Evolve's Problematic Partners: Bankruptcies, Regulatory Actions, Abrupt Shutdowns
Sequoia, Craft Urged Portfolio Companies To Pull $200m in Funds From Evolve-Linked Mercury, Sources Say
Hey all, Jason here.
I finished up drafting this week’s newsletter yesterday, as the World Cup played in the background. I’m not particularly a soccer (futbol) fan, so I wasn’t really rooting for either team USA or Netherlands — given my connections to both countries, I figured “my team” would win either way.
Around the time this hits your inbox, I’ll be taking off for a couple days in Riyadh, Saudi Arabia, where I’ll be speaking about open banking/open finance at a fintech event. I hope to learn a lot about the local fintech ecosystem in the short time I’m able to spend there!
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Alleged Fraud, Multiple Bankruptcies, Regulatory Actions: Evolve’s Problematic Fintech & Crypto Partners
Key Points
Evolve has failed to manage its sprawling partnerships; sources say it is working to cut ties with platforms Synapse, Solid, and the companies they support, and potentially numerous others.
VCs’ warnings led startups to pull as much as $200 million from Mercury, which partners with Evolve.
Deserve, a credit card platform, is stuck with $100m+ of BlockFi’s credit card receivables — and angry borrowers who don’t want to pay.
Curve, Binance, and Deserve itself were interested in acquiring BlockFi’s 87,500 credit card customers, but Evolve will most likely block the move and terminate the program altogether.
From Sleepy Tennessee Bank to Major Player in Fintech
On paper, Evolve Bank & Trust looks like a sleepy, small-town bank. Based in West Memphis, Tennessee, Evolve holds just $1.3 billion in assets and about $1.1 billion in deposits, according to its most recent call report. Evolve has about $103 million in equity capital — making it well capitalized — and it has generated about $16 million in net income this year through the end of the third quarter.
But the small size of Evolve’s balance sheet belies the immense complexity under the hood.
Over the course of recent years, Evolve has, well, evolved into arguably the most significant player in the “partner banking” or “banking-as-a-service” space.
Evolve announced its partnership with BaaS platform Synapse back in 2017 and has grown substantially since then by adding numerous platform partners and direct fintech relationships.
Evolve now partners with BaaS and payments platforms that include Apto Payments, Bond, Deserve, PayGears, Sila, Solid, Stripe Treasury, and Synapse.
Both through direct relationships and those partnerships, Evolve powers dozens of customer-facing fintech and crypto companies. Searching for public terms and conditions, which are required for deposit and card programs but not for other capabilities, like ACH and wires, reveals at least 80 programs built on Evolve. Industry experts suggest the actual number is likely significantly higher.
Evolve’s Problematic Partners Go Far Beyond FTX & BlockFi
With the sheer number of partner programs Evolve is supporting, it isn’t surprising some of the companies have failed — after all, most of these companies are venture backed-startups attempting to develop novel products and business models.
But compared to other major players in the partner bank space, like Blue Ridge, The Bancorp Bank, and Pathward (formerly Metabank), the number, size, and sheer messiness of Evolve’s partner failures is stunning.
Crypto exchange FTX is certainly the highest profile disaster that Evolve is affiliated with.
The company collapsed in spectacular fashion after experiencing, essentially, a bank run and amidst allegations of outright fraud. FTX’s new CEO, John J. Ray III, who is overseeing the bankruptcy, describes the situation as the worst he has seen in his career in a bankruptcy filing, saying:
“Never in my career have I seen such a complete failure of corporate controls and such a complete absence of trustworthy financial information as occurred here.
From compromised systems integrity and faulty regulatory oversight abroad, to the concentration of control in the hands of a very small group of inexperienced, unsophisticated and potentially compromised individuals, this situation is unprecedented.”
Evolve partnered with FTX to issue its debit cards and provided capabilities for FTX users to direct deposit funds to the platform; according to repeated statements from Evolve, the bank did not and does not have direct financial exposure to FTX.
Evolve also partnered with now-bankrupt crypto lender BlockFi as the bank sponsor of its crypto rewards credit card program. BlockFi ran into trouble amid crypto market turmoil earlier this year and was bailed out by… FTX. After FTX’s failure, BlockFi quickly slipped into bankruptcy — making for two of Evolve’s partners filing in as many weeks.
The bankruptcy wasn’t BlockFi’s first issue — the company had previously been under investigation by state securities regulators and the SEC. It ultimately settled the matter, agreeing to pay a $100 million settlement to the states and SEC — but had only actually paid $70 million of that, before collapsing in bankruptcy.
Evolve-linked disasters haven’t been limited to crypto. The bank also had links to short-lived “anti-woke” neobank GloriFi. Evolve served as the bank sponsor and worked together with card platform Deserve to power GloriFi’s credit card offering.
The Ken Griffin and Peter Thiel-backed project abruptly shut down late last month after the Wall Street Journal profiled the company’s missed launch dates, technology and vendor failures, and chaotic and allegedly abusive working environment.
The issues with FTX, BlockFi, and GloriFi are merely the highest-profile issues to emerge about companies Evolve supports.
Evolve Partners’ Legal and Regulatory Scrutiny
The CFPB probed Evolve partner Dave, a cash advance and neobanking app, to assess if it was “in compliance with the prohibition against UDAAPs, the EFTA, and, to the extent it applies, the Truth in Lending Act.” The CFPB ultimately closed the probe without taking action.
The New York Department of Financial Services launched an investigation into Earnin’, another Evolve partner that purports to offer “earned wage access,” in 2019. Ten states joined New York into looking into Earnin’ and the broader sector but, ultimately, no actions were taken, though the company settled a civil class action suit against it for $12.5 million.
SoLo Funds, which partners with Evolve via BaaS platform Synapse, has also run afoul of banking regulators. Connecticut issued a cease and desist to bar the company from operating in the state, alleging the company was operating without necessary licenses, deceiving users, and charging APRs that reached 4,280%. In an apparently unrelated matter, this September, Synapse had its lending license in Connecticut revoked for failing to provide audited financial statements.
While FTX, BlockFi, GloriFi, Dave, Earnin’, and SoLo Funds have generated the most headlines and legal action to date, there are numerous other Evolve partners engaged in higher-risk business models that could drive increased regulatory risk.
Potentially problematic partners can be roughly grouped into three categories: cash advance apps, opening US accounts for foreign non-residents, and crypto-related products.
Cash Advance & Earned Wage Access Products
Examples of cash advance- and earned wage access-style fintechs that partner with Evolve include B9, Branch, Dave, Earnin’, FloatMe, Gerald, Grid, GigWage, SoLo Funds, and Zirtue.
As mentioned above, Dave, Earnin’, and SoLo Funds have already been subjects of regulatory and civil actions.
While the specifics vary company to company and product to product, common risks in the category include structuring products as “cash advances” rather than loans, claiming 0% interest/APR, encouraging users to leave “tips,” charging expedited funding fees, and charging membership fees, among other potential issues.
These products’ structures and how they are marketed can carry various legal and regulatory risks, including under UDAAP, the Truth in Lending Act (TILA), Electronic Funds Transfer Act (EFTA/Reg E), Equal Credit Opportunity Act (ECOA), and the Military Lending Act (MLA).
Like all financial businesses, they also incur privacy and information security risks that need to be properly mitigated.
US-Based Accounts for Foreign Non-Resident Nationals
Evolve also appears to power several startups that offer US bank accounts to non-resident foreign nationals. Nomad, Yorbis, Kyshi, and RBR all are pursuing some variation of this model.
Yorbis, which partners with Evolve through BaaS platform Solid, describes itself as “The Mobile Banking App Designed for Globetrotting Citizens.” The site describes the founder’s “many challenges getting basic banking services while living overseas.”
UK-incorporated Kyshi describes itself as “the neo bank for Africans globally.” It also partners with Evolve via Solid. A post last month on its website touts how, “in a bid to serve Africans in the United States,” it has “partnered with Solid bank [sic], a US-based digital bank.”
RBR’s website contains virtually nothing beyond its tag line, “Barrier Free Banking for Everyone,” and a promise that its new site is launching soon. RBR also partners with Evolve through Solid.
Finally, there’s Nomad, a neobank enabling Brazilians to open a US demand deposit account with an associated debit card, powered by Synapse and Evolve. Nomad also partners with DriveWealth to offer investment products.
Unique risks here primarily revolve around BSA/AML compliance when opening US-based accounts for foreign non-residents.
The Bank Secrecy Act (BSA), as amended by the PATRIOT Act, requires banks and financial institutions to adopt and maintain a Customer Information Program (CIP) as part of their KYC/KYB processes. Section 326 requires FIs to collect users’ name, date of birth, address, and identifier (most commonly a US SSN or ITIN).
FIs aren’t actually required to verify each piece of information; rather, they need to be able to form a “reasonable belief” of the true identity of their customers.
So, while it is possible to open US accounts for foreign non-residents, historically, banks and other FIs have generally shied away from doing so. Due to the increased challenges and complexity of forming a “reasonable belief” in the identity of a foreign non-resident customer, such a program is likely to be viewed as higher risk and thus in need of more robust BSA/AML controls and oversight.
Crypto, DeFi and Web3
Perhaps most worrisome given this year’s crypto market chaos and the implosion and likely loss of customer funds at FTX and BlockFi is the large number of crypto- and defi-related products Evolve powers.
Beyond FTX and BlockFi, companies with crypto-linked products that Evolve partners with include: ByteFederal, Flycoin, Hightop, Juno, DogeCard, Rollfi, Series Financial, Status Money, Starlight, Step, Swype, Unbanked, and Zelf.
While the exact product formulations vary, the unifying theme is to offer some type of crypto, defi, or web3 product alongside a traditional “fiat” account and spending/payment capabilities.
The product concepts themselves are not inherently non-starters; companies as varied as Robinhood, Cash App, and PayPal offer basic crypto buying and trading alongside traditional financial products.
Rather, the risks appear primarily to come from how some of these companies describe their products, their relationship to Evolve, and, specifically, the applicability of FDIC insurance.
The issue of crypto companies potentially misleading customers about what is and is not covered by FDIC insurance came to the forefront earlier this year, with the FDIC issuing an advisory statement and sending cease and desist orders to five crypto companies, including to Evolve partner FTX US over this now-infamous (and since deleted) Tweet:
The advisory statement, issued in July, said in part (emphasis added):
“The FDIC is concerned about the risks of consumer confusion or harm arising from crypto assets offered by, through, or in connection with insured depository institutions (insured banks). Risks are elevated when a non-bank entity offers crypto assets to the non-bank’s customers, while also offering an insured bank’s deposit products.
Inaccurate representations about deposit insurance by non-banks, including crypto companies, may confuse the non-bank’s customers and cause those customers to mistakenly believe they are protected against any type of loss. Moreover, non-bank customers may not understand the role of the bank as it relates to the activities of the nonbank, or the speculative nature of certain crypto assets as compared to deposit products.”
In addition to consumer protection risks, the FDIC also points out risks to the banks in such relationships, should consumers become concerned about banks’ exposure and move their funds (emphasis added):
“Moreover, misrepresentations and customer confusion could cause concerned consumers with insured-bank relationships to move funds, which could result in liquidity risk to banks and in turn, could potentially result in earnings and capital risks.”
And yet, months later, multiple Evolve partners are still making potentially deceptive and confusing claims related to FDIC insurance.
For instance, Liquidity Financial, the company behind DogeCard, prominently displays a “Member FDIC” logo in the upper right corner of its site, along side a description of its product as enabling users to “Buy, sell, send, spend, earn Dogecoin” — potentially leading users to erroneously believe their Dogecoin is FDIC insured.
Meanwhile, Evolve partner Zelf, which positions itself as the “Bank of the Metaverse,” describes its product as capable of holding USD, crypto, and “game loot,” with “funds” FDIC insured up to $250,000 — a description and presentation that seems likely to cause consumer confusion.
Crypto “Contagion” Spreading to Fintech?
With the collapse first of FTX and then BlockFi, unsubstantiated rumors about risks the situation could present to Evolve have begun to circulate. Evolve has issued a series of six statements on the matter, attempting to quell anxiety about potential exposure.
Evolve has reiterated that it doesn’t currently nor has ever held cryptocurrencies on its own balance sheet; that it did not lend to FTX or its affiliates; that it does not lend against crypto nor custody crypto assets; does not invest or trade crypto; and does not have any exposure to the traditional USD receivables of BlockFi’s credit card program.
Looking at Evolve’s public filings and accepting its statements at face value, there is no reason to believe the collapse of FTX and BlockFi pose a material solvency or liquidity risk to the bank.
However, that hasn’t stopped prominent venture capital funds from advising their portfolio companies to pull money from Mercury, a banking and treasury management platform for startups that partners with both Evolve and Choice Financial Group.
Multiple VCs, including Sequoia and Craft Ventures, have advised their startups to move funds away from Evolve-backed platforms, resulting in about $200 million being moved off Mercury, according to multiple people with knowledge of the matter.
Immad Akhund, co-founder and CEO of Mercury, didn’t deny that the funds had been moved and characterized the amount as “not really material,” saying the company has “billions of dollars in deposits across 100K customers and [is] profitable.”
Akhund characterized the money movement as “primarily folks diversifying, rather than full churning,” by moving funds to Mercury’s other bank partner, Choice, or into Mercury’s treasury management product.
While the shifting of deposits may be immaterial to Mercury, it’s unclear how significant of an impact, if any, it could have on Evolve’s deposit base and liquidity. Asked about any potential impact, an Evolve spokesperson said:
“Evolve is a well-capitalized FDIC-insured financial institution and is well positioned to meet the liquidity needs of our customers — including large withdrawals should they occur. In addition, Evolve has tested contingency plans for these sort of events and is more than prepared to respond if the need were to arise.”
Deserve As ‘Bagholder’ on BlockFi Credit Card Receivables
The company facing the biggest direct financial exposure from FTX and BlockFi’s collapse may turn out to be credit card platform Deserve — over $100 million in outstanding card balances, according to people familiar with the matter.
It is Deserve’s $250 million credit facility, in turned backed by names like Goldman Sachs and Waterfall Asset Management, that could end up taking losses as a result of the abrupt shutdown of BlockFi’s credit card program.
BlockFi cardholders’ ability to make new purchases was suspended on or around November 11th — according to an Evolve spokesperson, the bank discussed the matter with Deserve and BlockFi and “all parties agreed” it was the best course of action.
BlockFi cardholders appear not to have been notified before their cards were deactivated; when asked if it had notified cardholders in advanced, Evolve pointed the finger at Deserve, saying, “[a]s the program manager, Deserve is responsible for cardholder notifications.”
Binance US, Curve, and Deserve itself were reportedly interested in acquiring the 87,500 BlockFi credit card accounts, according to reporting and sources close to the companies.
However, people with knowledge of the matter suggested Evolve wasn’t interested in seeing customers transferred to a new program manager and, instead, wanted it shut down to begin to distance itself from crypto-related companies.
Meanwhile, statements and emails from Evolve, the card issuer, and Deserve, its servicer, politely reminded BlockFi cardholders they were still on the hook for outstanding balances. Per an update on Evolve’s site on November 29th (emphasis added):
“While all BlockFi accounts continue to remain suspended, we encourage all users to use the new portal by Deserve to make payments, monitor transactions, view statements and more. We will provide more information as it becomes available.
As a reminder, any existing balances need to be repaid per the payment requirements outlined within your cardholder agreement.”
BlockFi credit card holders — who had just had any card-related bitcoin rewards and other crypto funds they held on the platform indefinitely frozen — were understandably not happy:
While these borrowers are legally obligated to repay, and Deserve can and is likely to use all legal means available to collect on what it is owed, it seems reasonable to assume defaults and charge offs on the portfolio will be higher than forecast.
Regulatory Fallout Likely to Outweigh Financial Impact
While the risk of financial contagion has been top of mind, the bigger disruption is likely to be from actual or perceived risk of regulatory action.
Numerous sources indicate Evolve is working to offboard platforms and programs, to the extent its contracts permit it to, with an emphasis on companies that had crypto-related offerings. People with knowledge of the matter said Solid was “kicked off” Evolve earlier this month, and sources indicated Synapse has gotten its marching papers as well.
Arjun Thyagarajan, co-founder and CEO at Solid, denied this, saying things are “going really well” with Evolve and that it was “business as usual.” Asked about that characterization, a Solid customer described it as “a lie,” adding that even Solid had acknowledged Evolve was a “lackluster” partner.
This all leaves Solid, Synapse, and other Evolve-linked platforms scrambling to find new bank partners. Synapse recently announced a partnership with American Bank, a small community bank in northwest Iowa. Some clients of Solid running products on Evolve were informed last month that Solid was “switching bank partners,” and that they would need to migrate.
Moving bank partners is a time-consuming, expensive, and risky disruption that no company, let alone an early-stage fintech, would be excited about undertaking.
Depending on the products and how they’re implemented, a transition could involve a BIN migration, reissuing cards, and/or providing new ACH and account number information, among other potentially necessary technical and legal updates.
For fintechs, it’s a drain on resources, encourages customer churn, and carries risk of disrupting customers’ ability to access their funds.
For consumers, it’s a nuisance to update stored account and card details. Though these days, every fintech or customer pain point is an opportunity to build a business: card-switching-as-a-service startup KnotAPI, keying in on the potential headaches for Synapse customers, is trying to capitalize on the opportunity.
Time for a Rethink on Banking-as-a-Service Models?
It’s important to acknowledge that the approaches to compliance vary by partner bank, BaaS platform, and consumer-facing fintech.
But in Evolve’s case, it seems the bank was all too willing to buy the sales pitches of BaaS platforms like Synapse and Solid.
The platforms promised banks like Evolve easy, scalable revenue without the headaches of actually having to deal with early-stage companies and their often inexperienced founders.
At the same time, the promise of some BaaS platforms to their clients — lower cost and faster speed to market — hinged in part on the platforms being able to step in and provide compliance infrastructure, advice, and supervision.
It seems increasingly clear that this approach hasn’t been fit for purpose. For instance, some Synapse clients described a fairly straightforward initial compliance review, consisting of a 15 page “checklist,” with the process taking a total of about three weeks to complete.
But, once live, there was little to no ongoing compliance monitoring — and, some reported, obvious gaps in Synapse’s systems became apparent. For instance, Synapse clients reported reviewing suspected fraud cases, only to realize some approved users’ identity documents consisted of an image of a meme, a photo of a photo of a document, expired documents, or crude forgeries.
In the current regulatory model, the obligation for ensuring compliance ultimately resides with the licensed bank. While the number of intermediaries between Evolve and an end customer increases the challenge of operationalizing a compliance management system, that complexity doesn’t excuse failure.
There are alternate models that could reduce the US fintech ecoystem’s reliance on increasingly byzantine legal and technology structures; for instance, in the UK and EU, it is substantially easier to be granted a full banking license, and alternate license categories, like e-money and payment institutions, reduce the need for fintechs to work with licensed banks.
Easier access to Fed master accounts, which looks unlikely to become a reality, could also reduce the need for fintechs to partner with banks.
Given the incredibly low odds of legislative or regulatory progress on these fronts, non-bank fintechs will need to continue to partner with licensed banks for the foreseeable future; figuring out how to operate these relationships, at scale, in a safe, sound, and compliant manner is critical to transitioning to a more mature phase of fintech.
In addition to the above comments, a spokesperson for Evolve Bank & Trust said, “Lastly, this is an example of why sponsor bank model works. Because Evolve is a well-capitalized, FDIC-insured institution with processes and procedures designed to limit risk to the bank and our customers, customer funds are secure, and there is no financial risk to the bank. Again I would reiterate, Evolve’s business practices are not under ‘heightened regulatory scrutiny,’ nor under any investigation.”
Representatives for Deserve said, “Deserve is dedicated to providing transparency to BlockFi customers. Evolve Bank & Trust has been a great partner and we are continuing to work with them to provide accurate and up-to-date information for BlockFi cardholders.”
Representatives for Stripe declined to comment and pointed to Evolve’s statement.
Representatives for Synapse declined to provide a comment for publication.
Representatives for BlockFi didn’t respond to a request for comment.
Representatives for Sila didn’t respond to a request for comment.
Representatives for Apto Payments didn’t respond to a request for comment.
Representatives for PayGears didn’t respond to a request for comment.
Other Good Reads
Let’s Stop Treating Crypto As If It Were Finance (Todd H. Baker)
A Microcosm for Fintech (Fintech Takes)
Two Fintechs Fueled Extensive Pandemic Relief Fraud, House Report Finds (NYTimes)
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