Is Synapse's Meltdown Fintech's FTX Moment?
Desperate Users Beg Court For Help, Federal Reserve Says "Not My Problem"
Hey all, Jason here.
If any members of Congress (or their staffs), federal or state regulatory or law enforcement agencies, consumer advocacy groups, or press want a briefing on the ongoing Synapse/Evolve situation, in which as many as 10 million consumers and businesses have lost access to their funds, from an unbiased third-party, please reach out (jason@fintechbusinessweekly.com), and I am happy to arrange a time.
If you enjoy reading this newsletter each Sunday and find value in it, please consider supporting me (and finhealth non-profits!) by signing up for a paid subscription. It wouldn’t be possible to do what I do without the support of readers like you!Is Synapse's Meltdown Fintech's FTX Moment?
On Friday, there was another hearing regarding Synapse’s ongoing bankruptcy, ostensibly to rule on several matters: Synapse’s ability to use cash collateral to continue operating in Chapter 11, the US Trustee’s emergency motion seeking either to convert the case to a Chapter 7 liquidation or to appoint a Chapter 11 trustee, either of which would remove Synapse’s current management’s involvement, and an emergency motion from Evolve Bank & Trust seeking to restore its access to Synapse’s dashboard and permission to close all end-user accounts that remain at the bank.
But the more than five-hour long hearing meandered through numerous other topics, including heartbreaking stories from end users, who have seen their access to funds — in some cases, their entire life savings — caught up in the ongoing meltdown.
Attorneys for both Evolve and Lineage supported appointing a Chapter 11 trustee, which would technically allow Synapse to continue operating while the parties work to restore users’ access to funds, but would put the Synapse bankruptcy estate under the control of a trustee rather than Synapse’s current management.
American Bank, another Synapse partner institution, expressed a preference to continue operating in Chapter 11, either with or without a trustee being appointed.
The attorney representing TriplePoint, one the secured creditors, made the blunt argument that Synapse has no money, even if a trustee were appointed in Chapter 11, there are no funds to pay the trustee, and it is inevitable that the case will convert to a Chapter 7 liquidation at some point.
However, according to Synapse’s general counsel, fintech clients of Synapse have “gifted” the company money to enable it to continue operating in Chapter 11, on the condition that it not terminate the employees who are currently keeping the lights on, so to speak.
There was some discussion of whether or not these contributions from fintech clients are payments for services that would be subject to the cash collateral order, with TriplePoint and Silicon Valley Bank, the other secured creditor, arguing at one point in the hearing that they should be, which would require the secured creditors approving how Synapse uses those funds. (The irony of SVB, which itself went bankrupt last year in a bank failure that cost the FDIC $20 billion, potentially trying to impound these funds isn’t lost on me.)
However, numerous parties, including several fintech clients of Synapse, argued that the current management team has been working around the clock in an effort to resolve the situation and expressed concern that a conversion to a Chapter 7 liquidation or the appointment of a Chapter 11 trustee would slow progress on restoring users’ access funds, as any trustee stepping into that role would lack the necessary knowledge to resolve the situation in a timely manner.
Assistant US Attorney Elan Levey, a bankruptcy attorney at the Department of Justice, appearing at the request of the court, also provided an update on the judge’s request that she reach out to relevant federal regulators, and relayed the following on behalf of the Federal Reserve, Evolve’s primary regulator, which is worth reading in full (emphasis added):
The Federal Reserve understands that the debtor maintains relationships with various fintech platforms whose direct customers use these platforms to deposit funds. The Federal Reserve understands that the debtor has a deposit relationship with Evolve. The Fed is the primary federal banking agency responsible for the supervision and regulation of Evolve Bank.
In this role it conducts examinations of the bank and does so on a very regular basis to assess its safety and soundness and has the legal authority to address regulatory violations of the banking laws as appropriate.
The Federal Reserve does not though supervise or regulate fintech companies, such as the debtor, nor does it mediate or have the authority to mediate disputes among commercial entities.
The Federal Reserve understands that Evolve has filed a statement of possession here that hopes to address the events that caused certain end users to lose access to the funds that the debtor maintained at Evolve. The Federal Reserve is actively monitoring the situation and will help ensure that Evolve complies with all legal requirements related to the debtor’s accounts at Evolve, including any applicable consumer protection laws and is appropriately prioritizing this matter.
It is my understanding that the FDIC insurance is only available in the event of a bank failure. Lastly and importantly, the Federal Reserve only has supervisory or regulatory authority over state member banks such as Evolve and institution-affiliated parties of the bank. Thus to the extent the debtor has accounts at other banks, the Federal Reserve may not be the appropriate federal supervisor.
A representative for the California Department of Financial Protection and Innovation, the state’s financial services regulator, also briefly spoke at the hearing, relating that the agency is actively monitoring the situation and its impact on California consumers.
Users’ Heartbreaking Stories Illustrate Human Impact
Numerous end users of fintechs that have had their ability to access their funds frozen shared the devastating impact it has had on their lives with the court and the hundreds of attendees dialed in to the hearing.
One user, a single mom who had just bought a home, who may be unable to make her first mortgage payment due to the disruption, told the court, “I’m scared, I’m terrified. While they point fingers at each other, I just want to know, when I can pay my mortgage? That’s the only question I have for anybody involved in this situation.”
A user of Juno told the court their entire life savings was tied up, and expressed understandable frustration after contacting Evolve, Synapse, and Juno, with each party pointing fingers at the other with seemingly nothing getting done.
Users of Yotta took to social media, with equally harrowing stories. One user shared that they had to back out of buying a home, because their $8,000 for the downpayment was frozen in their Yotta account, and numerous users lamented incurring late fees or needing to take out loans or use credit cards, as they couldn’t access their funds.
End users lambasted the lack of communication about the devolving situation at Synapse from their respective fintech services in advance of the May 11th freeze, as well as abysmal customer service since then — though some praised the responsiveness and information Synapse’s customer service has been able to provide.
What’s Necessary To Resolve The Situation?
In an unexpected twist, Evolve’s Chief Technology Officer, W. Christopher Staab, took the stand and was sworn in to give testimony, facing questioning from Synapse’s attorney.
Staab testified that he worked with Synapse for a period of at least eight months as Synapse struggled to maintain the ledger for its brokerage program. Staab described the issues as stemming from how Synapse was calculating balances related to its sweep program, resulting in an inaccurate ledger and “material deficiencies” with the balances held at AMG, American, and Lineage.
As far as what’s necessary to resolve the current situation and either restore users’ access to or otherwise return their funds, Staab testified that Evolve would need the ledger data from Synapse and to assess its accuracy, settlement reports, and funding for the transactions.
He clarified that determining the accuracy of the ledger would involve looking at what has occurred since the last report Evolve received, on May 5th, to when payment processing was frozen, on May 11th, to examine the transactions, determine their legitimacy, assess the legitimacy of the balance, and to reconcile transactions that occurred during that timeframe.
For its part, Synapse said it has sent every fintech client and bank a final report of all end user balances as of the end of day on May 14th.
It remains unclear why Evolve lost access to the Synapse “dashboard,” which precipitated it freezing payment processing, in the first place.
Representatives for Synapse didn’t respond to questions whether the loss of access was some kind of technical error or if it had been done intentionally — and if so, why.
What’s Next In The Case?
Judge Martin R. Barash did make some limited rulings in Friday’s hearing.
Specifically, he granted in part and denied in part Evolve’s emergency motion. Barash ordered Synapse to restore and maintain Evolve’s access to its dashboard, if it has not already so, until further notice.
Barash also ordered Synapse to provide transaction and settlement reports requested by Evolve as soon as possible, if it has not already done so. He declined, however, to grant Evolve’s request for permission to close all DDA accounts that remain at the bank.
Judge Barash further ordered a “meet and confer,” an informal discussion between the parties, to be attended by counsel for and representatives of Synapse and Evolve with decision making authority and technical knowledge of the issues at hand.
Representatives for other banks, including Lineage, may but are not required to attend. The counsel for the US Trustee, the Assistant US Attorney, and any agreed to private mediator may also attend.
The judge declined to allow fintechs to participate, arguing it would be “too many cooks in the kitchen,” potentially impeding progress rather than helping.
The meet and confer will take place no later than Monday, May 20th, and the next public hearing is scheduled for next Friday, May 24th, at 8:00am PT.
Following Friday’s hearing, Evolve released a statement that said in part:
Judge Martin R. Barash’s remarks serve to validate what we have steadfastly asserted all along: Synapse’s abrupt shutdown of essential systems without notice and failure to provide necessary records needlessly jeopardized end users by hindering our ability to verify transactions, confirm end user balances, and comply with applicable law.
Synapse’s CEO Sankaet Pathak fired back, releasing his own statement, which says in part:
We are aware of the recent press release issued by Evolve Bank & Trust, which we believe contains several inaccuracies and misrepresentations regarding the court hearing and Judge Barash’s ruling…
Judge Barash’s ruling did not validate Evolve’s position as claimed in its press release. To the contrary, the Court ordered both parties to meet and confer to resolve depositors inability to access their funds currently in the custody of Evolve, clearly stating that he has made “no judgment as to who is to blame.”
Fallout For Banking-as-a-Service, Fintech Remains To Be Seen
The repercussions from the ongoing situation to the “partner banking” or banking-as-a-service operating model, specifically, and fintech ecosystem, in general, will likely reverberate for years.
It’s a bit easier to assess the impact on the players directly involved in this story.
While representatives for Synapse said there had been in influx of interest from potential buyers of the assets of the company, it seems far-fetched that such a deal could come together in a way and time that would meaningfully impact the current situation.
The outlook for fintech clients of Synapse seems fairly dire. Despite having ample warning of serious issues at Synapse and Evolve, which have been public for nearly 18 months at this point, they chose not to migrate to other providers or develop a reasonable business continuity plan.
Synapse’s fintech clients have likely irrevocably lost their end users’ trust. Some have already begun attempting to pivot their businesses as they navigate the fallout.
When it comes to Synapse’s banking partners, it is difficult to imagine they emerge unscathed. One, Lineage Bank, was already hit with a wide-ranging consent order from its primary regulator, the FDIC, stemming from its relationship with Synapse.
While Evolve has avoided a public enforcement action to date, it seems unlikely to be able to continue to do so, given the magnitude of the impact to end users from Synapse’s collapse.
The other direct bank partners, American Bank and AMG Trust, may have comparatively less exposure.
As far as the future of the partner banking / banking-as-a-service, the disorderly failure of Synapse and the impact on end users is likely to confirm policymakers’ and regulators’ worst fears about the operating model and fintech in general. While regulators have limited ability to outright prohibit partner banking models, they can make life more difficult for banks engaged in such practices.
For their part, middleware platforms, of which Synapse was one, have been tripping over themselves to re-characterize their model as providing software and services to banks to facilitate “direct” relationships between said banks and fintech partners. Time will tell whether or not reality matches the new talking points, and whether or not the new approach will withstand regulatory scrutiny.
Jason Henrichs, CEO of community bank group Alloy Labs, emphasized to Fintech Business Weekly that bank and VC “tourists” to the banking-as-a-service business model have underestimated the difficulty of doing it right, saying, “Too many programs, banks, and VCs got into the business not knowing this stuff is hard. Very hard. Very very hard. Too many banks think because they have a compliance department they are good at compliance. Doing [it] via a channel (or a channel to a channel) is infinitely complex.”
Asked about how the fallout from Synapse’s bankruptcy might impact venture investors’ appetite for fintech, Sardine’s Head of Strategy and Fintech Brainfood author Simon Taylor told Fintech Business Weekly, “The V in Venture stands for venture. It risks big failures. That’s par for the course. Only a bad VC would see this as a negative reflection on Fintech.”
Fintech Takes creator Alex Johnson pointed out that disclosures, even when compliant and legally accurate, may not mean much to end users, saying, “I think my biggest takeaway from all of this is that consumers don’t draw a meaningful distinction between fintechs and banks. You can say prominently in your website ‘Chime is a financial technology company, not a bank. Banking services are provided by the Bancorp Bank and Stride Bank, members FDIC’ but the only thing consumers are going to take from that is ‘this is built on banks and has FDIC insurance, it’s safe.’”
When it comes to fintech writ large, Synapse’s failure is a black eye for the entire industry, and risks giving critics ammunition to paint the industry with a broad brush — potentially unfairly punishing good actors who are striving to improve financial services for consumers and business alike through innovative technology like open banking, earned wage access, payroll data portability, credit scoring/cashflow-based underwriting, and numerous other areas. It is ultimately these companies that will end up doing penance for Synapse, Evolve, and others’ failures.
Have a tip about what’s happening in the Synapse case? Reach me on secure messaging app Signal at +1-316-512-1571.
CFPB Sues SoLo Funds For Deceiving Borrowers With “Tips,” “Dark Patterns”
Last week, the Consumer Financial Protection Bureau filed suit against unlicensed peer-to-peer payday lender SoLo Funds, alleging the company misrepresents the cost of loans it brokers, uses “digital dark patterns” to trick borrowers, makes false threats to collect money consumers do not owe, and creates a “social credit score” without proper safeguards.
The company, which counts accelerator Techstars and tennis legend Serena Williams’ venture fund as investors, has received glowing coverage in outlets like American Banker, Bloomberg, Banking Dive, Business Insider, Fast Company, was admitted to Visa’s Fast Track program, and was named to CNBC’s “Disruptor 50” list last year.
It’s even certified as a so-called “Public Benefit Corporation,” which is suppose to accredit companies’ positive efforts and impact in areas like corporate governance, customers, and community.
But the problems with SoLo Funds, which, until recently, partnered with Synapse and Evolve Bank and Trust to operate its business, have been well known since at least 2021, when Fintech Business Weekly analyzed the company’s model, which relies on customers paying “tips” and “donations” on small loans that can be equivalent to APRs as high as 4,280%.
Further, the company then and still lacks the appropriate licenses for the business it’s conducting, including lending and/or broker licenses, debt collection licenses, and permission to operate as a consumer reporting agency.
State and local regulators, including in California, Minnesota, Connecticut, and Washington, DC, have taken action against the company.
The CFPB’s suit alleges that SoLo Funds violated the CFPA by:
deceptively marketing its loans as “no interest,” “0% APR,” and “0% interest.” Through 2022, 99.5% of SoLo Funds users paid a tip and/or donation when taking a loan, according to the CFPB.
providing deceptive TILA disclosures
engaging in the abusive act of obscuring the option not to pay a “donation,” by making it overly burdensome to find the option not to donate when requesting a loan
engaging in deceptive, unfair, and abusive practices by collecting or attempting to collecting amounts consumers did not owe, as loans in certain states that violated state licensing and/or usury laws are void and unenforceable (a legal argument I coincidentally raised in regards to SoLo Funds the day before the CFPB’s suit was filed)
engaging in deceptive practices, by falsely threatening to report negative information to credit bureaus
through its violation of the the Fair Credit Reporting Act (FCRA), by not following reasonable procedures to ensure the consumer reports SoLo Funds assembled and referred to as users’ “SoLo Scores” are accurate
The CFPB is seeking:
to permanently enjoin SoLo Funds from committing future violations of the CFPA, FCRA, and any other provision of Federal consumer financial law
granting additional injunctive relief as the court may deem necessary
awarding monetary relief against SoLo Funds, including restitution, refunds, disgorgement or compensation for unjust enrichment, and payment of damages
awarding a civil monetary penalty
awarding costs against SoLo Funds
awarding additional relief as the court deems is just and proper
SoLo Funds cofounder and CEO Travis Holoway claimed to be blindsided by the suit, telling PYMNTS:
“As a new model, SoLo has diligently followed the rules, engaging with leading legal counsel and approaching regulators requesting collaboration since its inception. SoLo Funds has been voluntarily working with the CFPB for the last 18 months, attempting to work toward a regulatory framework that maintains its affordability for Americans. We had primarily agreed on a path forward last night, and unbeknownst to us, we were blindsided this morning with a suit.”
It’s difficult to reconcile Holoway’s statement that “SoLo has diligently followed the rules,” given the numerous state and local actions against the company to date.
Ultimately, in some regards, the CFPB’s suit may be moot — SoLo Funds’ service has been unusable for many consumers for nearly a month now, after the company appears to have botched a transition from working with now-bankrupt Synapse and Evolve Bank to middleware provider Treasury Prime and Bangor Savings Bank.
Other Good Reads
“There’s A Bank Run That's Going To Happen,” Synapse CEO Says In Leaked Internal Meeting (Fintech Business Weekly)
An Open Letter to CFPB Director Rohit Chopra (Patrick Spaulding Ryan)
Foolish Fintech Questions: Part III (Fintech Takes)
The Rise and Fall of Banking-as-a-Service (Net Interest, paywalled)
Visa Expands The Payment Pipe (Noyes Payments Blog, paywalled)
Federal Regulators Won’t Rescue Thousands Of “Depositors” Caught In Synapse Bankruptcy (Forbes, paywalled)
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