The Fed’s involvement in drug prohibition became official last month, when the Federal Reserve Bank of Kansas City informed Denver’s Fourth Corner Credit Union — a non-profit cooperative formed by Colorado’s state-licensed cannabis manufacturers — of its decision to deny its application for a master account. Since asking any sort of depository institution to operate without such an account, and hence without access to the Fed’s payment facilities, including its check clearing, wire transfer, and ACH facilities, is like asking a commercial airline to make do with propeller-driven biplanes, and established banks don’t want the extra hassle that comes with dealing with pot growers, the Kansas City Fed’s action forces Colorado’s marijuana industry to do business on a cash-only basis, with all the extra risk and inconvenience that entails.[1]
The Fourth Corner Credit Union isn’t taking this sitting down. On the contrary: it is suing the Federal Reserve Bank of Kansas City. Your typical civil action isn’t exactly a page turner. But this one reads like a chiller, largely because that’s exactly what it is. If you like a good horror story, I suggest you read the whole thing. But for the sake of those in a hurry, here are the CliffsNotes. Unless otherwise indicated, the details are as alleged by the lawsuit itself.
The basic legal facts as set forth in that document are, first, that it is the essence of the so-called “dual” banking system that both state governments and the Federal government have the right to grant charters to banks and other depository institutions, and, second, that, according to the 1980 Monetary Control Act, “All Federal Reserve bank services…shall be available to nonmember depository institutions and such services shall be priced at the same schedule applicable to member banks.”
Furthermore, as if to resolve any doubts regarding whether access to the Fed’s payment services was to be granted even to depository institutions that did business with pot growers, on August 13, 2014 the Board of Governors, together with the FDIC, the Comptroller of the Currency, and the National Credit Union Authority, issued guidelines declaring that
Generally, the decision to open, close, or decline a particular account or relationship is made by a bank or credit union, without the involvement of the supervisor. This decision may be based on the bank or credit union’s particular business objectives, its evaluation of the risks associated with offering particular products or services, and its capacity to effectively manage those risks.[2]
Now to the facts of the case, also as presented in the suit. On November 19, 2014, The Fourth Corner Credit Union acquired an unconditional charter from the state of Colorado, having received a conditional charter from the state some months before, pending its application for share deposit insurance. Fourth Corner applied to the Kansas City Fed for a master account on the same day. As it had previously applied for and received a Routing Number from the ABA, and had applied with the National Credit Union Authority (NCUA) for deposit insurance (and was exploring options for private insurance in case its NCUA request was denied), it had satisfied the only eligibility requirement for having such an account, and so had only to submit a “resolution” authorizing the Fed to open an account for it, together with an FRB “Official Authorizations List.” Once these documents were approved, the Kansas City Fed was expected to accept and process a one-page Master Account Agreement completed by the credit union. No other documents were necessary.
According to the Kansas City Fed itself, the suit alleges, processing a Master Account Agreement “may take 5–7 business days.” That is, it usually takes only a week or so for an account to be established once the necessary paperwork is submitted. But although Kansas City Fed officials quickly approved of the credit union’s paperwork, the bank refused to process its Master Account Agreement, saying that its application would be processed “upon approval by credit and risk.” When the Fourth Corner’s lawyers asked the Kansas City Fed what the rules for such approval were, they were at first told that no such rules existed.
Months later, on January 7, 2015, Kansas City Fed president Esther George at last sent a letter to Fourth Corner’s lawyers. In it she observed that the Fed Bank’s Operating Circular, besides setting for the explicit requirement for opening a master account,
also states that a master account is subject to other applicable Federal Reserve regulations and policies. These include policies related to risk posed by a financial institution and how the risk will be mitigated when determining whether and under what conditions an account may be opened. Issuing of a master account is within the Reserve Bank’s discretion and requires that the Reserve Bank be in a position to clearly identify the risk(s) posed by a financial institution and how that risk can be managed to the satisfaction of the Reserve Bank (my emphasis).
Given the time normally allowed to process a master account application, it is doubtful that the Kansas City Fed can have bothered to investigate the risks posed by previous applicants for such an account. One may wonder, moreover, whether any Reserve Bank, or the Fed Board, has ever shown itself capable of “clearly” identifying the risks posed by different financial institutions — let alone ones that have yet to open for business. But the more important point, which the credit union’s attorneys claim they pointed out to the Kansas City Fed, was that it simply had no authority to deny their client an account, on any grounds whatsoever, given that it had already met all of the provisions of the law.
Still Fourth Corner received neither an account nor any further explanation. In vain did Deirdra O’Gorman, its CEO, write to both Esther George and Janet Yellen to request a meeting to discuss the risks to which George had alluded. Not only did both decline, but the Kansas City Fed replied by instructing the credit union to stop submitting documents to it, whether testifying to its safety or otherwise. Nor did an earlier letter to Yellen and George, from Colorado Senator Michael Bennet, noting the “significant public safety concerns” raised by the cash-only basis to which Colorado’s cannabis industry was being confined, appear to have made any difference.
And so matters stood until July 2, almost nine months after Fourth Corner had applied for its master account. On that day the NCUA’s Office of Consumer Protection denied the credit union its application for federal share deposit insurance, while (according to the complaint) secretly and illegally sharing a copy of its confidential letter with the Kansas City Fed.[3] Two weeks later, on July 16, 2015, the Kansas City Fed denied Fourth Corner’s request for a master account, justifying its decision in part on the grounds that the NCUA had rejected its application for federal insurance. The decision remains the sole instance in which the Kansas City Fed has denied a master account to any applicant since the passage of the 1980 Monetary Control Act.
Although the Kansas City Fed attempted to justify its action by referring to the NCUA’s refusal to grant federal insurance to Fourth Corner, according to the credit union’s attorneys that justification had no legal merit: a state-chartered credit union is entitled to a master account “irrespective of whether it has obtained federal share deposit insurance; it only need be ‘eligible to make application to become’ federally insured.” In fact, federal law doesn’t require that a state-chartered credit union have any insurance at all. In any event, as I’ve noted, the Fourth Corner Credit Union was prepared to arrange for private insurance when its master account was denied. Currently, 129 credit unions rely primarily if not solely on private insurance, and all have master accounts.[4]
According to Fourth Corner’s attorneys, the Kansas City Fed had acted in concert with NCUA:
The NCUA is on record that it is against private deposit insurance because the NCUA has no authority to supervise, regulate, or examine privately insured state chartered credit unions. Apparently, the NCUA does not trust the highly qualified state regulators with superior local knowledge to supervise state-chartered credit unions without NCUA oversight. Thus, in order to carry out their nefarious scheme to unlawfully block TFCCU [The Fourth Corner Credit Union] from the Federal Reserve payments system, FRB-KC and the NCUA concocted an aggressively expressed denial of the federal deposit insurance application that also gratuitously impugned the reputation and work of the multitude of highly qualified professionals… .
Here, finally, is the verdict of the plaintiff’s counsel regarding the Kansas City Fed’s actions:
FRB-KC’s denial of the TFCCU’s master account application is anti-competitive; it is detrimental to public safety; it is an abuse of monopoly power; it is a collusive practice in restraint of trade; and it is statutorily and constitutionally unlawful.
I’m an economist, not a lawyer. Still, this seems like a fair conclusion to me.
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[1] Since February 14, 2014, when formal Federal guidelines for dealing with “Marijuana-Related Businesses” were first issued, hundreds of financial institutions in states (and the District of Columbia) where marijuana production and sales are partly or entirely legal, have been compelled to submit several thousand marijuana-related “suspicious activity” reports. On the legal reasons for banks’ reluctance to offer accounts to marijuana related businesses, see Julie Andersen Hill, “Banks, Marijuana, and Federalism,” in the Case Western Law Review.
[2] This is the wording as it appears in the suit. That of the original guidance, as I discovered it, has a few typographical differences. The suit also incorrectly gives the year of this statement as 2013 rather than 2014.
At the time of Fourth Corner’s application for a master account, the Federal Reserve’s official payments system risk management policy included a passage stating that “relevant safety and soundness issues associated with [relationships between financial institutions and their customers] are more appropriately addressed through the bank supervisory process” than by policies governing access to the payments system. This passage was, however, removed in the December 31, 2014 amended policy.
[3] According to 12 U.S.C. 1784 — “Examination of Insured Credit Unions,” the NCUA is permitted to share information about a credit union with the Fed only “for the purpose of facilitating insured credit unions’ access to liquidity” and then only provided that the Fed offers “appropriate assurances of confidentiality” (my emphasis). The NCUA’s conduct is the subject of a separate Fourth Corner Credit Union lawsuit.
[4] Although the NCUA has tried for years to get Congress to abolish the private insurance option, and to give it control over state-chartered credit unions, Congress has consistently refused to support its plan.
