More than 25 states allow the sale of marijuana for medicinal use; eight states permit the sale for recreational use. This activity has created new business opportunities for many accountants, but there are unique challenges and risks in serving these businesses.

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In July 2014, the use of medical marijuana became legal in the state of New York; in January 2016, the state set forth regulations for dispensing the drug. The regulations were some of the strictest among states that had legalized medicinal marijuana; the state limited the number of legal dispensaries within the state, required physicians to complete a training course in order to prescribe the drug, and limited usage only to patients suffering from a few enumerated chronic illnesses.

In an effort to increase patient access, in August 2017, the New York Department of Health moved to loosen its restrictions on medical marijuana (“New York State Department of Health Announces New Regulations to Improve State’s Medical Marijuana Program for Patients, Practitioners, and Registered Organizations,” press release, Aug. 10, 2017, http://on.ny.gov/2fl8yTT). Nurse practitioners and physician assistants will be allowed to certify patients for the drug, and the number of chronic conditions qualifying for medicinal marijuana treatment has increased. While there is no indication that the state will move towards full legalization, many New York CPA firms may be interested in serving this burgeoning industry.

Concerns for CPAs Serving Marijuana Businesses

Providing services to clients engaged in a business that is legal under state law but illegal under federal law has raised concerns among CPA firms regarding professional liability risks and compliance with professional standards, laws, and board of accountancy regulations. Under federal law, marijuana remains illegal under the Controlled Substances Act. This exposes firms that service marijuana businesses to charges of aiding and abetting or conspiracy to violate this law, as well as criminal prosecution and civil claims alleging violation of federal racketeering laws.

Many banks refuse to provide services to marijuana businesses due to concerns about application of both the Controlled Substance Act and anti–money laundering laws. As a result, these businesses handle large amounts of cash, highlighting the need to address internal controls and the risk of theft and fraud. In addition, the application of federal and state tax laws to income tax reporting by marijuana businesses is complex, requiring a heightened focus on compliance by both CPAs and their clients.

Quality control procedures will be of heightened importance for any accountant serving marijuana businesses. Vigilance in client engagement acceptance and continuance can help mitigate the elevated risks of servicing these businesses. Consider performing personal and criminal background checks on firm management and the principal owners. Determine if management has knowledge of applicable banking laws, and ask about the resources they plan to utilize to manage compliance with federal, state, and local laws and regulations. Inquire about legal counsel’s expertise in serving the marijuana industry.

In addition, both audit and tax services present unique challenges, such as the valuation of inventory and the disallowance of tax deductions under IRC section 280E. Prior to agreeing to render these services, CPA firms should discuss management’s plans for inventory management systems, and briefly explain the limitations of available tax deductions under IRC section 280, gauging management’s responses. Prospective clients that are reluctant to commit the necessary resources to comply with recordkeeping requirements and tax regulations will present elevated professional liability risk and will be difficult to service effectively.

These factors create obvious risks for CPA firms providing services to marijuana businesses. When assessing client acceptance and continuance, firms should determine whether the business has conducted criminal background checks of its employees and if any adverse findings will affect the firm’s ability to effectively render services. When entering into an engagement, firms should obtain a representation letter from the business principals, expressly stating that they fully understand and intend to comply with all state laws applicable to their business. Engagement letters should clearly define the scope of the services to be rendered and require client management to acknowledge its responsibility for maintaining all tax and accounting records as needed to respond to inquiries, investigations, or audits initiated by regulators and criminal or tax authorities. In addition, all communications with the client should be documented in writing.

In light of the fact that marijuana businesses remain illegal under federal law, claims may include allegations that the firm engaged in dishonest, fraudulent, or criminal acts.

Liability Insurance and Marijuana Businesses

A related concern raised by many CPAs is how professional liability insurance coverage applies to claims that may arise from servicing marijuana business clients. Insurance coverage cannot be determined prospectively by an insurer, agent, or broker; however, understanding how coverage applies can ease the process of evaluating and mitigating the risks of servicing this growing industry.

Professional liability insurance policies include a definition of “professional services,” which generally is broadly drafted to cover services performed by accounting firms. The majority of services CPA firms are likely to render for marijuana businesses are no different from those performed for other client industries, and thus would fit under this definition.

Many policies also provide coverage for the costs associated with responding to a disciplinary or regulatory investigation. While coverage varies, these policy provisions are designed to provide coverage for the legal costs of responding to a complaint filed against the CPA firm or its employees by licensing boards or regulators. Professional liability policies generally do not, however, provide insurance coverage for the legal costs of responding to a criminal investigation or defending criminal charges filed against the firm or individuals. Policy exclusions specifically define and deny coverage for these exposures. In addition, these policies generally do not provide coverage for civil or criminal fines, penalties, sanctions, or forfeitures. Coverage for these exposures is usually limited by the definition of “loss” contained in the policy.

As a practical matter, how does this play out in the event a CPA firm or its employees encounter civil or criminal investigations, claims, or legal action? Coverage will be determined pursuant to a policy’s terms and conditions, as well as applicable laws, regulations, and professional standards.

Professional liability claims and lawsuits.

Insurance coverage will generally apply, just as it would to services rendered for clients in other industries. In light of the fact that marijuana businesses remain illegal under federal law, however, claims may include allegations that the firm or individuals employed by the firm engaged in dishonest, fraudulent, or criminal acts. Coverage is typically excluded if this occurs, but the relevant policy exclusions contain important exceptions, which usually indicate that the exclusion does not apply unless there is a final judgment by a court finding that the insured party is guilty of the allegation.

Fines, penalties, sanctions, and forfeitures.

Policies generally exclude coverage for these exposures. This includes penalties imposed by licensing, taxing, regulatory, and other legal authorities. Individuals or firms that come under investigation by any of these authorities should promptly place their professional liability insurer on notice. While there likely will be no insurance coverage for these exposures, there may be insurance coverage for the costs to hire legal counsel to defend the firm or individual, subject to other limitations contained in the policy.

Criminal investigations and criminal legal actions.

The costs to defend these matters generally are excluded from coverage. Once a firm becomes aware of such investigations or actions, it should promptly retain a qualified criminal attorney.

An Ounce of Prevention

This article is intended to serve as a brief overview regarding coverage under professional liability insurance policies for claims and lawsuits that could arise in connection with rendering professional services to legal marijuana businesses. CPAs should consult with competent legal counsel and their insurance agent or broker for further questions, including implications regarding other types of insurance coverage. All CPAs considering providing services to clients in the marijuana business should review the AICPA white paper, An Issue Brief on State Marijuana Laws and the CPA Profession (http://bit.ly/2xg5P4m), which addresses relevant legal, regulatory, and risk mitigation concerns.

Stanley Sterna, JD is a vice president at Aon Affinity, Chicago, Ill.
Joseph Wolfe is a risk management consultant at Aon Affinity, Chicago, Ill.