"There's A Bank Run That's Going To Happen," Synapse CEO Says In Leaked Internal Meeting
Synapse Has "Grossly Mismanaged" Bankruptcy Estate, US Trustee Says In Emergency Filing
Hey all, Jason here.
It brings me no joy to write this emergency update today, but, I figured it was worth providing some brief additional details in advance of this morning’s court hearing in Synapse’s ongoing bankruptcy case.
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!Synapse CEO Says “There Is A Bank Run That’s Going To Happen” In Leaked Recording Of Internal Meeting
In a leaked recording of an internal meeting, obtained exclusively by Fintech Business Weekly, Synapse CEO Sankaet Pathak suggests that Evolve would face a “bank run,” were it to unfreeze fintech programs and end user accounts.
In response to an employee question about how quickly end users might regain access to their funds in order to meet pressing financial obligations, Pathak said, “Right now, Evolve’s completely shut down all access, and I think we all know why, because there’s a shortfall and they know that as soon as they turn on access, there is a bank run that’s going to happen.”
Evolve did not respond to questions about if it is concerned about the possibility of a bank run and what steps, if any, it has taken to mitigate the risk of such a scenario.
(To be clear, Evolve is well capitalized, I think the likelihood of a such a bank run is de minimis, and it is arguably irresponsible of Pathak to speculate about such a scenario, even in an internal meeting.)
Evolve did, however, provide an update to the bankruptcy court in a filing yesterday, May 16th, in advance of this morning’s hearing.
In Evolve’s statement, it reiterates that Synapse’s “unilateral decision on the morning of Saturday, May 11, 2024 to revoke Evolve’s access to the Dashboard” presented the bank with two options (per the filing):
(i) continuing to process payments with no ability to determine whether a transaction was authorized or fraudulent, view the actual balance within an individual account to determine whether there were adequate funds, or to perform legally-required transaction monitoring for irregular, fraudulent, unauthorized, or unlawful conduct, or
(ii) freezing account activity pending system restoration, validation, transaction reconciliation and settlement funding.
Evolve determined, per applicable law and its obligations to end users, the only viable option was to freeze account activity, which it did so on May 11th at 2:47pm, after notifying Synapse and affected fintech platforms. Notably, the freeze does not apply to the sweep account holding funds related to Synapse’s brokerage entity, Synapse Brokerage LLC.
The filing continues to explain that, when Evolve and Synapse’s contract ended on September 29th, 2023, the program entered a “wind down” phase, during which Synapse “began migrating Platforms and their End Users from the Evolve Program to a cash management program offered through the Debtor’s licensed broker-dealer subsidiary, Synapse Brokerage.”
According to Evolve, “the funds belonging to the Platform’s End Users, which had been held in Evolve DDAs, were transferred by Synapse from the FBO accounts at Evolve to Synapse Brokerage. Evolve had no role in the creation of, or migration of Platforms to, the Synapse Brokerage Program, beyond executing the payment instructions that Synapse provided as part of their fiduciary responsibility overseeing the program.”
The primary custodian of end user funds for the Synapse Brokerage program and the cash management accounts it offers is AMG National Trust — suggesting that, as Synapse transitioned fintech programs and their end users from Evolve DDAs (“checking accounts”) to Synapse Brokerage accounts, Synapse presumably moved end user funds from Evolve to AMG.
Evolve is not a program bank for Synapse Brokerage, though it did continue to operate as a receiving depository financial institution (RDFI) for incoming ACH transactions and handled debit and credit card issuing for fintech programs operating via Synapse’s brokerage entity. Lineage acted as the originating depository financial institution (ODFI) for ACH transactions, until it terminated these services on May 9th.
While Evolve’s filing confirms that Synapse has restored most access to the so-called “Dashboard,” it says that a key portion of the system that provides end user account statements remains inaccessible and that, without access, Evolve cannot validate end user account balances.
Evolve Tries To Shift The Spotlight To Synapse Brokerage, AMG National Trust
Evolve’s filing attempts to shift the focus to Synapse’s brokerage entity, the brokerage’s custodian, AMG, and the sweep network operator, the American Deposit Management Company (“ADMC” as seen in the diagram above).
But there are legitimate questions about whether end users were even aware and properly consented to the opening of an account in their name at Synapse Brokerage and authorized the transfer of funds from an Evolve DDA to Synapse Brokerage.
At least three Synapse programs — Yotta, Juno, and Copper — automatically opened accounts in users’ names and moved funds from Evolve to Synapse Brokerage, unless users emailed Synapse to opt out:
Communications to end users actually characterized this as an improvement. For example, Juno’s email to end users said in part (emphasis added):
To enhance your financial experience, we are making some important changes. This will help improve the functionality of the platform including the potential to provide enhanced FDIC Insurance coverage on balances up to $500,000. This change comes at no additional fee to you. No actions by you are necessary at this time.
To emphasize, unless end users specifically contacted Synapse, a company they had likely never heard of, to opt out, their demand deposit account (“checking account”) at Evolve, an FDIC-insured bank, would functionally be replaced with a brokerage account at Synapse Brokerage LLC, with cash held by Synapse’s custodian.
This is, to put it bluntly, not what end users signed up for.
To date, no one is really representing the end users’ interests in the bankruptcy proceedings — the closest is the fintech platforms.
But it is these very platforms, in at least some cases, that agreed to and helped implement the conversion of end users’ DDAs at Evolve to brokerage accounts at Synapse and the transfer of end user funds.
Admitting this may have been done improperly and without necessary end user consent is an argument the fintech platforms themselves are unlikely to raise in the bankruptcy, as it exposes them to potential liability.
US Trustee Seeks To Convert Case To Chapter 7 Liquidation Or Appoint A Chapter 11 Trustee, Saying Synapse Has “Grossly Mismanaged” Estate
In a scathing filing on Wednesday, to be addressed at this morning’s hearing, the US Trustee asked the bankruptcy court either to convert the case to a Chapter 7 liquidation or to appoint a Chapter 11 trustee, arguing that Synapse, as debtor-in-possession, “has grossly mismanaged the estate and there is substantial and continuing loss to or diminution of the estate and an absence of a reasonable likelihood of reorganization.”
The trustee argues that Synapse terminating Evolve’s access to its systems constitutes “gross mismanagement,” saying that Synapse “inexplicably cut off access to its computer systems on a weekend,” which “played a material role in end users losing access to their funds.”
The filing goes on to say that “[a]t a minimum, an independent fiduciary is needed to see if a resolution can be reached that minimizes further harm to depositors.”
The conversion to a Chapter 7 liquidation or the appointment of a Chapter 11 trustee would remove Synapse management from ongoing decision making and instead put a US Trustee in charge.
In a creditor committee meeting on Wednesday, attorneys for Synapse suggested the possibility of Synapse’s fintech clients contributing funds to allow the company to continue operating in Chapter 11 — presumably in the hopes of quickly restoring end user access to funds.
But, given Evolve’s posture and the complexity of the work necessary to release end user funds — a full reconciliation between Synapse’s records and the actual cash balances — it seems unlikely that buying another week or two would be adequate to resolve the situation.
What’s Next?
It’s worth remembering there are real, everyday people on the other end of this — approximately 100 fintechs with 10 million end users, according to documents Synapse filed earlier in the bankruptcy — including end users who used the services as their primary and only bank account or for their children’s savings, as this Copper customer did:
A hearing is scheduled for 9:00am PT this morning to address Synapse’s motions regarding use of cash collateral, Evolve’s emergency motion requesting restoration of access to Synapse’s “dashboard,” and the US Trustee’s emergency motion to either convert the case to Chapter 7 or to appoint a trustee.