FDIC's Warning On "Third-Party Apps" Won't Help Consumers
Synapse Trustee Makes Public Plea For Free Help To Untangle Complex Ledgers
Hey all, Jason here.
I had the chance to attend Money2020 here in Amsterdam last week — a great chance to connect with industry colleagues as always. Keep your eyes peeled for a couple of forthcoming podcasts I recorded during the event: one with the Money2020 team and other with Nicolas Benady, CEO of European embedded finance firm Swan.
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In what I suspect was not coincidental timing, the FDIC’s most recent consumer newsletter addressed the topic “What to know about fintech, banking relationships, and deposit insurance.”
The bulletin acknowledges how technology has and continues to change the American banking landscape, noting (emphasis added), “If and how a bank is involved is key to understanding whether or not your money is protected by deposit insurance. However, in some cases, it is not always clear to consumers if they are dealing directly with an FDIC-insured bank or with a nonbank company.”
When it comes to whether or not users’ funds in non-bank apps are protected by FDIC insurance, the agency’s bulletin tells consumers: it depends!
The bulletin — which, remember, is purportedly designed for an average end consumer, not an expert in banking law or how fintech-bank partnerships work — goes on to say (spacing adjusted and emphasis added):
It is important to be aware that nonbank companies themselves are never FDIC-insured. Even if they claim to work with FDIC-insured banks, funds you send to a nonbank company are not eligible for FDIC insurance until the company deposits them in an FDIC-insured bank and after other conditions are met.
If the nonbank company deposited your funds in a bank, then, in the unlikely event of the bank’s failure, you may be eligible for what is referred to as “pass-through” FDIC-deposit insurance coverage. However, the nonbank company must take certain actions for your funds to be eligible for FDIC insurance.
For example, after the nonbank places your funds on deposit at a bank, records must be kept to identify who owns the money and the specific amount that each person owns. Ownership of the money is important and is typically determined by the applicable deposit account agreements and state law.
There are other requirements as well. It is important to make sure you read the disclosures and terms of service carefully to understand if the account may be eligible for FDIC insurance.
However, FDIC deposit insurance does not protect against the insolvency or bankruptcy of a nonbank company. In such cases, while consumers may be able to recover some or all of their funds through an insolvency or bankruptcy proceeding, often handled by a court, such recovery may take some time.
As a result, you may want to be particularly careful about where you place your funds, especially money that you rely on to meet your regular day-to-day living expenses.
In an attempt to address end user confusion, the FDIC undertook a notice-and-comment rulemaking in 2022 to “modernize” FDIC signage requirements and clarify expectations around false advertising, misrepresentation of insured status, and misuse of the FDIC’s name or logo.
The final rule went into effect April 1, 2024, though enforcement of the measure is deferred until January 1, 2025.
The rule is meant, in part, to address the rise of bank/fintech partnerships, like those facilitated by BaaS intermediaries, including clarifying how deposit insurance applies in such arrangements and the kinds of disclosures non-bank fintechs should make to avoid end-customer confusion.
The rule clarifies that:
using the FDIC’s advertising statement or FDIC associated images or terms in a way that implies a company other than an insured depository institution is insured by the FDIC is a misrepresentation, unless it is next to the name of one or more insured depository institutions
if a non-bank makes a statement regarding deposit insurance coverage, it is a material omission not to clearly and conspicuously disclose that the non-bank company itself is not FDIC-insured and that FDIC insurance only protects against the failure of an insured depository institution
if a company makes statements about “pass-through” deposit insurance coverage, it is a material omission not to clearly and conspicuously disclose that certain conditions must be met for such coverage to apply
But, in practice, what does this actually look like, and is it likely to be comprehensible to a typical consumer (or business, for that matter)?
Here’s an example of what a disclosure — which may appear in a tooltip or at the bottom of a lengthy website — that would conform with the new requirements could look like:
FDIC Insurance: [COMPANY] is a financial technology company, not an FDIC-insured bank. FDIC insurance only covers the failure of an FDIC-insured bank. FDIC insurance up to $250,000 is available on customer funds through pass-through insurance at [BANK], Member FDIC where we have a direct relationship for the placement of deposits and into which customer funds are deposited, but only if certain conditions have been met. There may be a risk that FDIC insurance is not available because conditions have not been satisfied. In such cases, funds may not be fully insured in the event the insured depository institution where the funds have been deposited were to fail.
No Depositor Has Ever Lost A Penny Of FDIC-Insured Funds
One of the great successes of the American banking system is that users don’t need to worry about the safety of their money — the combination of modern prudential regulation and deposit insurance, born in the aftermath of the 1929 stock market crash and Great Depression, has, overall, been phenomenally successful.
The FDIC even brags that no depositor has ever lost a penny of FDIC-insured funds (surely this would be surprising news to end users whose funds are tied up in Synapse’s bankruptcy.)
Whether a user holds their funds at a too big to fail GSIB, like JPMorgan Chase, or a small-town community bank, they can sleep at night, knowing that money is safe.
So it’s understandable a consumer using a nonbank fintech app wouldn’t question the safety of their money — particularly as many fintechs purposefully sought to capitalize on the trust users associate with the term “bank” and with the FDIC, with numerous examples of companies deploying potentially deceptive or misleading claims like this one, from Stake, a client of BaaS intermediary Unit and Blue Ridge Bank and TransPecos Bank:
The company removed the FDIC logo and language after inquiries from Fintech Business Weekly earlier this year, but still makes claims that could deceive or mislead a typical consumer into believing it is a bank:
Expecting consumers — who have been effectively trained not to worry about the safety their money — to parse websites’ disclosures and scour terms and conditions is unrealistic.
And, in fact, it’s literally impossible for an end user to verify if a fintech meets the requirements for pass-through insurance to apply: there is no way for a user to check how a fintech’s account(s) at an insured depository institution are titled, nor is there any way to inspect the fintech or the bank’s books and records to ensure their accuracy.
The FDIC’s advice to consumers is, essentially, useless, as even if a consumer wanted to verify their account and funds are eligible for pass-through coverage, there is no mechanism by which they can do so.
What Can Be Done?
So, if pushing the responsibility to end users isn’t feasible, what actions can regulators and legislators take, particularly in the wake of Synapse’s collapse?
There are a range of possibilities, some of which are near-certain to happen, others of which are extremely unlikely:
Banking regulators lean on the tools they have: emphasizing banks’ responsibility to oversee third-party partners, including middleware intermediaries and customer-facing fintechs. This was already happening, as evidenced by the numerous BaaS-related consent orders, prior to Synapse’s collapse, and, I imagine, will only escalate due to recent events.
FDIC more strongly polices misuse of FDIC language and logo. Again, we’ve already seen more activity here, particularly following the collapse of a number of high-profile crypto firms that had misused FDIC language. Still, the FDIC is basically limited to sending sternly worded letters after the fact and hoping these admonishments serve as a deterrent to others.
CFPB taking more aggressive enforcement action against fintechs for UDAAPs. While the CFPB lacks supervisory authority over fintechs, it does have enforcement authority. With the existential threat of the Supreme Court challenge to its funding out of the way, might we see stepped up enforcement actions against fintechs?
State regulatory actions. Chime was memorably given a slap on the wrist in California and Illinois for describing itself as a “bank.” Absent a stronger response from federal regulators, more action at the state level, particularly in jurisdictions like California and New York, seems likely.
New state licensing regimes. We’ve seen this in areas like earned wage access and buy now pay later. The idea of requiring middleware intermediaries and consumer-facing fintechs to obtain some kind of license at the state level — and be subject to supervision — is not out of the question. While a reasonable policy response, a state-by-state licensing regime would create headaches and substantial compliance overhead for fintechs operating nationwide.
New federal licensing regime. There’s about zero chance of this happening, given the vocal opposition from banking lobbies to anything that would erode the benefits of a banking charter by enabling non-banks to lend nationally, issue payment cards, or have direct access to payment rails without working through a chartered bank.
The e-money and payment institution licenses offered in many other countries could help address some of the challenges we’ve seen lately in the US and to codify regulators’ expectations, but there is little chance of these coming to pass. The closest might be state-issued special-purpose banking charters, though, again, the state-by-state model and interplay between special-purpose state banking licenses and federal privileges, like deposit insurance and Fed master accounts, remains unresolved.
Bankruptcy Trustee Makes Public Plea For Free Help To Untangle Synapse’s Complex Ledgers
Friday marked the first status hearing in Synapse’s bankruptcy since the appointment of former FDIC Chair Jelena McWilliams as Chapter 11 trustee.
The hearing largely covered information contained in the status report McWilliams filed with the court, with the key takeaways being:
The top priority is restoring end users’ access to their funds
Partner banks hold a total of about $180 million in cash of end user funds and reserve balances vs. an expected trial balance of $265 million — for a shortfall of $85 million
The cause of the shortfall, including whether movements of user funds and negative account balances increased or decreased shortfalls at each partner bank, is not known
Partner banks require substantial additional information to determine the amount of Synapse FBO funds held by each bank and the amount owed to each end user
The bankruptcy estate lacks funds to engage a third-party forensic audit firm or former Synapse employees to aid with reconciliation efforts
“We’re in unchartered territory… this is a serious situation and people are in crisis” — Synapse bankruptcy Judge Martin Barash
Of the four possible paths for funds held in FBO accounts, the general consensus of stakeholders and apparent recommendation of McWilliams was “option 3,” or partial payments to end users whose funds are in both reconciled and not-yet-reconciled FBO accounts.
American Bank supported the partial payment option, but noted it believes it is owed around $2.3 million in unsettled debit transactions from other partner banks.
The attorney for AMG Trust, however, expressed a preference for option 1 or 2, releasing full amounts due for funds in reconciled FBOs and either nothing or partial payments for funds in not-yet-reconciled FBOs.
The attorney for Lineage Bank told the court the bank’s position is that it should send the funds it holds — which account for around a third of known funds — to a custodian for Synapse Brokerage.
Evolve’s attorney did not speak in the hearing, but, per the status report, proposed two paths:
to have all partner banks consolidate Synapse Brokerage FBO funds into one account, and have the trustee or court determine the amounts to be paid to each fintech or end user; or
to allow the trustee or court to determine the amounts to be paid to each fintech or end user, based on the cash balances held by each partner bank, and have each partner bank make such payments — even if there is a shortfall
The partial payment option, McWilliams argued to the court, gets at least some relief to all end users.
Still, despite a seeming endorsement for the partial payout plan, there was no indication of if or when that might actually happen.
The bankruptcy estate’s lack of funds seemingly remains a barrier to quickly getting to a solution for end users.
In response to a question from Judge Barash, McWilliams told the court that the estate has had conversations with fintech programs about contributing funds to aid in its work. Similar conversations about contributing funds haven’t happened with banks, McWilliams said, as the bank partners are already contributing human capital and working around the clock on attempting to reconcile the accounts.
While it may not be obvious from the court filings and appearances, the interests of the four banks are not necessarily aligned here: they are implicitly arguing over who may be responsible for the apparent $85 million shortfall.
In the absence of funds for the bankruptcy estate to hire an external third party, McWilliams is relying on the banks to work together to complete the reconciliation necessary to get funds back to end users — but, this may not be the fastest path, as each bank maneuvers to minimize its own potential liability.
Proposed counsel for the Chapter 11 trustee, a Cravath colleague of Ms. McWilliams, told the court that what is really needed is an independent third-party investigation firm — but that the estate lacks the funding to pay for such services.
Instead, counsel for the trustee made a public plea, saying the trustee would welcome a “public-interest minded” firm that is capable of doing the work and willing to do so on an “uncertain” payment basis.
Other Good Reads & Listens
The strange tale of a $457 million deposit, 100 million masks from China, and one tiny bank (Semafor)
Regulatory Catch Up (Fintech Takes)
How do we fix issues that led to Synapse/Evolve? (Fintech Brainfood)
CFPB Launches Process to Recognize Open Banking Standards (CFPB)
Listen: The BaaS Bomb Drops & Synapse Bankruptcy (Breaking Banks)
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