in terms of selling or purchasing it for recreational use. Although many of the larger municipalities within the state, such as Philadelphia, Pittsburgh, and Harrisburg have decriminalized possession of marijuana at a certain level, meaning you have to have a certain amount on you. I know there's a continuing debate within the state just along the lines of whether or not the state will consider adopting recreational marijuana as a legal form.

As was said there, it's a tricky situation that on the federal level, cannabis is still technically illegal, but on some state levels, many states have permitted its use for medical and recreational purposes. So what sort of conundrum does this present for CPAs looking to provide services for these businesses?

[Sterna] Obviously the conundrum is the fact that you have the dichotomy between the state law and federal law. Because, as you noticed, federal law, it's still illegal. It's considered a controlled substance on par with dangerous drugs, such as heroin, under federal law. It's still illegal under federal law to sell it for medicinal purposes as well as obviously recreational purposes. So that dichotomy creates a dilemma for any CPA or any professional for that matter that wants to get into this industry. They have to balance the risk and the reward. As you mentioned, with the changes in various state laws and seemingly a push toward, at least from many states in many segments of society, that kind of accepted cannabis sale and usage is something that could be regulated and controlled almost like liquor or even prescription drugs in a sense where it could be readily available.

It's presenting all sorts of opportunities for CPAs and professionals. A lot of firms that we speak to look at this opportunity as it's good for business. These entities are going to need professionals like CPAs, especially with all the different laws that apply to them and the restrictions. But at the same time they have to balance the idea of getting involved with a business that still has the stigma of being, under federal law at least, illegal. You have to balance the risk versus reward.

CPAs and the CPA industry and accounting, it's something that relies heavily on ethics and maintaining a solid reputation. What are some of the particular ethical considerations CPAs have to keep in mind when they're considering working with cannabis businesses?

[Sterna] I think one of the main ethical dilemmas is whether or not it could be considered an act discreditable to your license. So as to whether or not that's an ethical violation. The Pennsylvania State Board of Accountancy has not opined on this. Other state boards have. Those that have have indicated that they don't look at it as an ethical violation or a discreditable act, as long as the Department of Justice is not enforcing the federal drug laws. Under the Obama administration, there was something issued by the Department of Justice called the Cole Memo. That Cole Memo had specific requirements for the federal prosecutors to come in and prosecute marijuana businesses, and they were pretty, I guess, extreme types of situations, such as selling to underage individuals, selling to school children, things of that nature, drug trafficking, and more serious drugs as well.

That memo was rescinded during the current administration, but the federal government hasn't done anything really to prosecute those crimes. So you have that dilemma, whether or not it's a discreditable act by providing services to these type of businesses. So far, with the Department of Justice not doing anything, most of the state boards are not determining or indicating that it's an ethical issue. So, in Pennsylvania, what do you do? Pennsylvania hasn't provided an opinion. What I usually suggest is that CPAs might look at other institutions that they belong to some belong to networking organizations, alliances, things of that nature – and see what they have determined with regard to servicing these types of industries.

Right now there hasn't been an opinion, but I don't necessarily think that's a bad thing. I think Pennsylvania is taking the same road that a lot of state boards of accountancy are doing that haven't said anything. They are just saying, "As long as the status quo is that the feds are not prosecuting this, we're not going to go out there and determine it's an ethical violation."

In doing the research for this interview, a piece I saw you did for the Journal of Accountancy talks about the reputational risk of working with cannabis clients. We just talked about it a little bit there. I wonder, with some of the legalization that's going on, is that negative perception beginning to die down at all?

[Sterna] I think so. From what I see, I mean, five, six years ago, there were a lot of clients that would be up in arms if their accountant was diving into this industry. Five, six years ago, a lot of CPAs looked at the marijuana industry. Even at that time, when you just had one or two states that had legalized it or were considering legalizing it, just a handful that had medicinal that they legalized. They looked at it as kind of a stigma if they get into it. Am I going to have a reputation issue? Are my clients going to be concerned that I'm delving into something that can be considered unethical or illegal? But I do think that the pendulum has swung much more in terms of favoring legalization and accepting it.

I've seen recent Gallup polls that indicated that across party lines, whether you're conservative or more progressive, that there's 50% or more support for legalization. So the pendulum is swinging. But what I would recommend firms do is they need to understand their own client base. They need to understand who their clients are and how their clients are going to react to them delving into the space. I think most clients will probably look at it and, especially if it's in a state where there's been a lot of publicity that's been legalized, that everyone's aware of it, they see these stores or these dispensaries in their community and they understand that maybe some of the things and that people thought were going to happen in terms of rising crime and whatnot maybe aren't happening and it's becoming more acceptable, those people might not be alarmed by it.

Then again, there's always conservative clients that don't want to do business with somebody who is involved in this. So firms have to weigh the benefits of getting into this potentially lucrative area of practice against the negative reaction that their clients may have.

When we talk about risk mitigation steps that CPAs should take when they're working with cannabis clients, what are we looking at in particular? Are the steps similar to other clients or are there ways that they differ because of this?

[Sterna] I would say they're very much similar except I would say it has to be a little bit more rigorous, some of the steps that you take when you're dealing with a client in this industry. When I say that, what I'm mainly referring to is client acceptance and continuance procedures. If you're bringing in a client who has operated in a business that is illegal under federal law, you have to make sure when you're taking a hot client like that that they have thorough knowledge of not only the industry but the applicable state and even local laws because a lot of the states that have legalized marijuana, there's ... it goes into so much detail where you have municipalities and counties also regulating the business as well. You're going to have to know going in that a client has a thorough industry knowledge, they have knowledge of the act of laws and regulations.

I think criminal background checks are important. Not everyone does criminal background checks on clients when they come in. I think, in this particular space, it's something that you consider or should consider. I think in the marijuana space firms have to develop a specialty. It's always important to develop a specialty when you're dealing with a niche service area or industry. I think it's particularly important here because there's just so many different nuances in terms of the regulations and the law. You have to train your employees that are going to service these accounts. They're going to have to understand the nuances of working with the cannabis business.

Then you also have to understand you're doing tax services, bringing a client, and you're going to have to understand that some of the normal tax laws that apply to an ordinary business don't apply to a legalized marijuana business for example. 280-E limits the ability to deduct expenses if you're operating a business that is involved in what's considered illegal trafficking of drugs under federal law. That creates an issue. You have to be aware of what you're deducting. If you deduct too much, the IRS may come in, disallow the expenditures and assessed penalties. If you don't deduct enough, you might have a client saying, "Hey, I paid too much tax and why weren't these deductions taken?"

You also have a situation where you have these types of businesses, just like any other business like this, are going to be more of a target for the IRS to have audits and conduct audits in terms of tax services. So those are the type of things you're going to have to consider when you're bringing in a client like this.

Another one here because I just think it's pretty interesting because it seems like an obvious one. But when you're talking about a marijuana business, maybe it's not a group that knows everything about business, let's put it that way. But an important risk-mitigation strategy: do not allow clients to pay with cash. Again, it seems so obvious, but why is it so important here?

[Sterna] Well, this is an all-cash business, marijuana. Because right now they don't have access to federally insured banks. So they're dealing with an all-cash business. So whenever you're dealing with an all-cash business, not only do you have a heightened degree of IRS scrutiny, but you have a higher risk of embezzlement or money laundering and some of these businesses, there is a concern that they're being used or utilized for money laundering purposes. You certainly don't want to be in a situation where you're accepting cash and then later on you're part of a money laundering operation. The same is true with receiving cash.

I’ve had plenty of firms that have done extreme vetting of everyone they bring in to work for them. For whatever reason, it could be personal issues, it could be whatever reason, they're enticed to steal money from a client. Certainly, when you have an all-cash business, that enticement becomes even heightened. So you have to be careful in the all-cash business for those very reasons. One thing that we like to do is, or at least mention, is not only do background checks of your client, but also obviously understand the background of the employees that you're going to maybe have on site if you're going to have employees that may be working with the business.

I also suggest that when you bring in a marijuana client, have them sign a management rep letter. Usually, that's done in the attest type of services, but have them sign a management rep letter for any type of service that states we are representing them, we are operating our business in accordance with all the state and local regulations. At least then you have some sort of comfort to know that this is hopefully an above-board business and at least that's the representation. It's certainly going to be a much more ... it's going to be easier to defend any sort of accusation that you were involved in any sort of money laundering or there was some sort of a nefarious situation at the particular business that goes beyond just selling cannabis.

As this becomes a little bit of a bigger business, we could say it's going to affect other businesses. So what are marijuana-adjacent businesses and why is it important to be careful when you're working with them?

[Sterna] Because some of these adjacent businesses can be part of the whole web of operating in the marijuana industry. That can be tied into whether or not it's federally ... it's illegal under federal law. I'll give you an example. I mean, you could do business with, let's say, a local hardware store that maybe provides some soil or maybe a Home Depot or whatever that provides something to a grower that they're using to cultivate the marijuana. That's a pretty far removed business and I wouldn't be too concerned about that. But if you're doing a business with, let's say, a company that makes special lighting in order to grow these plants or something of that nature, that can create an issue. So you should always be aware of how close the business is to the actual marijuana business and make sure 280-E, the IRS regulation, and, like I said, limits expenses, that that doesn't apply to that business, make sure that you are following all local regulations.

Is that business considered a part of the marijuana industry? Is it being regulated? Those are some of the things that you should consider when you're working with closely, I would say, connected adjacent businesses for the marijuana industry.

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Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.