Four years ago, Lauren Scott was scrolling through TikTok when she saw a video from EcommJess, a personal finance influencer with 750,000 followers, promoting Yotta Savings, a fintech app offering a chance to win cash and other prizes on top of regular interest. Scott liked the novel sweepstakes incentive and Yotta’s lack of fees, along with something way more traditional. “It was FDIC-insured, which was one of the main things that I looked for because you never know what to trust,” says Scott, 27, who lives in the Tacoma, Washington suburbs with her husband and seven-year-old daughter. Eventually, the couple moved all their money to Yotta.
Today, the Scotts are among the roughly 200,000 fintech consumers (plus 85,000 from Yotta) who have been denied access to their “FDIC-insured” accounts since mid-May, following the Chapter 11 bankruptcy of a San Francisco-based fintech intermediary, Synapse. Financial technologies. It’s unclear when they’ll have access to their cash, or even if they’ll get it back in full; At a court hearing Friday, former FDIC Chair Jelena McWilliams, who has been named bankruptcy trustee in the case, said there was a “gap” between Synapse’s records and those of the banks estimated lately at between $65 million and $96 million. Significantly, he added, this is most likely not just a case of poor accounting, but a genuine shortfall (i. e. , lack of cash) that existed prior to the bankruptcy filing and may require time and thorough investigation to resolve.
“Look, I don’t have a PhD in finance, do I? I’m not. I’m just an ordinary man,” says David Schulzinger, a 40-year-old Phoenix appraiser who had his $50,000 Yotta account frozen. He had accumulated more than 4 years for vacations and unforeseen expenses, like his wife’s. Recent operation. It has been announced that it is insured through the FDIC. If I had had a moment’s idea that this wasn’t the case, I would never have put cash into this account.
U. S. Bankruptcy Court Judge Martin R. Barash, from the Central District of California, who is presiding over the Synapse case, seemed equally dumbfounded by the regulatory “depositors” of the fintech black Hollow and his money was sucked out. “This is what end users think comes from this kind of thing,” said the exasperated lawyer, who has made getting other ordinary people to give him their money back his most sensible priority. But their strength to do is limited. ” “It’s a serious situation and people are in crisis,” he said at a hearing earlier this month. “People are suffering. “
The delay is even more shocking compared to what happened after Silicon Valley Bank shut down through California regulators on Friday, March 10, 2023. The following Monday, consumers had access to their money, and federal banking regulators had said that all deposits — including those above the FDIC’s overall insurance limit of $250,000 per depositor — would be covered to mitigate the threat that SVB’s failure would trigger more bank runs.
In the Synapse case, the FDIC says it cannot act because there was no bank failure. As noted in a “consumer information” bulletin issued after the Synapse disaster: “FDIC deposit insurance does not protect against the insolvency or bankruptcy of a non-bank business. In such cases, even if consumers are able to recover some or all of their budget through insolvency or bankruptcy proceedings, dealt with through a court, such recovery would possibly take some time. In other words, it’s not our job.
The scenario is such (with more cash in Synapse’s coffers to hire experts) that a lawyer for McWilliams has publicly called for the hiring of a volunteer forensic accountant. Barash wondered aloud if the federal Consumer Financial Protection Bureau could simply step in.
So, do fintech consumers get the FDIC coverage they thought they had?It turns out that most of them have FDIC transfer insurance, which means that their coins are kept in an FBO (to get the benefits) account at the bank. , combined with coins from other fintech consumers.
In the event of a bank failure, the popular deposit insurance is applied to the FBO budget, provided that, according to the FDIC, there are transparent records of who owns what. But keep this in mind: The bank itself is rarely necessarily guilty of keeping those records: Instead, it’s possible that those records are kept through a fintech or an intermediary like Synapse, which functioned as a bridge between fintech startups and smaller banks that keep visitors’ budgets, and apparently, in some cases, combined the fintech budget into each of their FBO accounts. .
Bottom line: If a bank fails and a fintech (or other third party) has smart records, fintech consumers deserve to be able to recover their insured deposits fairly quickly. If a non-bank fintech, especially one with poor records, implodes, all bets are off. Meanwhile, it’s difficult, if not impossible, for consumers to discern what duty individual fintechs have opened accounts promising FDIC insurance.
“Frankly, there’s a big hole in the financial design in a lot of ways,” says Paul Clark, Seward’s financial advisory and regulatory expert.
Although Synapse has been around for a decade, the concept of FDIC transfer insurance is an old one. The FDIC first followed regulations in 1946 that allowed the custodian of an account, as an outside fiduciary, to transfer insurance to the beneficiaries of that account, according to a law review article drafted by Clark.
In 1980, after Congress liberalized interest rates and raised the FDIC’s insurance limit from $40,000 to $100,000, agents like Merrill Lynch began offering market-rate CDs to retail consumers who purchased FDIC transfer insurance. These “negotiated deposits” – commonly known as “hot money” – fueled the savings and credit crisis of the 1980s, which ended up costing American taxpayers some $300 billion today. (Ironically, traded CDs may simply be a relatively solid source of investment in today’s banking system, when depositors can level out a run on a bank like SVB with an undeniable mouse flick or tap of a screen. )
Then, in 2000, Merrill Lynch (with Clark’s help) broke new ground by proposing to move coins from clients’ currency control accounts to FDIC-insured transfer accounts, or holding them in currency market mutual funds. Today, Merrill Lynch is owned by the Bank. of America, and bank accounts are a mainstay of broker and fintech offerings.
For example, Fidelity Investments’ coin control account offers features similar to a checking account, such as ATM delivery, online bill pay, and debit card, as well as $5 million in FDIC insurance, which Fidelity provides when transferring clients’ coins to FBOs. accounts in 24 partner banks. Even The Vanguard Group, a conservative mutual fund giant, recently introduced a Cash Plus account that provides $1. 25 million per user (or $2. 5 million per couple) of FDIC insurance by transferring coins to FBO accounts at five other FDIC-insured banks. The account offers fewer features and looks more like a bank currency market than a checking account. But it will pay an increase consistent with the annual interest rate, ultimately 4. 6% compared to 2. 72% for Fidelity. )
Both Fidelity and Vanguard are supervised through the Securities and Exchange Commission. Each of them has more than 50 million consumers and manages billions in assets, all of which reassures those who rely on them for FDIC transfer insurance.
Sankaet Pathak co-founded Synapse and its chief executive until a bankruptcy trustee took over this month.
As Synapse’s case shows, the mix of small, low-sized, low-regulatory fintech start-ups operating with small, unsophisticated banks presents another point of risk. At a bankruptcy court hearing last month, a lawyer for one of Synapse’s smaller partner banks (Lineage Bank in Franklin, Tennessee), defended its efforts to deal with the factor by noting that it had only forty-five employees.
On the fintech side, some players were even smaller, but they were able to market a diversity of banking-like services, adding debit and credit cards and deposits through Synapse, which it subsidized through prominent venture capitalists, such as Andreessen Horowitz. Synapse’s main banking partner, Evolve Banco
On Friday, Evolve agreed to a strict and sweeping stop-and-desist order from the Federal Reserve and the Arkansas State Department of Banking, which prohibits it from expanding its fintech partnerships (either with new customers or with new products) without permission from banking regulators. The order states that review reports released last August and in January found that Evolve’s Open Banking (OBD) department, which deals with fintechs, violated similar regulations on threat management, offshore foreign assets, money laundering and customer compliance. To order, Evolve will have to submit plans to regulators to revamp OBD procedures and hire an independent third party to review the department.
In a statement, Evolve said it “remains well capitalized” and that the order “does not affect our existing businesses, consumers or deposits. “He called the enforcement actions “similar to orders” obtained through other banks that work with fintechs.
Synapse also has a meetup line that connects fintechs and their consumers with FDIC banking and insurance. However, in April 2020, Forbes reported that the startup, under the leadership of CEO and co-founder Sankaet Pathak, had control issues so serious that they threatened its future. In a bankruptcy filing, Pathak said that as of early 2024, Synapse had 100 fintech consumers serving about 10 million users. By the time the company filed for Chapter 11 bankruptcy last April, many of those consumers had fled to other middlemen. or established direct relationships with banks. However, in addition to Yotta, clients of Juno Finance, Copper Banking, GigWage, Grabr, Gravy, IDT, Latitud, Sunny Day Fund, Abound and YieldStreet have been caught in the mess.
“When we first introduced Mercury, we were in Synapse and had nine employees,” recalls Immad Akhund, CEO and co-founder of investment banking startup Mercury, a member of the Forbes Fintech 50 for 2024. “Actually, we probably want twice as big to free up a team working directly with the spouse’s bank. This means that you want to raise more cash and are willing to do so, but at the same time, it may not be so undeniable to do those things.
Last October, Mercury announced to Synapse that it would be transitioning to a direct banking relationship with Evolve. Synapse claimed in a bankruptcy filing that, as part of the move, Evolve transferred more budget from Synapse’s FBO accounts than it had, a claim that Evolve and Mercury deny. Anyway, when Synapse filed for Chapter 11, his relationship with Evolve was coming to an end amid litigation and unreconciled books.
“You erode confidence in the banking sector if cash is scarce and not reconciled,” said Chris Nichols, director of capital markets at SouthState Bank in Winter Haven, Florida. “SouthState has total assets of $45 billion and has adopted a cautious technique in its fintech partnerships, sponsoring three prepaid debit cards and a secured credit card (a setup in which cash is deposited in advance to back up the credit card). fees).
“Fintechs have arbitrated the industry in the sense that they have enjoyed all the benefits of banking without the dangers and costs,” adds Nichols. “Banks allowed this in an effort to accumulate fees and deposit balances. The solution lies in a combination of factors: less complexity, greater compliance, more transparency, improved governance and more technology.
Evolve is the first bank to take aim at how it has controlled (or more accurately, failed to manage) its relationships with fintechs. Regulators have urged banks, through enforcement measures, to take on more responsibilities in their fintech partnerships, especially when it comes to complying with know-your-customer regulations and the Bank Secrecy Act. Blue Ridge Bank, Cross River Bank, Metropolitan Commercial Bank, Vast Bank, B2 Bank, First Fed Bank, Choice Financial Group, Piermont Bank, Sutton Bank and, in particular, the same Lineage Bank involved in the Synapse case has signed consent orders related to its supervision of fintech programs.
In March, a report via The Information detailed how involved FDIC officials were, in particular, about Choice Financial Group’s partnership with Mercury and how the startup had opened accounts for consumers overseas, adding in Russia, Pakistan and Myanmar. (A Mercury spokesperson told The News, “Despite demand for our product, we onboard consumers who align with our robust threat framework. The company declined to comment further on the matter to Forbes. )
Part of the regulatory reaction – and specifically the rhetoric of regulators – goes beyond being applied after the fact, from bank to bank.
In November 2022, the Treasury Department submitted a report to President Biden’s White House Competition Council calling for greater oversight of bank-fintech partnerships and warning of new customer protection dangers similar to regulatory arbitrage and knowledge security. The report also praises the role played by fintechs in fostering the festival in key customer lending markets. At the time of the report’s release, Treasury Secretary Janet Yellen warned that “with existing authorities, regulators can inspire festival and innovation while further protecting customers”; in other words, they can do more to protect customers even without Congress passing new laws.
A year later, the Consumer Financial Protection Bureau proposed a rule that would subject non-bank tech corporations that provide virtual wallets or payment apps under the agency’s authority to conduct reviews of customers’ compliance with monetary laws. The proposal is designed to apply to corporations that process more than five million transactions per year.
Meanwhile, the FDIC has taken several steps to make sure consumers perceive what they’re getting when FDIC insurance is promoted through fintechs. In December 2023, it announced new rules requiring non-bank establishments, in addition to fintechs, to transparently disclose that they are not the FDIC. -Insured establishments and that deposit insurance only protects against the failure of an FDIC-insured bank. In the case of transfer insurance, fintechs will also need to make it clear that certain conditions must be met for this transfer. through insurance to apply for it. The deadline for compliance with the regulations is January 1, 2025, however, some fintechs, such as Mercury and Current, have already updated the data on their websites.
In a speech delivered at Vanderbilt University in February, Acting Comptroller of the Currency Michael J. Hsu warned that there could be a broader threat when banking services are bundled and sold through non-bank establishments (i. e. , fintechs) outdoors during the day. banking regulatory structure. ” From a monetary stability perspective, deposit collection activity deserves maximum attention due to the vulnerability it creates to runs,” he said. “Any entity that manages cash on behalf of consumers can face a run if consumers have concerns about the protection of their cash. “
There’s no doubt that fintechs have driven innovation, forcing banks to up their game and offer services to low-income and low-income people that banks might have ignored. For example, Chime, the country’s largest fintech bank with seven million consumers, has been a pioneer. consumer-friendly innovations, in addition to giving its consumers access to direct deposited paychecks two days before banks. Chime offers FDIC transfer insurance through master accounts at two banks: Stride Bank and The Bancorp Bank. It claims that within those general accounts, it has created individual deposit accounts for its consumers and reconciles its records with those of banks on a customer-by-customer basis. “When an account is out of balance, the bank and Chime take care of it. Even a $1 discrepancy would show up in the daily reports,” Chime said in a statement to Forbes.
Jackie Reses, CEO of the bank
Meanwhile, some marketers have spotted a business opportunity in helping the fintech sector draw a blank. In 2022, Jackie Reses, former head of Square Capital, and her partners acquired Lead Bank, a 96-year-old bank founded in Kansas City, Missouri. They now have about 30 technical painters working on a formula that reconciles bank statements with their fintech clients’ books. Its formula looks for anomalies in real-time and provides instant alerts in the event of a problem. An example may be simply alerting the bank to potential violations of Office of Foreign Assets Control regulations designed to enforce U. S. sanctions. Equally crucial: Reses, who is Lead’s chief executive, says he will only work with fintechs with a certain point of sophistication. the Forbes Fintech 50 list and Reses herself is on the Forbes list of the richest women who made themselves).
“Fintechs want to have an accounting formula, cash movement, and compliance teams for continuous monitoring,” says Reses. “Every fintech wants to have a formula that is not easy in terms of scalability and reliability. Total stop. “
This is the opposite of Synapse’s approach, which presented smaller, less complicated fintechs with a way to launch without the hassle or expense of building their own systems and expertise. But it remains complicated for a consumer, without any specific wisdom from fintech or banking players. , Make a Difference.
Even after the Synapse fiasco, the move-fast-and-break-things mentality is still alive in some sectors of the fintech world. Recently on LinkedIn, Adam Shapiro, co-founder of monetary consulting firm Klaros Group, reported that a fintech CEO complained (after the Synapse bankruptcy) that a bank was seeking too much information. That probably wouldn’t be enough anymore, Shapiro told Forbes. Fintechs want to see that their regulators will now require banks to demonstrate that they know what is happening with their fintech partners. What’s more, he says, the fintech industry itself will want secure criteria, “something that gives consumers moderate confidence that when they are told they have insurance, those records are being kept (responsibly) and that someone is reconciling budgets and verifying that they are there.
“It’s the new world,” he says.