$13M in Missing User Funds: Evolve, Synapse Play Blame Game as BaaS Crisis Intensifies
$13M in Missing User Funds: Evolve, Synapse Play Blame Game as BaaS Crisis Intensifies
FTV Sues Solid and Its Cofounders For $61M Over Alleged Fraud
Hey all, Jason here.
It was a short four days in Tokyo — I didn’t even get over my jet lag before getting on a flight back to Europe — but an amazing trip and opportunity to learn more about the banking, VC, and startup ecosystem in the country. I’d like to extend my thanks and gratitude to the Tokyo Metropolitan Government for organizing the trip and hosting me. Stay tuned for additional analysis from my trip in the coming weeks!
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$13M in Missing User Funds: Evolve, Synapse Play Blame Game as BaaS Crisis Intensifies
Key points:
Synapse FBO accounts at Evolve have a “deficit” of over $13 million
Evolve is holding a $16 million payment — which includes end customer interest payments — from Synapse; Evolve has further demanded Synapse set aside $50 million in a reserve account
Mercury — Synapse’s largest client — notified Synapse it wouldn’t be renewing its agreement, instead transitioning to work directly with Evolve
Apparently facing a cash shortfall, Synapse has confirmed it laid off 40% its workforce and declined to pay any severance
Solid’s Series B lead investor, FTV, is suing the company and its cofounders personally in attempt to recoup its $61 million investment
The slow-moving crisis engulfing banking-as-a-service seems to be reaching a breaking point.
Late last month, Evolve Bank & Trust notified BaaS platform Synapse that it believed the company was in breach of contract. And on September 27th, Evolve informed Synapse of its intention to terminate the relationship.
Challenges in the relationship have been well known for some time.
But now, sources, granted anonymity out of fear of retaliation, and documents reviewed by Fintech Business Weekly indicate that disagreement over who was responsible for a “deficit” of over $13 million in FBO accounts holding customer funds at Evolve, among a myriad of other issues, drove a rapid deterioration of the relationship.
At the heart of the issue is Synapse and Evolve’s fundamental inability to reconcile accounts and transactions between their various systems — a problem each party blames the other for.
Numerous sources highlighted the pairs’ inability to reconcile accounts and transactions and that Evolve never seemed particularly concerned about the issues.
In a September 27 letter Synapse founder and CEO Sankaet Pathak sent to Evolve Chairman and CEO, Scot Lenoir, and President of Open Banking, Hank Ward, Pathak alleges an error on Evolve’s part led to third-party payment processor TabaPay incorrectly debiting an FBO account for an amount that “appears to exceed a staggering $12 million, with the actual figure potentially far greater.”
According to Synapse CEO Pathak, the company raised concerns with Evolve about a potential deficit in FBO accounts as far back as November 2022.
Pathak’s letter alleges the inappropriate debits from end customer funds held in Evolve’s FBO accounts has been occurring since 2020, and possibly earlier, given Evolve and TabaPay’s relationship dates to 2018.
The fact that such erroneous debits could go undetected for nearly three years underscores Synapse and Evolve’s collective and fundamental inability to properly monitor and reconcile accounts and transactions.
The cost attribution issue isn’t the only example of Synapse and Evolve being unable to do basic reconciliation of their accounts.
Reconciliation of remote deposit capture (RDC) and checks were a long-standing problem for the two companies.
Problems included voided checks that were settled when they shouldn’t have been, causing losses to end customers; checks that had been marked settled but were subsequently returned; checks for which Synapse did not receive settlement but should have; checks Synapse desired to designate as “do not honor”; and checks that were numbered “0.”
Synapse and Evolve clients that have been impacted by these issues include major fintech companies such as Mercury, Rho, Yotta, YieldStreet, Copper, Relay, and Stilt:
Despite frequent communication about the problem over the course of much of 2022, Pathak’s letter to Evolve states that the companies never determined the root cause or total financial implications of the issues.
Missing and delayed ACH return files also caused problems, including negative impacts to Synapse clients and end customers.
According to one example cited in Pathak’s letter, “from August 26th, 2022 to September 5th, 2022 Evolve failed to provide ACH Return files to Synapse. As a result, approximately 41,500 transactions totaling $3,492,910.61 were returned late. These late returns resulted in a loss of $82,416.33 to Synapse.”
In an effort to address the persistent and serious reconciliation issues, Synapse worked with Evolve’s third-party accounting firm, Moss Adams. An analysis of a single week of data, for the period July 24-31, 2023, found discrepancies totaling nearly $6.5 million:
Pathak himself describes the potential size of the problem as “truly astonishing,” saying in the letter, “The magnitude of unresolved discrepancies over our years of collaboration, which dates back to 2017, makes it clear that the scale of the problem could be truly astonishing,” though he places the blame squarely on Evolve.
“The balances tend to differ a couple hundred million on the daily”
A November 2022 email from Evolve’s open banking controller, Chris Vendetti, to Synapse’s director of finance and accounting illustrates just how astonishing the reconciliation problems seem to have been (emphasis added):
“The balances tend to differ a couple hundred million on the daily. I am comparing the Synapse data to the FBO for consumer and business users. Are there other Evolve core accounts that we should take into consideration for the totals?”
The cost attribution issue, the reconciliation problems, and other charges Pathak describes as being erroneously taken from Evolve’s user FBO drove a total deficit in FBO funds in excess of $13 million.
While apparently a long-running problem, these issues came to a head in late September.
Evolve had been moving to de-risk its BaaS activities for some time, but there were a number of programs — those that constituted the bulk of the deposits — that the bank wanted to retain, including the largest program: Mercury.
Sources with knowledge of the matter indicate Mercury accounted for some 60-70% of all of the deposits sourced through Synapse.
For months, Synapse and Evolve had been discussing moving to a new, tri-party structure, where fintech clients would contract directly with both Synapse and Evolve. Clients would also integrate certain functions and compliance capabilities directly with Evolve, giving the bank better oversight of risks in its fintech programs.
But in late September, Evolve and Mercury came to a deal — only cutting out Synapse altogether. The plan seems to have been brewing for some time, given that Mercury has already integrated its systems with Evolve and completed the transition this weekend.
Synapse learned Mercury wouldn’t be renewing its agreement and instead had already integrated and would work directly with Evolve on September 25th.
With the bulk of the deposits secured, that same day, September 25th, Evolve sent multiple letters to Synapse regarding issues with the relationship and, on September 27th, informed Synapse it intended to terminate the relationship.
Evolve also seized $16,154,677.10 — an amount that includes interest payments owed to end users — citing “the continuing deficiency in the FBO Account balance and in order to protect the interests of End Users.”
In addition to the over $16 million in fees Evolve owed to Synapse, Pathak’s letter alleges that Evolve had been underpaying Synapse all along. As an example, Pathak provides an analysis of March 2023, claiming it demonstrates Evolve underpaid Synapse by nearly $3.3 million in that month alone:
Evolve also demanded that Synapse allocate $50 million — an amount the company almost certainly does not have — to a reserve account to protect the best interests of end customers and protect the bank from losses.
A representative for Mercury didn’t have any comment on the matter for publication.
Nothing in researching this piece suggested that TabaPay was aware, responsible, or involved in the issues cited at and between Evolve Bank & Trust and Synapse.
“Two paths forward,” Threats, And The $3.25 Million in FBO Funds Synapse “Incorrectly” Received
Pathak’s letter lays out two paths forward — which include not only a thinly veiled threat to notify Evolve’s regulators, but the stunning revelation that Synapse itself erroneously received $3.25 million in funds from the FBO account that it is struggling to pay back (emphasis added):
“The first option entails Synapse taking decisive steps to wind down its operations with Evolve. As part of this wind-down plan, Synapse is committed to repaying $1.75 million to the FBO Account and will make any necessary regulatory notifications. (Based on our reconciliation efforts to date, it appears that Synapse may have incorrectly received $3.25 million from the FBO account, with subsequent payments to the FBO account in the amount of $1.5 million.) This decision is rooted in the recognition that, under the current circumstances, Synapse cannot ensure a complete and accurate reconciliation, which necessitates that we send appropriate notifications to your regulatory bodies.
The second option, which we believe would be in the best interests of all parties, involves Evolve and Synapse collaborating to establish a reasonable payment plan. This would allow Synapse to continue its reconciliation efforts with Evolve and facilitate an orderly wind-down of the partnership. It's important to note that this option aligns with Evolve's prior agreement regarding the proposed payment plan, which Mr. Lenoir communicated to me by phone on September 17, 2023. To proceed with this second option, Evolve would need to commit to remitting the full rebate payment by September 28, 2023, in accordance with our prior agreement, and agree to the negotiated terms of the $1.75 million payment plan by September 29, 2023.”
Given that Synapse’s employees were notified on September 29th off the mass layoff (as confirmed by Techcrunch) — and, unlike previous layoffs, the lack of any severance payment — it seems reasonable to assume the two companies did not come to an amicable, collaborative resolution to the problems.
Why Were Funds From Evolve-linked DDAs Held At Lineage?
Synapse’s mounting challenges aren’t limited to Evolve.
With its so-called “modular banking” approach, a single Synapse fintech client’s program could be spread across multiple banking partners: DDAs, BIN sponsorship, and payment processing could all be run through different banks.
In order to pave the way for a deeper relationship with one of its newer partner banks, Lineage, Synapse moved the bulk of its ACH processing to the bank, including for DDAs held at Evolve.
Moving the processing to Lineage enabled the bank to start driving revenue immediately, rather than waiting to onboard net-new fintech client programs that wouldn’t generate meaningful deposit volumes for some time.
But, in a highly unusual move, Synapse agreed to let Lineage hold funds up to a certain threshold — despite underlying customer deposit account agreements being with Evolve — rather than sweeping those funds to Evolve.
Sources with knowledge of the matter said that, at times, Lineage has held as much as $200 million in funds that actually belonged to Evolve accounts.
All of the implications of the unorthodox arrangement are unclear, but the practice would likely complicate deposit classification, reporting, and accounting, including end customer FDIC insurance coverage limits and both banks’ deposit insurance assessments.
With Evolve moving to terminate its relationship with Synapse, it’s unclear what the impact on Lineage’s ACH processing revenue and deposit funding may be.
A representative for Lineage Bank didn’t respond to a request for comment.
A representative for Evolve Bank & Trust didn’t respond to an extensive list of questions and requests for clarification, including regarding the “deficit” in FBO accounts, withholding end user interest payments, and whether or not depositors were at risk of losing funds.
A representative for Synapse shared the following statement: “We deeply regret saying goodbye to incredibly talented and dedicated members of Synapse team. However, we have a strong group in place to manage all of our operations and support our customers going forward. We don’t have anything to add to this right now beyond what’s been previously reported.”
FTV Suing Solid And Its Cofounders Personally, Seeking To Recoup $61 Million Investment
Synapse isn’t the only banking-as-a-service platform with rapidly escalating challenges.
Solid, which Fintech Business Weekly exclusively revealed has been manipulating its customer and revenue numbers, is being sued by its Series B lead investor, FTV.
On Tuesday, September 26, FTV filed a lawsuit against Solid and its cofounders Arjun Thyagarajan and Raghav Lal personally, seeking to rescind its Series B purchase agreement and recover its $61 million investment, other related damages, and the cost of bringing the suit.
While FTV’s filing is publicly available, it is heavily redacted, obscuring a complete picture of FTV’s claims.
Consistent with Fintech Business Weekly’s previous reporting, the suit alleges the company and its cofounders lied about revenue, customer churn, and the business generally.
In the lead up to the Series B fundraise, Solid claimed a 10x year-over-year increase in revenue, customers, and transactions, and claimed to have $10 million in annual recurring revenue (ARR), the suit alleges.
The company claimed the unaudited financials produced as part of due diligence for the fundraise were prepared according to GAAP standards, according to the filing.
But, the suit says, the financial statements were actually fabricated.
In the filing, FTV claims Thyagarajan and Lal “manipulated the books and records of the Company to create a picture of a thriving start-up company with $10 million of ARR, almost no customer churn, and an ever-increasing pipeline of new customers” and that “the majority of the Company’s revenues were fictional.”
The suit further claims the company inflated transaction revenue, overstated its cash position, concealed the termination of material contracts, represented that contracts were valid, binding, and enforceable when they were not, and concealed the departure of material customers.
FTV claims these alleged actions represent breach of contract, fraud in the inducement, fraudulent concealment, breach of fiduciary duty, breach of the implied covenant of good faith and fair dealing, and unjust enrichment.
With a board deadlock — FTV and Headline each have a seat, as do the two Solid cofounders — the investors have been unsuccessful at removing Thyagarajan and Lal from the company.
The lawsuit isn’t the only major challenge Solid is facing.
After losing Evolve as its key bank partner, Solid has been working to identify and onboard new banks willing to work with it.
But, Fintech Business Weekly has learned exclusively, after last month’s revelations the company had faked revenue numbers and promised clients and bank partners capabilities that didn’t exist, a potential bank partner that was ready to sign with Solid ultimately declined to do so.
A representative for FTV Capital didn’t respond to a request for comment.
A representative for Solid said that the company refutes the claims laid out in FTV’s suit and intends to file responses to FTV’s claims and counterclaims this week.
What Happens When A Banking-as-a-Service Platform Fails?
What would the impact of a disorderly failure of a BaaS platform be on its partner banks, fintech clients, and their end customers?
Unfortunately, it seems likely we may find out, with both Solid and Synapse facing potentially catastrophic challenges to their businesses.
Together, Synapse and Solid power dozens if not hundreds of fintech programs — names like Yotta, Kraken, Cadre, GigWage, Juno, Yieldstreet, Nomad, SoLo Funds, Zirtue, Starlight, Abound, GrabrFi, DolarApp, Latitu, Trace Finance, Relay, and numerous others.
These programs, especially the smaller or higher-risk ones that serve foreign geographies, SMBs, or crypto/web3 companies, are likely to have a difficult time finding a new platform or bank partner should their current one fail.
Combined, these fintechs serve millions, if not tens of millions, of end users around the world, including retail consumers, small businesses, and startups.
Whether or not Synapse, Solid, Evolve, and the other bank partners are prepared to wind down programs in an orderly way — and return end user funds in a timely manner — remains to be seen, but, given the challenges they’re facing, it is a legitimate area of concern.
Other Good Reads
Listen: Deposits have Changed: The Age of Fintech Has Reshaped a Basic Banking Product (Innovative Payments Association)
Listen: New From the Fintech Front - September 2023 (Breaking Banks Europe)
Eight Questions About The Future Of Open Banking (Fintech Takes)
They Studied Dishonesty. Was Their Work A Lie? (The New Yorker)
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