A $7 Billion Marijuana Loophole

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Technology that lets people use plastic to pay for weed is a fast-growing industry. But some methods deceive the banking system, and the profits could go up in smoke.

The McDonald’s in Great Barrington, Mass., had hired extra employees to keep up with the flow of hungry customers from a marijuana shop nearby. What its managers didn’t realize, on a Saturday afternoon in December, was that the payment processing technology at the dispensary was misidentifying a purchase of pear-flavored THC chews as a withdrawal from an ATM—at the burger joint’s address.

The dispensary, Theory Wellness, didn’t know about the wrong address either. But why did the purchase show up as a cash withdrawal? Theory’s payment machine, which looked to a customer a lot like a card reader at a coffee shop, was in fact running a so-called cashless ATM. Instead of spitting out $20 bills, the machines work with software that programs them to send signals down debit rails, where they eventually run through a sponsor bank before triggering a sweep of funds from a customer’s account to the store’s. Still, the bank saw the sale of edibles as a cash withdrawal and reimbursed its customer the $2.75 they paid to use a debit card, just as it would have for an out-of-network ATM.

The transaction that day—one of eight documented at multiple dispensaries by Bloomberg News—was just an ordinary sale of marijuana, which is legal in Massachusetts. Yet it was made possible by an unusual technology that enables dispensaries to get around the fact that banks and credit card companies don’t want to handle such transactions because of federal laws criminalizing marijuana sales. Industry participants estimate that more than one-quarter of the $28 billion in U.S. dispensary sales forecast this year by market research firm BDSA may be disguised by cashless ATMs. Those sales could generate more than $500 million in fees for payment processors, based on average purchase sizes.

Brandon Pollock, chief executive officer of Theory Wellness, says that the company was unaware of the address mix-up and that its former payment processor—it has since switched—attributed it to a mistake that was rectified. “We, like the majority of dispensaries, have relied on vendors to provide these solutions over the years with the understanding that these services are in full compliance with all applicable laws and regulations,” Pollock says.

Yet even when an address is correct, the nature of a purchase using one of these machines is disguised. “The problem with the cashless ATM model is that you’re masking a marijuana transaction,” says Andrew Kline, a lawyer in the Denver office of Perkins Coie specializing in cannabis law. “You’re saying this is just a normal ATM transaction, when in fact it’s not. You’re basically lying.”

Visa Inc. said in a Dec. 2 memo to clients that it was “aware of a scheme” involving cashless ATMs and that such transactions are prohibited on its network. A spokesperson for the card company declined to elaborate but said in a statement that “transactions in the U.S. involving the purchase or trade of marijuana are not permitted on the Visa network, until such time as federal law allows.” Mastercard Inc. says that it’s reminded banks to ensure merchants code transactions properly and that it continues to monitor the situation and seek guidance from regulators.

Scott Talbott, senior vice president for government affairs at the Electronic Transactions Association, a payments industry trade group, calls the use of cashless ATMs a “transactional gymnastics” that’s resulted from the conflict between federal and state law. Three-quarters of U.S. states have legalized marijuana sales.

The stores would rather take plastic than cash. Customers spend as much as 20% more, and the dispensaries avoid theft risks. Pollock says his industry needs federal legislation that would allow cannabis businesses the same access to banks that other companies have. Such a bill has passed the House several times, only to be blocked in the Senate.

Pot fintech companies have stepped into the breach. Cashless ATMs, also known as point-of-banking technologies, are a subset of a larger industry called point-of-sale. POS companies with well-known investors, such as Flowhub, backed by Jay-Z, and Dutchie, backed by Snoop Dogg and Howard Schultz—and recently valued at $3.75 billion—sell software to manage dispensaries. They can end up promoting cashless ATMs by integrating them with software for accounting, inventory, and compliance with state cannabis laws.

Try to figure out which technology a POS company is working with, and you often run into layers of resellers and sub-resellers. Industry insiders say the cashless ATM business is dominated by Paybotic and Transact First, both based in Florida, and by Michael Shvartsman, who founded Transact First and now runs investment fund Rocket One Capital. Paybotic and Shvartsman declined to comment for this story, and Transact First couldn’t be reached.

A spokesperson for Dutchie, whose LeafLogix software is used by Theory Wellness, says the choice of payment technology is up to dispensaries and that cannabis transactions through cashless ATMs are “solely between the dispensary and the cashless ATM provider.” The company declined to comment on the mistaken address. Theory’s payment processor at the time was Paybotic, according to a person familiar with the arrangement.

The cashless ATM technology, even if it doesn’t involve transposed addresses, raises legal concerns. For dispensaries, it increases the risk that someone could use their books for tax or accounting fraud. Banks that process such transactions can run afoul of federal prohibitions and laws that require them to know their customers.

If authorities and courts decide cashless ATMs are being used in what another Perkins Coie lawyer, Sam Boro, calls “transaction laundering,” or money laundering that hides a merchant’s identity, that could be a problem for the companies that sell the technology. “Everyone knows it’s an obvious workaround,” says Peter Su, a senior vice president at Green Check Verified, which sells compliance software to state-chartered banks and credit unions that provide banking services to cannabis companies. “It’s a loophole, and it’s going to get closed down.”

That December purchase of pear-flavored chews with 52 milligrams of marijuana’s psychoactive ingredient THC at the barn-shaped Theory Wellness store had an awkward prelude. A cashier said banks are ashamed of the dispensary’s business, so they had to charge in this unusual way. The sale would be rounded up to the nearest $5 or $10. The customer would get change to true up to the actual cost of the goods plus tax, and also be charged a $2.75 fee.

That rounding up is the hallmark of a cashless ATM. It makes an $18 sale look like a $20 cash withdrawal. The customer slid a debit card—issued by Chase Bank and bearing a Visa logo—into a sandwich-size hunk of plastic. That’s where the software that’s often sold to dispensaries along with the hardware kicks in. Some compare it to a hack into the banking system that miscodes cannabis transactions as ATM withdrawals. Since the sales are illegal in the federal government’s eyes, others in the industry say, no correct code can be entered.

As the miscoded signal bolted out of Theory’s card-reading machine, it likely would have sped along electronic rails owned by a major card company before landing at a sponsor bank batched with other transactions. While batching is a normal practice, it can be used for deception, as parties that aggregate transactions can misrepresent the contents of the portfolios they present to banks.

When the purchase settled, it appeared in the customer’s account as a “Non-Chase ATM withdrawal” and was coded to the McDonald’s address, rather than Theory Wellness’s. The same address was displayed next to the $2.75 fee. Of the eight transactions documented by Bloomberg, four by one customer resulted in fees being reimbursed by Chase. Another customer was reimbursed by Bank of America Corp. Spokespeople for both banks declined to comment.

“I didn’t realize that was happening,” Amy Sanford, a manager at the McDonald’s franchise for eight years, says of the use of its address. Another employee says she’d gotten calls from people complaining they had a charge from the address, which they’d never visited. Wrong addresses appeared on four of the transactions, all made after Visa’s memo. In addition to the one at Theory Wellness, two others were in Great Barrington. Calyx Berkshire Dispensary showed up at the address of Baba Louie’s Sourdough Pizza. The Rebelle dispensary appeared at the location of the Great Barrington Bagel Co. The fourth, from Sunnyside Cannabis Dispensary in Chicago, showed up at the address of a pizzeria called Nude Dude Food.

Like Pollock at Theory, Rebelle CEO Charlotte Hanna says the company’s payment processor attributed the address mix-up to an error that’s been fixed. Cresco Labs Inc., which owns Sunnyside, says the same, adding that an audit of other locations across the U.S. showed 4% were programmed with incorrect addresses. Cresco says all have been corrected and that it wouldn’t knowingly use a platform that isn’t transparent. Calyx declined to comment.

Accidental or not, incorrect addresses can help block an audit of prohibited locations and disguise large money flows, something banks typically watch for to alert them to suspicious activity. Some in the cannabis industry say wrong addresses aren’t just random mistakes. “The address is being used to trick parties to the transaction,” says Nathaniel Gurien, CEO of New York-based FinCann, which advises cannabis industry clients on payment processing and sells a product that competes with cashless ATMs. “This is part of the overall program. You’re not going to see Bob’s Cannabis Store.”

Finding out where the fees generated by cashless ATMs go is like following a three-card monte game. Even for people who work in the industry, it’s hard to tell who’s processing payments. “We get calls from people all the time who want to work with us, and then we find out they are selling the same product,” said Josh Glantz, chief revenue officer of Treez, a POS company, some of whose clients use Transact First’s cashless ATMs. “It’s a little like Whac-A-Mole.”

Companies such as Dutchie and Flowhub are like “referral agents” for cashless ATM technology, says FinCann’s Gurien. Dutchie, based in Bend, Ore., recently pitched dispensaries a “cashless ATM, beautiful hardware, and intuitive software” for $3.50 per transaction. Denver-based Flowhub has a relationship with Greenway Payments. The business can be lucrative. One 2021 contract that Transact First offered to a potential POS company, seen by Bloomberg News, said the party would get 40 cents out of every $2.75 transaction fee.

Rebelle in Great Barrington says it uses technology from both Paybotic and Newport Beach, Calif.-based Blaze. “Paybotic has the sole responsibility for the coding and locational identification of each transaction processed via their payment processing system,” Paul Violas, general counsel for Blaze, says about the incorrect addresses. Blaze also has its own point-of-banking processing, BlazePay, that’s integrated with Blaze Retail Point of Sale. The support page for that system says that customers who need help with processing should contact Transact First. Violas declined to comment on Blaze’s relationship with Transact First.

Greenway founder Eli Rubin, one of the earliest players in cannabis transactions, says Transact First is his biggest competitor. “If we’re the Nobu of payment processing,” Rubin says, “they’re the all-you-can-eat sushi.”

Shvartsman, Transact First’s founder, certainly has a diverse business appetite. His Rocket One Capital invests in fintech, entertainment, and real estate. He co-founded Joblio Inc., a global migrant labor company, and has been a registered director or officer of three other payment firms that one former employee described as the “main monthly revenue drivers” for Rocket One.

It’s unclear what role he plays today at Transact First, but one person who met with him at a convention in Las Vegas in October said he was pitching payment innovations and boasting that the firm cleared about $4 billion in annual transactions.

On Quora, a question-and-answer website, a photo of Shvartsman in white jeans and a blue t-shirt with aviator sunglasses dangling from the neck appears next to questions that go back nine years asking for more general high-risk payment processing solutions for businesses like “the gentleman’s club industry,” CBD, and debt collection.

“There are a few major cashless ATM players,” says FinCann’s Gurien. “But the granddaddy of them all is Michael Shvartsman.”