ZELF, Evolve's Latest Headache, Reveals Stunning Gaps In Its Controls
CFPB Digest: Nexo, Cash App, SCRA; Adam Neumann Does Fintech
Hey all, Jason here.
I enjoyed the couple of days I was able to spend in Saudi — despite some notable differences in the financial services landscape (Sharia-compliant products), there were more similarities than differences: lots of discussion of the opportunities presented by open banking, instant payments, the viability of BNPL, and the future of crypto and blockchain.
That was my last work-related trip from the year — I’m looking forward to a hopefully slower end of the year!
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CFPB Digest: Nexo, Cash App, SCRA
Last week, the CFPB revealed its first inquiry into a crypto company in a filing regarding an ongoing investigation into Nexo Financial.
According to the filing, the CFPB began its investigation to determine (spacing adjusted):
“(1) whether subject entities were engaged in conduct that is subject to federal consumer financial law (specifically, the Consumer Financial Protection Act and Regulation E, which implements the Electronic Fund Transfer Act);
(2) whether those entities had violated the CFPA and Regulation E; and
(3) whether a Bureau enforcement action would be in the public interest.”
The inquiry dates to last December, when the CFPB sent the company a civil investigative demand (CID). At that time, Nexo offered a number of products, including interest-earning crypto products and lines of credit.
After several meetings in late 2021 and early 2022, Nexo petitioned to modify the bureau’s CID.
Specifically, Nexo wanted the CFPB to exclude its “Earn Interest Product” from the scope of the CID. The company argued the CFPB lacked jurisdiction over it because another regulator, the SEC, “believes interest-bearing crypto lending products are securities,” and thus any examination of the product would fall under the SEC’s and not the CFPB’s authority.
While Nexo illustrated its argument by pointing to the SEC’s order on BlockFi’s similarly structured product, it did not state that the SEC had actually determined that Nexo’s Earn Interest Product is a security nor did Nexo concede that it was — talk about trying to have it both ways.
Unsurprisingly, the CFPB denied Nexo’s request to narrow the scope of the CID.
The CFPB isn’t the only one interested in Nexo’s activities. Eight state securities regulators, including in California and New York, filed suit against Nexo in September, arguing its interest-bearing accounts constitute unregistered securities. Companies offering similar products, like now-bankrupt Celsius and BlockFi, faced similar legal challenges.
As a result, earlier this month, the company decided to wind down its US operations, saying in a blog post:
“It is now unfortunately clear to us that despite rhetoric to the contrary, the US refuses to provide a path forward for enabling blockchain businesses and we cannot give our customers confidence that regulators are focused on their best interests.”
Judge Tells Cash App To Comply With CID by Jan 5
Block has been slow-walking responses to what is now a two-year-old inquiry into whether its Cash App unit has deprived users of access to their funds or failed to adequately manage fraud and errors on its platform.
Now, a judge has ordered the company to comply with the CFPB’s civil investigative demand no later than January 5th.
While Zelle has been the primary target of legislators and regulators in recent months, the frequency of transaction disputes is actually significantly higher on non-bank networks. According to the Bank Policy Institute, PayPal has triple the rate of disputes vs. Zelle, and Cash App’s rate is six times higher.
The Electronic Funds Transfer Act (EFTA) and its implementing rules, known as Reg E, protect users from unauthorized transactions — but the fraud that has become pervasive in peer-to-peer payments apps typically relies on tricking users into making transactions voluntarily. Banks and the payment apps argue this means the transactions are, in fact, “authorized,” and thus the companies don’t have any liability or requirement to reimburse customers.
Servicemembers Civil Relief Act: Report
The Servicemembers Civil Relief Act (SCRA) is one of those peculiar pieces of American regulation, like its sibling, the Military Lending Act, that even many in financial services aren’t aware of or don’t understand the implications of.
The act is intended to provide certain benefits and protections to members of the military when they’re deployed to active duty, including:
“the ability to reduce the interest rate on any pre-service obligations or liabilities to a maximum of 6 percent; protections against repossession of certain property without a court order; protections against default judgments in civil cases; protections against certain home foreclosures without a court order; and the ability to terminate certain residential housing and automobile leases early without penalty.”
Last week, the CFPB released a report analyzing usage of SCRA benefits, specifically interest rate reduction and protection from repossession, and making a set of recommendations for how lenders can improve access for eligible servicemembers.
The report found that shockingly few servicemembers eligible for interest rate reductions actually take advantage of the benefit — less than 10% do so for auto loans and about 6% for personal loans in the period from 2007 to 2018. The missed opportunity to reduce interest rates represents about $100 million in foregone savings during that period, according to the bureau’s analysis.
The report makes three key recommendations to boost access to SCRA protections for eligible servicemembers:
Apply SCRA interest rate reductions for all accounts held at an institution if a servicemember invokes protections for a single account.
Explore ways to automatically apply SCRA interest rate protections.
Develop comprehensive and periodic indicators of SCRA benefit utilization.
Evolve Abruptly Shuts Down “Anonymous” “Bank of the Metaverse” Startup ZELF Just One Day After Official Launch
Last week’s newsletter took a deep-dive on some of Evolve’s problematic fintech and crypto partners, including a brief mention of ZELF, which refers to itself as “Bank of the Metaverse.”
ZELF enables users to hold US dollars in a typical checking account opened for them at Evolve via BaaS platform Solid; it also lets users deposit crypto, NFTs, and “game loot,” and convert these into dollars. Alex Johnson at Fintech Takes has an excellent analysis of the product and additional context on prior iterations here.
According to ZELF’s press release last week (emphasis added):
“Payment privacy and security is a major concern for many people, especially when it comes to making purchases online. ZELF is solving this problem by allowing users to open a USD checking account without any identity verification, only requiring their name, email, and phone number. This means that customers are not required to provide any personal information, such as document scans, proof of address, or social security numbers. Within 30 seconds, ZELF opens a checking account and a virtual debit card that works with Apple Pay and Google Pay, both online and offline.
ZELF offers users the ability to recharge their accounts with traditional ACH and wire transfers, as well as incoming crypto payments. Currently, deposits in USDC, USDT, and ETH are supported”
Last Thursday, the company launched a promotion on Product Hunt and, well, if the goal was to attract attention, it definitely succeeded.
In its post on the site, ZELF describes its offering as an “anonymous debit card with crypto”:
Below the description, company founder Elliot Goykhman commented that “any citizen of the world” could get the card (Iranians? North Koreans?) —
And as promised, I was able to successfully open an account, get issued a card, and load it into Apple Pay with just a (fake) name and phone number:
Now, my understanding of the Bank Secrecy Act and USA PATRIOT Act is that any time a customer applies for or opens an account with a financial institution, the institution must collect the customer’s name, date of birth, government identifier (which must be an SSN if they have one), and physical address and form a “reasonable belief” that it knows the true identity of the customer.
But, I wanted to make sure I wasn’t missing something, so I pinged several regulatory and compliance experts.
The overwhelming and immediate answer when I asked if what ZELF is doing was feasible was “no.”
There are examples of products and services where less intensive (or no) KYC is permitted — non-reloadable prepaid debit, check cashing, or foreign currency conversion, for instance.
One expert I spoke to was more charitable, and described ZELF’s approach of opening an account with only a name and phone number, but requiring KYC for certain types / larger transactions, as “technically doable,” but that it would require substantial, sophisticated data capabilities and compliance systems to ensure bad actors weren’t creating and using bogus, non-KYC’d accounts at scale.
Who OK’d ZELF?
ZELF leverages banking-as-a-service platform Solid, which, in turn, works with Evolve as its partner bank. Although ZELF’s official Product Hunt launch occurred last week, the product has actually been live, opening accounts, and issuing cards since June.
There are two scenarios for how such an obviously problematic product got to market, either of which suggest alarming gaps in Evolve’s compliance processes and controls.
Either ZELF and Solid didn’t get Evolve’s review and sign off before it launched, and ZELF only came to Evolve’s attention with last week’s promotions — which would be a pretty stunning gap in Evolve’s controls.
Or Evolve did know about ZELF and approved it anyway — despite the no-KYC product structure (not to mention a handful of other potential UDAAP concerns.)
A spokesperson for Evolve didn’t respond to multiple requests for comment on the matter.
Evolve Pulls the Plug
ZELF officially launched Thursday, distributing its press release and promoting itself on Product Hunt.
By midday Friday, Evolve shut down the program, citing its “positioning and recent advertising.”
Users were given no warning prior to their cards being suspended — leaving them without access to their funds or any idea of when or how they’ll be able to get access to any money in their accounts.
It also leaves ZELF, for its part, trying to resolve the issue with Evolve — or looking for a new bank partner altogether.
Adam Neumann’s Flow Will Offer Digital Wallet
After WeWork’s spectacularly botched IPO, company founder and CEO Adam Neumann got an exit package estimated at over $1 billion and disappeared for a while.
He used some of that money to scoop up some 3,000 apartment units in Miami, Fort Lauderdale, Atlanta, and Nashville that form the basis of his new venture, Flow, which is seeking to “transform” residential real estate.
Neumann also scored a $350 million investment from none other than Andreessen Horowitz — the largest individual investment it has ever made — which valued the “startup” at over $1 billion (though this presumably reflects the value of its real-estate holdings).
At the time, it wasn’t particularly clear what about the project was a “startup” or “tech” — frankly, it’s still not all that clear how this isn’t just a REIT masquerading as a tech startup.
But, last week, Flow announced it has selected banking-as-a-service platform Bond as its vendor to power a digital wallet (emphasis added):
“Bond, the leading embedded finance platform, announced today that residential real estate business Flow has selected Bond as the embedded finance platform partner to power Flow's planned digital wallet, which will offer differentiated financial products.
Bond's platform enables Flow to provide its community members with a unique set of embedded solutions within Flow's digital wallet. Specific capabilities will be announced at a later date.”
It’s unclear exactly what the wallet will do — rewards for rent payments? credit building? something web3-related? — but I guess this officially means Flow’s a fintech now. Hopefully this venture eschews imaginary metrics (“community-adjusted EBIDTA”) in favor of a realistic path to profitability and free cashflow.
FT Partners December Update
As Alex and I chatted about in our Fintech Recap podcast on Friday, deals — even in consumer fintech — are still getting done.
I wouldn’t expect a return to the go-go days of 2021 any time soon, but founders with a credible vision (and business plan) should still be able to find capital — it might just require more persistence these days.
Other Good Reads
FDIC Readies Updates to its Sign and Advertising Rules (Bank Reg Blog)
Generation Rent (Net Interest)
‘Bank of Twitter’: Is Elon Musk Spitballing or Could It Really Work? (The Financial Brand)
Listen: Regulators Look at BaaS (Banking & Payments Show Podcast)
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