Synapse Now Seeking More Than $30M From Mercury, New Court Filing Reveals
Synapse Now Seeking More Than $30M From Mercury, New Court Filing Reveals
Synapse And Its Fintech Clients Automatically Converting Some Users To Brokerage Accounts
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Synapse Now Seeking More Than $30M From Mercury, New Court Filing Reveals
New year, same BaaS drama. With the messy unwinding of Synapse’s relationship with key bank partner Evolve Bank & Trust, activist shareholders’ ouster of Lineage’s board of directors and executive management, Mercury’s arbitration claim and lawsuit against Synapse, and a sense that more public bank enforcement actions are a matter of when, not if, there is a distinct feeling of waiting for the other shoe to drop.
While Synapse’s promised countersuit against Mercury has yet to appear, the company did file a response last week to Mercury’s request to seal or redact significant portions of the dispute between the two companies.
Synapse’s response argues the public has a right to know the facts of the case — and says that Synapse is seeking “an amount exceeding $30 million” from Mercury for breach of contract and fraud (emphasis added):
It is important for the public to know that Synapse not only denies Mercury’s claims and has strong factual and legal arguments against them, but also that Synapse has its own claims against Mercury for breach of contract and fraud through which Synapse seeks to recover an amount exceeding $30 million. Mercury has failed to provide any specific facts to support the sealing of any part of this proceeding, let alone the sweeping sealing order Mercury requests. Mercury’s Motion to Seal is without merit and should be denied…
The filing did not have any additional context on Synapse’s allegations of breach of contract and fraud. Ask about the claims, company CEO Sankaet Pathak said via email that Synapse had filed a counterclaim against Mercury as part of the private arbitration process its former client kicked off last December.
Asked about Synapse’s breach of contract and fraud claims, a Mercury spokesperson told Fintech Business Weekly, “From the beginning, our intention has been to resolve this contractual dispute through the legal process while respecting both parties’ confidentiality. We’re not going to comment extensively on ongoing litigation, but we disagree with the assertions and intend to make our case in court, not in public.”
Chaotic Situation Forces Fintech Clients To Navigate Disruptions, Look For Backup Plans
At present, around 30 fintechs list disclosures on their websites that indicate they are currently or were previously clients of Synapse. Not all of the companies currently allow users to open new accounts.
The unfolding situation with Synapse is forcing some fintech clients to quickly figure out a Plan B — and how to navigate significant disruptions to end users.
Customers of one Synapse client fintech, which provides a platform for businesses to manage and pay contractors, faced delays in paying 1099 employees shortly before Christmas, as funds held at Lineage, which Synapse uses for ACH processing, were not adequate to cover the company’s disbursements.
Longtime Synapse client Yotta, a neobank whose initial business model focused on encouraging responsible spending and savings habits with prize-linked behavioral techniques, has transitioned to opening new user accounts at Thread Bank via Synapse-competitor Unit.
Based on user-facing disclosures, most Synapse clients — though not all — that offer a checking/spending account appear to be somewhere in the process of transitioning to offering brokerage accounts with a cash management feature via Synapse’s brokerage subsidiary.
Some Synapse clients’ sites and apps continue to include terms and agreements specifying that a user is opening a demand deposit account at Evolve, though it isn’t clear if this is actually what is happening on the backend. A representative for Evolve didn’t respond to questions for this piece, including whether or not any Synapse clients remain live on Evolve.
Some Synapse clients have users simultaneously agree to terms for both a DDA at Evolve and a brokerage account at Synapse, in an onboarding process that is likely to confuse users about what they’re actually signing up for:
Synapse & Partner Fintechs Automatically Converting Users’ Deposit Accounts To Brokerage Accounts, Unless They Opt Out
Synapse announced its “Global Cash” offering, built on top of its own broker-dealer license, in May 2022. Rather than a technology layer to facilitate fintechs integrating with underlying bank partners to offer traditional “checking” (demand deposit) accounts, with the new structure, fintechs and their end users would only have a direct relationship with Synapse’s brokerage entity and have no direct relationship with underlying bank partners.
End users open a brokerage account at Synapse with a cash management feature, where Synapse is responsible for sweeping funds to its partner banks.
There’s nothing wrong with this structure per se — established brokerages like Fidelity and neobrokers like Robinhood have similar offerings. Robinhood memorably called its offering a “checking” account and had to quickly backpedal after regulators began asking questions.
However, in Synapse’s case, there are reasons to be skeptical about the company’s ability to operate the structure in a safe, sound, and compliant manner.
Synapse itself has acknowledged a shortfall of over $13 million in end user funds, admitted to erroneously taking $3.25 million from customer FBO accounts — an amount it couldn’t fully repay as of October 2023, has had ongoing “reconciliation challenges” with Evolve, and is embroiled in a tit-for-tat arbitration and legal dispute with its former largest customer, Mercury.
Leaked communications between Synapse and Evolve memorably described the scale of the reconciliation problems as potentially “truly astonishing,” with one Evolve employee saying reported balances from Synapse vs. what was actually held in Evolve FBOs “tend to differ a couple hundred million on the daily.”
The brokerage/cash management structure entrusts Synapse with even great control over fintech programs and end user funds. While Synapse still works with external bank partners, like AMG and Lineage, to hold cash management funds and process payments, those banks do not have any direct relationship with Synapse’s fintech clients or with end users. The CMA structure arguably has even less oversight and visibility than the previous Evolve-powered DDA model.
If fintechs and end users have less visibility about who is holding their funds, the inverse is true as well: the banks holding swept brokerage funds and processing payments also have less visibility into the source of these funds or business purposes (and risk levels) of transactions.
The lack of visibility may obscure the level of risk of some of the clients leveraging Synapse’s brokerage account/cash management structure — making it difficult for banks holding funds or processing transactions to ensure they have adequate compliance controls in place.
For instance, several fintech clients that use the CMA structure appear to offer consumer and business accounts to US non-residents in countries that include India, Brazil, Mexico, Colombia, Argentina, and numerous others:
Latitud, which, like Synapse, is backed by Andreessen Horowitz (a16z), aims to be an “operating system” for LatAm-based fintechs.
The startup helps LatAm based companies set up corporate structures designed to be appealing to foreign VC investors, including the so-called “Caymans Sandwich,” in which a Cayman Island-based holding company owns a Delaware LLC, which owns a country-specific operating company, or a “Delaware Tostada,” where a Delaware LLC owns a local country operating company.
Latitud also offers business financial accounts to LatAm startups, touting them as a great solution for offshore structures, including specifically mentioning Caymans-based entities.
The Cayman Islands boasts robust bank secrecy laws and a zero-tax regime. Due to its elevated financial crime risk, the Cayman Islands were placed on the FATF’s “grey list” in February 2021. The country remediated the three action points that landed it in the penalty box and came off the grey list in October 2023.
Latitud’s site describes its accounts as being offered “only” with “chartered banks” and as offering up to $5 million in FDIC coverage — but, although the company’s terms repeatedly refer to users’ “Bank Account,” based on disclosures on the site, Latitud is actually offering a Synapse brokerage account with a cash management feature, not a bank account.
And as of October 24, 2023, Synapse only has a maximum of 14 program banks, for a hypothetical maximum of $3.5 million in deposit coverage. Such coverage would only apply once funds were placed with sweep partner banks and would only protect end user funds in the event an insured depository institution failed — not in the event Synapse or Synapse’s brokerage entity were to fail or face a shortfall in funds.
While the brokerage/cash management structure itself is defensible, it raises novel risks that Synapse, its banks, and its fintech clients need to be aware of in order to mitigate appropriately.
Fintech clients building on this structure need to have an adequate understanding of what the product they’re offering is (and isn’t), in order to market it in a way that isn’t misleading. Calling the offering “banking” or a “bank” or “checking” account risks misleading users about material attributes of the product or service. Claims about when and how much insurance coverage apply, both FDIC and SIPC, should be aligned with the actual operating structure and any requirements, risks, or limitations should be clearly disclosed to end users.
For bank partners, whether those holding funds swept from brokerage accounts or processing payments, there are risks in the reduced visibility they have into whom they are holding funds or processing transactions for — primarily BSA/AML-related, which is an area regulators have recently zeroed in on in banking-as-a-service relationships.
Synapse has previously argued to bank partners that its brokerage entity is the bank’s customer, and thus bank partners shouldn’t need to review or sign off on new fintech clients.
But the result could be that Synapse’s remaining direct bank partners — Lineage, AMG, and American Bank — end up holding funds or processing payments for higher-risk end customers, including, for example, foreign/non-resident business entities incorporated and/or operating in higher-risk jurisdictions.
Forced CMA Conversion Poses UDAAP, Reg E Risks
In addition to potential risks of the CMA structure itself, how some Synapse clients are moving customers from the prior model, where users signed agreements for DDAs at Evolve, to the new structure poses additional risks.
At least two Synapse clients — kids’ spending account and investing startup Copper and aforementioned prize-linked savings/spending account Yotta — have, essentially, forcibly transitioned users to the CMA structure, opening brokerage accounts on their behalf and moving funds unless they explicitly opted out.
In early October, Yotta emailed its customers, informing them that, “to improve the functionality of the Platform,” it would automatically open accounts with Synapse Brokerage and opt them in to the cash management feature, unless they contacted the company via email to opt out.
The notice also informed users that, after the effective date, any deposits they made to and any funds held in their DDA would automatically be moved to the brokerage account opened in their name.
Copper sent a largely similar notice to its users, with an effective date of November 21, 2023:
It’s understandable why Synapse’s fintech clients would want to transition users’ accounts and funds on an opt out basis: to reduce user churn.
Opening a new brokerage account on a user’s behalf without their explicit consent carries UDAAP risk.
Indeed, Finra’s guidelines discourage use of such “negative response” notifications when transferring a user’s existing brokerage account to a new provider, saying, Finra “staff generally believes that a customer should affirmatively consent to the transfer of his or her account to another firm.”
In the case of Synapse and its fintech clients, they’re opening an entirely different kind of account vs. what users were marketed and initially signed up for.
Forcibly moving user funds from a bank-held DDA to Synapse’s brokerage, absent user opt out, likely carries EFTA/Reg E risk, as it does not appear users are affirmatively authorizing such electronic funds transfers.
Synapse Appears To Lend In Some States Without Appropriate Licenses
An element of the unfolding Synapse story that has received scant scrutiny is its lending entity, Synapse Credit LLC, which holds state-issued lending licenses.
Only a handful of companies appear to have ever built anything on top of Synapse’s credit capabilities — primarily credit builder loans and secured credit/charge card offerings.
While, according to Synapse’s website, the company holds about 30 state lending licenses, it doesn’t hold licenses in key states, like Illinois, Texas, New York, New Jersey, and Virginia — claiming those are “states that do not require a license.” These states do, in fact, generally require lending licenses and have specific regulations defining permissible credit products in their states.
Synapse actually had renewal of its lending license in Connecticut refused, because the company was unable to provide audited financial statements, as required by the regulator to hold a lending license in the state.
In fact, last week, I was able to sign up for a $500 credit building loan — where, according to the current terms and conditions, the funds are purportedly held in a reserve account at Evolve Bank & Trust — using my Illinois address. Lending in the state is highly regulated and does normally require a lending license.
In addition to the licensing issue, it isn’t clear what source of capital Synapse is leveraging to fund loans it is making. The company has never publicly announced a debt facility, which would be necessary to scale its lending to any material volume.
A source with firsthand knowledge of Evolve and Synapse’s relationship described the agreement between the two as giving Synapse the “authority to rehypothecate” funds for yield generation purposes, which could have included using customer deposits for lending.
The most recent Evolve DDA agreement visible on Synapse’s website, revision dated October 2022, includes a clause, 6.2 Sub-Deposit Accounts, which states in part (spacing adjusted and emphasis added):
…you acknowledge and agree that the funds deposited in your Account and transferred to the Sub-Deposit Account may be used by us and/or each Insured Depository Institution as a source of funding and for investment; provided, however, we will only invest such funds in certain securities, equities and debt (e.g., U.S. Treasury Bills, U.S. or state issued or guaranteed securities, corporate bonds, mutual funds, exchange traded funds, etc.) or any other investments or assets permitted by applicable law.
For the avoidance of doubt and notwithstanding any other provision herein, Bank and each Insured Depository Institution intend to (and you authorize each such party to) use deposits in the Account and/or Sub-Deposit Account each such party holds to fund current and new businesses, including lending activities and investments
Legal experts who reviewed the document generally agreed that while it gave Evolve the right to use customer deposits, it didn’t necessarily give Synapse that right — though Synapse does have the right to act as “agent” of the bank in some capacities, and at least one version of the agreement defines “we,” “us,” and “our” to include both Evolve and Synapse.
Beyond the customer-facing DDA, it’s unknown what kinds of arrangements existed directly between Synapse and Evolve. The same source that said Synapse had the right to rehypothecate user deposits to generate yield also argued Evolve had virtually no visibility into what Synapse was doing, saying, “it was entirely obscure from Evolve’s side,” and that Synapse could have “done whatever they wanted” and Evolve wouldn’t have anyway to know, absent Synapse’s own disclosure.
Asked if Synapse had ever “rehypothecated” or leveraged user deposits to offer credit, Synapse CEO Pathak said via email, “No. Our loans are secured by either the end user reserves or by platform reserves. We currently do not take any capital risk. Some customers do bring in capital facilities as well, but they still have to be in the platform reserves.”
When it comes to running credit products, Synapse seems to have struggled with some of the finer points, like furnishing accurate data to credit bureaus.
In the brief time Synapse powered a kind of synthetic credit card/credit builder for Yotta — which was confusingly structured as a Synapse-issued line of credit drawn through an affiliated card — the offering generated numerous user complaints. Yotta describes the product as a “credit card,” that offers “up to 100% cash back,” and apparently told users it would be reported to credit bureaus as a “loan,” rather than as a revolving card, in order to boost their credit history.
Numerous users complained about Synapse furnishing inaccurate data to their credit reports — including one user that had a high balance of $16 million for their Yotta card reported to the bureaus.
Tally Shuts Some User Accounts With No Warning
Tally, which offers users tools to automate repaying credit card debt and offers a line of credit that can be used for debt consolidation, abruptly closed some users accounts late last year with little to no warning, Alex Johnson reported last week in his Fintech Takes newsletter.
The account closures caused some users significant hardship because of the nature and structure of Tally’s product: users can link their credit cards to Tally, make a single payment to Tally, and Tally intelligently and automatically posts payments to their cards.
Because of the line of credit and debt consolidation component, some users end up revolving a balance on Tally as well as continuing to carry a balance on their credit cards.
Some users who were informed that Tally would cease making payments on their behalf “effective immediately” had to resume payments to their credit cards that they hadn’t necessarily planned on or budgeted for and continue to pay on any debt they owed to Tally — causing some users significant hardship, based on numerous complaints on review sites and social media.
In communications to impacted users, Tally abdicated its responsibility, describing the situation as “beyond [their] control” and blaming an unnamed investor.
Presumably, an arrangement Tally had with a debt provider aligned with a specific credit box, for one reason or another, was terminated. Why Tally wasn’t able to give more timely notice to its users is a mystery.
I should also note I initially incorrectly described the situation as a “disorderly fintech failure” in a post on X — while an unknown number of users were impacted, it does not appear that the company itself is shutting down.
Representatives for Tally did not reply to a request for comment on the matter.
Republicans & Democrats Send Dueling Letters Asking CFPB For More Info On Proposed Wallet Rule
Late last year, the CFPB proposed a rule that would define and require “larger participants” in “general-use digital consumer payment applications,” commonly referred to as digital wallets, to submit to supervision by the Bureau.
The proposed rule would define nonbank covered persons as “larger participants” subject to supervision if they operate a digital wallet with an annual volume of at least five million consumer payments.
The relatively low threshold would bring not just payment apps, like Venmo, Cash App, PayPal, and Apple and Google Pay, under the Bureau’s supervision — but, potentially, also include retailers that offer payment wallets, including household names like Walmart and Starbucks.
Numerous trade groups submitted comment letters, with feedback generally critical of what many organizations argued was a rushed process that failed to take into account numerous complex issues or provide a meaningful cost-benefit analysis of the proposed rule’s potential impact on payments markets.
Congress also weighed in, with Republicans and Democrats separately filing comment letters last week.
The Democrat’s comment letter argued there was significant confusion about which markets would be covered and what risks the CFPB is attempting to mitigate. The letter requested the Bureau to provide greater specificity about the market and types of products it is seeking to regulate and to extend the deadline for larger participants to provide comments.
By comparison, Republican’s comment letter flagged concerns about the proposed rule’s impact on the ability of nonbank firms to develop and offer innovative products. The letter also raised concerns that the proposed rule’s scope isn’t clearly delineated, and could unintentionally impact small businesses that use third-party point of sale technology. Finally, Republicans flagged likely costs businesses would incur to comply with any new rules and whether or not the rule would apply to digital asset wallets.
Fiserv To Seek Georgia Limited-Purpose Bank Charter For Merchant Acquiring
They say there are really only two business models: unbundling and re-bundling.
Appears that Fiserv is pursuing the latter, looking to more tightly vertically integrate by applying for a limited purpose bank charter for merchant acquiring.
Reports circulated on social media last week that the core bank and payment processing provider had sent email communications to customers announcing the plan.
Friday, Payments Dive confirmed those reports, with a Fiserv spokesperson telling the outlet, “We are taking this step in response to recent market changes, as third-party financial institutions that have traditionally provided access to the card networks as sponsor banks increasingly focus on other areas of their business.”
Per Payments Dive, Fiserv was the largest non-bank merchant acquirer in 2022. Insourcing by acquiring its own limited bank charter could enable Fiserv to better compete with the largest merchant acquirer: behemoth JPMorgan Chase. The bank designation would allow Fiserv direct access to card networks without partnering with a third-party bank.
The Georgia special purpose charter was created in 2012, but no organization currently holds such a charter.
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Other Good Reads
Basel Proposal Violates The Law (Bank Policy Institute)
The (Unlikely) End Of The FICO Score (Fintech Takes)
How B2B Fintech Is Building A Deconstructed Silicon Valley Bank (Fintech Brainfood)
Tokenized Deposits: How I Learned To Stop Worrying And Love Stablecoins (Todd Phillips)
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