The implosion of banking-as-a-service pioneer Synapse Financial Technologies is shining a harsh and unflattering light on a key link that has enabled the growth of the digital banking industry in recent years.
At an emergency hearing Tuesday, U.S. Bankruptcy Court Judge Martin R. Barash, of the Central District of California, framed the situation starkly. “What we’re really looking at with the meltdown of this company (Synapse), and it is melting down – there was a purchase that didn’t go through, it’s almost out of cash – is a situation where tens of millions of people do not have access to potentially hundreds of millions of dollars of their deposits,” he said. Barash suggested it was time for the federal bank regulators to get involved.
In late April, San Francisco-based Synapse filed for Chapter 11 debtor-in-possession bankruptcy. At the same time, payment processor TabaPay announced it had agreed to acquire the failing firm’s operating assets and keep on many of its 100 or so employees. But that $9.7 million purchase fell through last week–for reasons that are still in dispute–and now Synapse is headed towards a Chapter 7 liquidation. Synapse operates as an intermediary connecting fintechs, who don’t have banking charters, to traditional banks, so that the upstarts can offer bank products, including FDIC-insured checking and savings accounts and credit and debit cards.
This past weekend, one of Synapse’s current four bank partners, Arkansas-based Evolve Bank & Trust, froze consumer deposits belonging to customers of fintechs serviced by Synapse, including Yotta Technologies, leaving tens of thousands of individual customers without access to their funds. A lawyer for Yotta, Michael Gottfried of Elkins Kalt Weintraub Reuben Gartside, in Los Angeles, put the frozen amount at $114 million. Gottfried described the complaints coming from Yotta’s customers as “heartbreaking,” saying he’d seen customer comments about having no money for groceries and no access to their directly deposited paychecks.
“Our number one priority is getting customers access to their funds, which are held at member FDIC banks through Synapse Brokerage,” Adam Moelis, CEO and cofounder of Yotta, said in a statement to Forbes. “Evolve Bank froze debit and credit card processing across all Synapse accounts without notice on Saturday. We have been contacting regulators and working around the clock with all parties to push them to start processing transactions and restore access to funds.”
One hard hit customer interviewed by Forbes is Mark Egidi, a 39-year-old in Phoenix who opened his account at Yotta three years ago, attracted by the gamified savings rewards and comforted by the FDIC-insurance it touted. “My money was going to be in a bank anyway, it might as well not be boring,” he said of his decision to open an account. Last June, he switched the direct deposit of his pay as a mechanic at a local garage from a traditional checking account with Wells Fargo to Yotta. “At this moment in time, it is absolutely every penny that I have,” Egidi said. “I am in Arizona with an 11-month-old in a house whose air conditioning went out and I just had hand surgery yesterday, so I’m not going to be working for a little bit of time, and literally every penny that I have is tied up in a bank account I cannot access.”
Evolve claims it was forced to take the drastic action because its employees had lost access to a Synapse dashboard necessary for the bank to run compliance screens and determine how much money each individual fintech customer actually has in pooled accounts maintained for their benefit. “We cannot release funds to people that we do not know they belong to or that we have not ensured have been fully screened for compliance with sanctions laws and anti-money laundering requirements,” said Evolve lawyer Caroline Stapleton, a financial regulation partner in Orrick, Herrington & Sutcliffe ‘s Washington, D.C. office.
Synapse General Counsel Tracey Guerin, for her part, insisted that Evolve had full access to the dashboard since Monday and that its employees hadn’t responded to numerous attempts to reach them–until 15 minutes before the hearing.
But Barash seemed less interested Tuesday in the back and forth than in figuring out how Synapse can be liquidated without putting what he said were 10 million to 20 million customers at risk. Synapse has said it plans to file a motion this week to convert its Chapter 11 bankruptcy (which leaves the company in the hands of management) into a Chapter 7 liquidation, which means its dissolution will be administered by the United States Trustee, an arm of the Department of Justice.
During the hearing, Barash implored representatives of the trustee’s office to request help from financial regulators to devise a plan so that Synapse bank partners can still use the software necessary to provide fintech clients, and their end customers, with access to their accounts. The judge noted that the fintech industry is new and largely unregulated, but that its customers are “everyday people” who deserve protection.
“This is a potential disaster,’’ he said. “At least 10 million or 20 million end users, you should think of them as depositors.”
The failure of Synapse comes at a time when some in the Treasury and the Consumer Financial Protection Bureau are already pushing for more oversight of the fintech industry. Over the past two years, traditional banks, including Blue Ridge Bank, Cross River Bank, Sutton Bank and Piermont Bank, have all been subject to regulatory enforcement actions accusing them of loose oversight of their fintech partnerships.
But the business of connecting fintechs and banks–known as banking-as-a-service–is still an attractive business. Last week FIS, a 56-year-old publicly traded financial technology company with a market cap of $43 billion, launched a new platform called Atelio to help its regional bank clients offer modernized financial products like deposit accounts and online invoicing to other businesses.
Synapse, for its part, has had a long slide. Founded in 2014, it raised a total of $51 million from venture capital investors and in 2019 was valued at $180 million, according to Pitchbook. But in early 2020, Forbes reported that CEO and cofounder Sankaet Pathak had management problems so severe that its future was in jeopardy. More recently, it has had other disabling problems, including a crumbling relationship with banking partner Evolve.
Much of Tuesday’s hearing was devoted to a discussion of just how dire Synapse’s current cash position is now that the deal with TabaPay has fallen through. The company is running out of cash to pay expenses, including payroll. “There would be no point in staying in Chapter 11 unless we had a viable purchase offer or funding option because the estate has no money,” said Synapse bankruptcy attorney Ron Bender, of Levene, Neale, Bender, Yoo & Golubchik in Los Angeles. “We have more budgeted expenses for Friday than we have cash.” In fact, a lawyer for the trustee’s office said Tuesday that if Synapse doesn’t file for conversion by Friday, the trustee itself will file a motion to force an involuntary liquidation.
During the hearing, two Synapse lenders that have a claim on its remaining cash agreed to allow it to use the money to pay employees this week, including payments to laid off workers for unused time off, as required by California law. “We’re trying to be good Samaritans here,” said Darren Azman, a New York-based partner of McDermott, Will and Emery, representing creditor TriplePoint Capital. “In a perfect world, we probably wouldn’t consent to the use of additional cash collateral under these circumstances, at least at a minimum without the entry of a final order to get us the protection that lenders typically require under these circumstances, but the company doesn’t have that time.”
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