Smoking out Pot’s Potential

Despite concerns that the federal government will crack down on state-sanctioned marijuana, a small band of payment providers is working to cash in on an exploding industry.

It’s no wonder that legal marijuana merchants, and their banks, have been feeling of lot of angst in 2018. In only a matter of weeks, the federal government sent out mixed signals about the sale of legal cannabis, signals that could directly affect the future of electronic payments in a nascent—and booming—industry.

In early January, U.S. Attorney General Jeff Sessions fired a salvo against marijuana merchants by rescinding the so-called Cole Memo. That was a directive forged by the preceding Obama Administration that allowed cannabis dispensaries in states where marijuana has been legalized to operate without federal interference, provided they adhered to the memo’s guidelines.

Marijuana remains a Schedule 1 drug in the eyes of the federal government. Schedule 1 also includes heroin, Ecstasy, and LSD.

Even with the Cole Memo, most financial institutions shunned providing legal marijuana businesses with merchant accounts, checking accounts, and other business services because of the ongoing conflict between federal and state law. They hoped that, some day, Congress would settle the matter.

‘Bags of Cash’

But by quashing the Cole Memo, Sessions, a former U.S. senator and long-time opponent of legal marijuana, gave federal prosecutors free rein to shut down cannabis merchants anywhere.

That move dampened optimism that electronic payments were on the verge of becoming standard for legal marijuana merchants. Hawaii, for example, had mandated that its medical-marijuana dispensaries offer patients an electronic-payment option. Hawaii’s decree, effective last Oct. 1, was viewed as a beacon for other marijuana-legal states, a recognition that it no longer makes sense for cannabis merchants to operate as cash-only businesses.

Without the Cole Memo’s legal cover, several financial institutions thinking of offering banking services to marijuana merchants reportedly backed off. It also put electronic-payment providers and banks servicing marijuana merchants on notice they may soon have to shut those accounts down.

As of last September, some 400 financial institutions—about three-fourths of them banks, the rest credit unions—were banking marijuana merchants, up from 318 in October 2016, according to the latest data from the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN).

But as is often the case with a controversial subject, there are many twists and turns. A few weeks after Sessions’s pronouncement, Treasury Secretary Steven Mnuchin muddied the waters with a seemingly contradictory statement.

Responding to questions from members of the House Financial Services Committee, Mnuchin said he would not replace current FinCEN guidelines on banking marijuana merchants without having an alternative that avoids, as he put it, “bags of cash.”

Mnuchin’s reasoning was grounded in the belief that banking services make it easier for marijuana merchants to pay income and excise taxes. That’s because they eliminate the cost of manually counting large cash tax payments on the receiving end—and the risk of employee theft at both ends—of the transaction.

Plus, bank services would reduce the need for merchants to keep large amounts of cash on premise, making them less likely to be targets for armed robbers.

‘It’s Only a Matter of Time’

So far, 30 states have legalized marijuana, most for medicinal use. Eight states and the District of Columbia have legalized cannabis for both medical and recreational use.

In 2018, legal marijuana sales in the United States are projected to total $11 billion, up from $3.4 billion in 2014, according to San Francisco-based Arcview Market Research. In 2021, Arcview predicts that figure will exceed $20 billion.

That’s a lot of mostly cash sales—and a lot of opportunity for electronic payments, which is why payments executives remain bullish about the legal marijuana industry, despite its political complexity.

“It’s only a matter of time before marijuana merchants are granted equal access to banking, and electronic-payment services, because governments don’t want these merchants paying taxes in cash,” says Lance Ott, chief executive of Vancouver, Wash.-based Guardian Data Systems, a provider of enterprise resource planning applications and point-of-sale software for marijuana merchants. “Handcuffing a fast-growing industry by restricting or denying financial services to merchants is ridiculous.”

Ott, who founded Guardian as a provider of a closed-loop payment system for marijuana merchants, is working in an advisory capacity with officials in Los Angeles to develop a payments system for cannabis businesses in the nation’s second-largest city. The sale of recreational marijuana became legal in California on Jan. 1. California voters had already approved the sale of medical marijuana in 1996.

A couple of years ago, Guardian transitioned out of payment processing for marijuana merchants to providing them business software. That was after its sponsor bank decided to stop serving marijuana merchants through independent sales organizations, Ott says.

Los Angeles officials’ decision to provide the framework for an electronic-payment system for marijuana merchants is sure to grab the attention of other states where cannabis has been legalized, says Ott.

“Los Angeles could very well spark the change to make payment services for marijuana merchants more widely available in the next 12 to 24 months,” he says.

Broadening electronic-payments acceptance among marijuana merchants hinges on two things, payments executives say. The first is compliance with state laws governing the sale of marijuana. Second is developing alternative solutions to accepting Visa- and Mastercard-branded cards, as both networks prohibit marijuana-related transactions.

Both Visa Inc. and Mastercard Inc. cite adherence to federal law. But Mastercard adds that it continues “to monitor the situation, seek guidance from regulators, and inform merchant acquirers of any new developments,” a Mastercard spokesperson says.

‘A Huge Learning Curve’

Payments providers believe compliance is the more critical of the two keys to success. State regulators hold the bigger stick in that they have the authority to shut down noncompliant merchants, along with their banking accounts, and fine their business partners.

Avoiding potential compliance pitfalls begins with recognizing that the laws governing the sale of marijuana in states where it is legal are not all the same. In addition, ordinances can differ between counties and municipalities within a state.

“Applying generalities when it comes to compliance is a mistake,” says Zachary L. Venegas, chief executive of Helix TCS Inc., a Denver-based provider of compliance and security services for marijuana merchants.

While it is the responsibility of the merchant to be compliant, several payments providers enforce their own compliance programs. The reason, they say, is that while many business professionals are opening retail marijuana locations, there are just as many inexperienced entrepreneurs opening stores. These rookies may unwittingly cut corners when it comes to compliance, payments executives fear.

Further, some cannabis entrepreneurs are former drug dealers who decided to go legitimate, so their commitment to staying on the straight and narrow may need to be monitored.

“There’s a huge learning curve with some of these merchants when it comes to compliance, and that’s why we have a compliance program for our merchants to make sure there are no issues, especially with our sponsor bank,” says Steve Hahn, managing partner for Weed Pay LLC, a Newport Beach, Calif.-based provider of so-called cashless ATM services for marijuana merchants.

Besides demonstrating that transactions are legitimate, compliance includes such crucial items as making certain cannabis retailers are checking customer identification to assure they are not selling to minors; adhering to limits on the amount of marijuana that can be purchased; and ensuring that no firearms are on the premises.

Venegas also recommends verifying a marijuana merchant’s license before opening an account and conducting a background check on store owners to avoid any potential compliance issues.

“If a merchant is loose on compliance, it puts the account, and your business, at risk,” he says. “Colorado regularly performs undercover checks on merchant compliance.” In 2012, voters in Colorado and Washington approved referendums making those two states the first to legalize recreational pot.

‘Less Skittish’

With the Visa and Mastercard networks off limits to marijuana merchants, several payments providers have developed alternative closed-loop solutions to cash in on the so-called green rush, such as electronic wallets funded through the automated clearing house network.

Two of the higher-profile providers in the legal marijuana space are Calabasas, Calif.-based PayQwick Inc., which services 300 marijuana merchants across Colorado, Washington, Oregon, Arizona, and Alaska; and Littleton, Colo.-based CanPay, which processes for about 100 merchants in 10 states.

PayQwick, which is awaiting regulatory approval to begin operating in California, Nevada, and Michigan, offers an e-wallet supported by a companion card that consumers use to make purchases at participating marijuana retailers. Consumers can sign up for the card at the PayQwick Web site.

To make a purchase, consumers fund their wallet through the ACH, then present the card at the point of sale. After the card is swiped through a terminal, the purchase is debited from the customer’s wallet and routed to the merchant’s account.

Users have the option of having their wallet automatically reloaded when the balance falls below a pre-selected level. There is no charge to consumers to set up a PayQwick account.

PayQwick, which was founded in 2014 and has bank partners in Washington and Colorado, declines to reveal its merchant fees, but says they are competitive with fees in other high-risk categories.

Like other providers in the legal marijuana space, PayQwick has a compliance program. “Compliance is what makes financial institutions less skittish about working with us,” says company president Kenneth Berke. “It’s important to be able to show that every dollar flowing through the network comes from a state-legal sale.”

In addition to enabling electronic payments for consumers at the point of sale, PayQwick provides a business-to-business platform for marijuana businesses that includes electronic invoicing, bill payment, and state excise tax payments.

Happenstance

CanPay, which landed the contract to provide payment services to Hawaii’s eight dispensaries, offers a slightly different approach.

CanPay users link a checking account to the CanPay mobile app. After entering the purchase amount into the app, the customer receives a single-use token in the form of a quick-response code. Tokens expire after 30 minutes.

The merchant enters the amount of the purchase into the CanPay terminal, then scans the QR code on the buyer’s mobile phone into the terminal to complete the transaction.

CanPay transactions are cleared through one of about 20 financial institutions. The institution debits the consumer’s checking account through the ACH and routes the money to the merchant. Merchant fees are about 2% of the transaction total.

CanPay, which began rolling out in late 2016, landed the contract with Hawaii’s dispensaries by happenstance, says Iris K. Ikeda, the state’s commissioner of financial institutions.

After officials decided a cashless payment option was a necessity for it dispensaries, Ikeda began contacting financial institutions outside the state known to be providing banking services to marijuana merchants. She asked them about handling the merchant accounts for Hawaii’s dispensaries, as no in-state institution had that experience.

Denver-based Safe Harbor Private Banking, which is one of the institutions CanPay works with and is a unit of Partner Colorado Credit Union, won the business. “We looked at a few payments providers, but since Safe Harbor already had the relationship with CanPay, it made sense to go with them,” says Ikeda.

Currently, four of Hawaii’s eight licensed dispensaries are up and running. The state legalized medical marijuana in 2015.

As part Safe Harbor’s deal with the state, it can only provide merchant payment accounts to licensed dispensaries. Adhering to that stipulation precludes Safe Harbor from having a physical presence in the state, Ikeda says.

“There is no federal law that says a bank has to be in-state, but our agreement with Safe Harbor is very specific,” says Ikeda.

Indeed, Carmella Houston, vice president of business services for Seattle-based Salal Credit Union, which banks more than 400 cannabis business accounts, says that while legal marijuana itself cannot cross state lines, money earned by cannabis merchants can flow to their banks across state boundaries, as well as through them to pay out-of-state vendors.

Another payment option is the cashless ATM. Weed Pay’s solution allows consumers to insert a debit card into a POS terminal, enter their PIN and the amount to be withdrawn from their checking account, and receive a voucher that is accepted by the merchant as if it were cash.

Weed Pay, which services about 60 retailers in 13 states that have legalized marijuana, processes these transactions through an undisclosed PIN-debit network.

Hahn says cashless ATM transactions account for between 20% and 40% of purchases for merchants in Weed Pay’s portfolio, and that the average transaction amount is $60. Merchant fees are 4.95% plus 35 cents per transaction, and consumers pay a $3 service charge.

In addition to its cashless ATM solution, WeedPay offers POS terminals and software that provides an audit trail for any marijuana product, from the growing stage to retail sale, to demonstrate end-to-end compliance.

‘On the Ground Floor’

With no shortage of electronic-payment options for cannabis merchants, the biggest hurdle to broadening acceptance remains the federal government. As long as marijuana is illegal at the federal level, most financial institutions, especially large banks, are likely to remain hesitant to dip their toes in the state-sanctioned waters, payments experts say.

It’s for that reason that community banks and credit unions, which have a history of banking small businesses that large banks won’t, are stepping up to partner with payment providers to serve legal marijuana merchants.

“Whether or not the federal government catches up with the states legalizing marijuana, there are opportunities to provide payment services to marijuana merchants,” says Houston of Salal, which is a CanPay partner financial institution. “We saw a chance to get in on the ground floor of an expanding industry.”

Until federal authorities shut down marijuana merchants or take away their bank accounts, close observers expect venturesome payments providers to continue to cash in on the green rush as more merchants, and the states that regulate them, look to move the industry away from cash sales. There are billions of reasons to do so.

 

How To Vet a Marijuana Payments Provider

Here are some key questions about payment processing that cannabis merchants should ask:

What name shows on the consumer’s bank/credit card statement for a purchase? (Hint: it should be the cannabis business’s trade/DBA name.)

Does the payment service disclose the financial institution(s) involved in the transaction flow and flow of funds?

Do funds, at any point, leave the U.S. banking system?

What is the funding timeline from purchase to deposit to the merchant’s bank account? Longer than two days likely involves overseas and/or intermediate accounts.

If Visa/Mastercard debit/credit cards are involved, what merchant category code is used?

Are any intermediate currencies or other methods of storing value used to convert payments?

Is the payment service required to be licensed as a money transmitter and/or money-services business? If so, is it licensed everywhere it operates?

What name shows on the deposit to the merchant’s bank account?

Does the payment provider publicly disclose the cannabis businesses accepting its service?

Does the payment service mention on its main Web site that it serves cannabis businesses, or does it use vague terms like “cash-intensive,” “cash-only,” or “highly regulated” businesses without identifying the marijuana industry?

Does the payments provider collect state-issued licenses for each cannabis business it serves, and does it maintain current licenses?

Does the payment processor require cannabis businesses to adhere to FinCEN guidance before using its service?

Source: CanPay