Acquiring: A Smoky Incongruity

Jim Daly

Despite the growing acceptance of pot in some states, the legal marijuana industry has a tough time getting payment-card processing and other banking services. When, if ever, will the smoke clear?

Could a multibillion-dollar new merchant market be going up in smoke because of a conflict between state and federal laws? That’s what merchant acquirers eyeing the medicinal and recreational cannabis industry are wondering even though the federal government has signaled that banks can provide financial services to cannabis retailers in states where marijuana is legal.

Trouble is, the recent pronouncements from the U.S. Treasury Department and the Department of Justice don’t go far enough in the eyes of many independent sales organizations and others in the acquiring industry.

Most legal marijuana (cannabis) purchases today are done with cash, and payments executives don’t expect that to change any time soon. That’s because banks, still fearful of being hauled into federal court or punished by regulators, are steering clear of the new merchant niche.

“I do not know of any sponsor banks that have given ISOs and acquirers the green light to provide merchant services to marijuana businesses,” says Adam McDonald, director of business development for Humboldt Merchant Services, a Eureka, Calif.-based ISO that is eyeing the legal cannabis industry. “We have not gotten even a yellow light from our sponsor. That light today is very, very much red.” Humboldt’s sponsor is Chicago-based BMO Harris Bank.

One ISO that consultant Lance Ott, principal of Guardian Data Systems, knows “got very close” to providing payment services to marijuana merchants. But “at the eleventh hour,” according to Ott, the ISO had a conversation with the Office of the Comptroller of the Currency, the bank-regulatory arm of the Treasury Department.

“They pulled out at the last minute,” says Ott, whose Vancouver, Wash.-based firm provides point-of-sale systems and other services to legal marijuana merchants.

Policy Changes

Eyeing new tax revenues and responding to public pressure to ease draconian marijuana laws, some 20 states and the District of Columbia have legalized the controversial use of cannabis for medicinal purposes, according to the Medical Marijuana—ProCon.org Web site.

On Jan. 1, following voter approval of a 2012 state constitutional amendment, Colorado became the first state to permit the sale and use of small amounts of marijuana for recreational purposes. Medicinal marijuana outlets opened in Colorado about five years ago.

The state of Washington also has decriminalized recreational marijuana but legal sales have not yet begun there. An advocacy group is working for decriminalization in Alaska, and similar movements are building elsewhere.

On the federal level, however, Congress long ago criminalized the sale and use of marijuana in the Controlled Substances Act (CSA). In fact, the federal Drug Enforcement Administration considers marijuana a so-called Schedule 1 drug, right up there with heroin, LSD, Ecstasy, and other hard drugs “with no currently accepted medical use and a high potential for abuse,” according to the DEA Web site.

The buzz that marijuana users could toke in peace in states where cannabis is legal, without fear of the feds, began early last year when Attorney General Eric Holder signaled that some policy changes would be forthcoming.

On Aug. 29, Deputy Attorney General James M. Cole issued a memo to federal prosecutors directing them to refrain from enforcing the marijuana provisions of the CSA in states where cannabis is legal as long as the states conformed with eight priorities he outlined. They included preventing the distribution of pot to minors, preventing marijuana revenues from going to gangs and cartels, preventing the diversion of marijuana from states where it is legal to those where it is still banned, and other provisions.

Then, in January, stores where cannabis could be purchased for in-state recreational use opened in Colorado—the first such stores in the nation. Recreational pot in the Rocky Mountain State generated a huge amount of national publicity.

But, besides describing the nearly infinite varieties of cannabis now available for legal purchase, many news reports also informed consumers that plastic was no good for purchases in most such stores because their owners couldn’t get mainstream financial services, including payment card processing.

‘Move from the Shadows’

Still, hopes rose this past winter that the situation might change. The payment card networks ban the signing of illegal merchants as card acceptors, but Visa Inc. issued a statement in January leaving it to the discretion of its acquirers about whether they wanted to sign the new pot shops.

“In offering our payment service, Visa adheres to the rule of law and seeks to prevent our network from being used for unlawful purposes,” the leading card network said. “In this instance, the federal government considers the sale of marijuana illegal, but has announced that it will not challenge state laws that legalize and regulate marijuana sales. Given the federal government’s position and recognizing this is an evolving legal matter with different standards applicable in different states, our local merchant acquirers are best suited to make any determination about potential illegality.”

(Visa didn’t respond to a Digital Transactions question about how acquirers responded to its stance.)

Things seemed to get ever sweeter on Feb. 14, when the Treasury Department’s Financial Crimes Enforcement Network (FinCen) and the DoJ announced new guidelines that signaled federal approval for banks to serve legal marijuana sellers provided they keep a close watch on suspicious activity.

“Now that some states have elected to legalize and regulate the marijuana trade, FinCen seeks to move from the shadows the historically covert financial operations of marijuana businesses,” FinCen director Jennifer Shasky Calvery said in a news release. “Our guidance provides financial institutions with clarity on what they must do if they are going to provide financial services to marijuana businesses and what reporting will assist law enforcement.”

Banks, credit unions, and money-services businesses are supposed to file so-called suspicious-activity reports (SARs) with FinCen when they suspect a customer of money laundering, terrorism financing, or other criminal activity. In the new guidance, FinCen said it expects financial institutions to perform their usual due diligence in evaluating a legal marijuana seller as a business customer, including whether that business has the proper licenses. The guidance outlined three types of SARs for financial institutions serving marijuana clients:

– The “marijuana-limited” SAR simply notifies FinCen that the financial institution’s customer is a legal marijuana seller and no illegal activity is suspected.

– “Marijuana-priority” SARs notify FinCen that the bank believes a legal marijuana business has violated provisions of the DoJ’s policies or state law.

– “Marijuana-termination” SARs declare that the financial institution ended its relationship with a marijuana seller because retaining that relationship would undermine its anti-money-laundering compliance program.

The guidance provided examples of red flags, including more sales than could be reasonably expected from a marijuana retailer’s demographic base and limitations under state law; deposit velocity, and other signs that the business may be selling illegal drugs, engaging in interstate or international transactions, or otherwise violating state or federal laws.

‘An Act of Congress’

It didn’t take long for the payments industry and banks to conclude that the new guidance didn’t change the fundamental fact that marijuana remains illegal under federal law. Serving cannabis merchants could still expose financial-services providers to regulatory action, possibly even prosecution.

“The real issue with pot is this dispute between jurisdictions, and you don’t know where the feds are going to come out on it,” says Rick Noble, chief executive of BCC Merchant Solutions, parent company of BankCard Central, a North Kansas City, Mo.-based ISO. “I would be very surprised, even with the FinCen and the DoJ comments, that banks will touch it.”

Indeed, the Colorado Bankers Association quickly weighed in with an analysis of why the new federal guidance hadn’t allayed bankers’ worries over serving cannabis merchants.

“The core issue is that regardless of state law the [CSA] prohibits everyone, including banks, from dealing with controlled substances or the proceeds from them—e.g. the cash used in the pot transaction,” Don A. Childears, the association’s president and chief executive, said in a statement. “In spite of comments by U.S. Attorney General Holder, I believe there is nothing the executive branch can do to change this. The resolution of this requires, literally, an act of Congress, which isn’t likely in the near future.”

Adds Ott, who became a medicinal marijuana user after contracting testicular cancer: “We need to see legislation.”

Some lawmakers are working to clear the legal thicket. For example, U.S. Rep. Ed Perlmutter, D-Colo., last July introduced H.R. 2652, the “Marijuana Businesses Access to Banking Act of 2013.” The bill would grant immunity from federal prosecution to depository institutions serving legitimate marijuana business customers, and would bar regulators from discouraging banks from doing business with such customers.

The bill hasn’t made much headway yet, however. Although it has 27 co-sponsors, as of late winter H.R. 2652 was still in a House subcommittee.

While financial services for marijuana merchants aren’t exactly on the top of Congress’s agenda, thanks to the FinCen guidance legislators are becoming aware that “there are practical issues” for businesses operating on a cash-only basis, according to Taylor West, deputy director of the National Cannabis Industry Association.

“We have certainly seen an enormous amount of progress on the issue as a whole,” West says. “Even people who aren’t strong supporters of a legal cannabis environment can see the problems of forcing these businesses to operate entirely in cash.”

‘It’s a Nightmare’

One of those businesses is Sticky Buds, a three-location dispensary of medicinal marijuana in Denver, two of which were scheduled to become recreational cannabis shops in March. Unable to retain a business bank account or payment card processing services, Sticky Buds takes tens of thousands of dollars each week to supermarkets, where it purchases money orders to pay bills.

“It’s a nightmare,” says managing partner Rod Hurlbut.

With all their legal woes, marijuana retailers sometimes are perceived to be high-risk merchants. But in reality, such merchants present chargeback or fraud risks that are little different from those of mainstream face-to-face merchants, according to Deana Rich of Los Angeles-based Rich Consulting, which advises ISOs on risk management.

“There’s a difference between high-risk and legal,” she says.

Offsetting the nightmares are pleasant dreams of profits for operators in a business emerging from illegality. ArcView Market Research, part of San Francisco-based The ArcView Group, estimates the legal U.S. pot market at $1.53 billion in sales in 2013 and predicts it will grow 68% to $2.57 billion this year. The market could hit $10.2 billion in a few years, ArcView forecasts.

“Gains will come in the form of increased demand in existing state markets, as well as from new state markets coming online within a five-year horizon,” an ArcView report says.

‘A Market in Waiting’

Despite the current legal hassles, some ISOs and acquirers want in on the emerging niche, according to payments consultant Todd Ablowitz of Centennial, Colo.-based Double Diamond Group.

“It’s clearly a market in waiting,” he says. “I know many players are on the sidelines, watching and waiting to pounce.”

Ott says Guardian Data Systems might register as an ISO and sign legal marijuana merchants should the federal stance change to give banks a clear okay to serve the cannabis industry.

Yet even if more states legalize marijuana and Congress eventually does provide some clarity, an ISO or acquirer will still need to thoroughly understand FinCen’s guidelines and related legal issues, according to McDonald of Humboldt Merchant Services.

“There’s going to be a transitory period where you’re going from a black market to a white market,” he says.

Being prepared, however, could produce rewards for the early adopters, according to McDonald: “The company that gets to market first is going to make a tremendous amount of money.”

When Card Payments Don’t Go to Pot

Talk about financial services with Rod Hurlbut, co-owner and managing partner of three legal medicinal-marijuana shops in Denver called Sticky Buds, and you’ll hear the word “nightmare” a lot.

How about his inability to retain a payment card merchant account despite generating more than $40,000 a week in revenues? Hurlbut has had services from at least two independent sales organizations since first opening in 2009, but the last one bailed in 2012 after getting pressure from the card networks.

“It’s a nightmare,” says the 58-year-old former accountant and real-estate developer. “It’s not a good thing. It’s absolutely a nightmare.”

Sticky Buds doesn’t even have a business checking account to deposit all that cash. It did for a while, but the bank concluded it didn’t want to facilitate transactions for the marijuana trade.

“The banks will not do business with us if we’re up front and tell them what we do,” says Hurlbut. He adds: “Not having a banking account is a nightmare.”

To process all that cash, Hurlbut has assigned one of his 26 employees to do nothing but visit 12 grocery stores to buy money orders, through which he pays the bills. He formerly used a check-cashing outlet to pay his hefty utility bills—Sticky Buds grows its own cannabis, in accordance with Colorado law—but that ended when the large transactions attracted the attention of authorities.

“It puts my employees at risk, it puts me at risk,” Hurlbut says.

Hurlbut says he even used a personal credit card from a major bank to pay business expenses for a while, but the bank cancelled the card after becoming suspicious about his transactions.

Sticky Buds does have ATMs in its stores and they charge a relatively low $1.50 surcharge. While the ATMs enhance customer convenience, they still don’t compensate for the lack of card acceptance, which would facilitate impulse buys and purchases from cash-short customers, according to Hurlbut. Based on his previous experience with cards, Hurlbut estimates he could get a 20% to 30% lift in sales with a merchant account.

“Even though it [the ATM] is only five steps away [from the cash register], it’s a little bit of a barrier, rather than giving a card,” he says.

Despite the hassles, Hurlbut says the legal marijuana business has plenty of rewards. He got into the trade after his real-estate development business went bust in the recession. He likes working with his young employees—most are under age 30—and he says the stores are poised for big growth now that Colorado has legalized recreational pot. In fact, he planned to convert two of the medicinal shops to begin selling recreational marijuana in March—and he’s anticipating a quadrupling of sales.

Hurlbut says he’s a legal seller, not a buyer. “My drug of choice is a martini,” he says.