How thousands of Americans got caught in fintech’s false promise

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Sanborn said acquiring Radius Bank opened his eyes to the risks of the “banking as a service” space. Regulators focus not on Synapse and other middlemen, but on the banks they partner with, expecting them to monitor risks and prevent fraud and money laundering, he said. But many of the banks running BAAS businesses like Radius simply don’t have the personnel or resources to do the job properly, Sanborn said. He shuttered most of the lender’s fintech business as soon as he could, he says. “We are one of those people who said, ‘Something bad is going to happen,’” he said. A spokeswoman for the Financial Technology Association, a Washington, D.C.-based trade group representing large players including Block, PayPal and Chime, said in a statement, “It’s inaccurate to claim that banks are the only trusted actors in financial services.” “Consumers and small businesses trust fintech companies to better meet their needs and provide more accessible, affordable, and secure services than incumbent providers,” the spokeswoman said. “Established fintech companies are well-regulated and work with partner banks to build strong compliance programs that protect consumer funds,” she said. Furthermore, regulators ought to take a “risk-based approach” to supervising fintech-bank partnerships, she added. The implications of the Synapse disaster may be far-reaching. Regulators have already been moving to punish the banks that provide services to fintechs, and that will undoubtedly continue. Evolve itself was reprimanded by the Federal Reserve last month for failing to properly manage its fintech partnerships. In a post-Synapse update, the FDIC made it clear that the failure of nonbanks won’t trigger FDIC insurance, and that even when fintechs partner with banks, customers may not have their deposits covered. The FDIC’s exact language about whether fintech customers are eligible for coverage: “The short answer is: it depends.” FDIC safety net While their circumstances all differed vastly, each of the customers CNBC spoke to for this story had one thing in common: They thought the FDIC-backing of Evolve meant that their funds were safe. “For us, it just felt like they were a bank,” the Oakland preschool owner said of her fintech provider, a tuition processor called Curacubby. “You’d tell them what to bill, they bill it. They’d communicate with parents, and we get the money.” The 62-year-old business owner, who asked CNBC to withhold her name because she didn’t want to alarm employees and parents of her schools, said she’s taken out loans and tapped credit lines after $236,287 in tuition was frozen in May. Now, the prospect of selling her business and retiring in a few years seems much further out. “I’m assuming I probably won’t see that money,” she said, “And if I do, how long is it going to take?” When Rick Davies, a 46-year-old lead engineer for a men’s clothing company that owns online brands including Taylor Stitch, signed up for account with crypto app Juno, he says he “distinctly remembers” being comforted by seeing the FDIC logo of Evolve. “It was front and center on their website,” Davies said. “They made it clear that it was Evolve doing the banking, which I knew as a fintech provider. The whole package seemed legit to me.” He’s now had roughly $10,000 frozen for weeks, and says he’s become enraged that the FDIC hasn’t helped customers yet. For Davies, the situation is even more baffling after regulators swiftly took action to seize Silicon Valley Bank last year, protecting uninsured depositors including tech investors and wealthy families in the process. His employer banked with SVB, which collapsed after clients withdrew deposits en masse, so he saw how fast action by regulators can head off distress. “The dichotomy between the FDIC stepping in extremely quickly for San Francisco-based tech companies and their impotence in the face of this similar, more consumer-oriented situation is infuriating,” Davies said. The key difference with SVB is that none of the banks linked with Synapse have failed, and because of that, the regulator hasn’t moved to help impacted users. Consumers can be forgiven for not understanding the nuance of FDIC protection, said Alt, the former OCC lawyer. “What consumers understood was, ‘This is as safe as money in the bank,’” Alt said. “But the FDIC insurance isn’t a pot of money to generally make people whole, it is there to make depositors of a failed bank whole.” Waiting for their money For the customers involved in the Synapse mess, the worst-case scenario is playing out. While some customers have had funds released in recent weeks, most are still waiting. Those later in line may never see a full payout: There is a shortfall of up to $96 million in funds that are owed to customers, according to the court-appointed bankruptcy trustee. That’s because of Synapse’s shoddy ledgers and its system of pooling users’ money across a network of banks in ways that make it difficult to reconstruct who is owed what, according to court filings. The situation is so tangled that Jelena McWilliams, the former FDIC Chairman now acting as trustee over the Synapse bankruptcy, has said that finding all the customer money may be impossible. Despite weeks of work, there appears to be little progress toward fixing the hardest part of the Synapse mess: Users whose funds were pooled in “for benefit of,” or FBO, accounts. The technique has been used by brokerages for decades to give wealth management customers FDIC coverage on their cash, but its use in fintech is more novel. “If it’s in an FBO account, you don’t even know who the end customer is, you just have this giant account,” said LendingClub’s Sanborn. “You’re trusting the fintech to do the work.” While McWilliams has floated a partial payment to end users weeks ago, an idea that has support from Yotta cofounder Moelis and others, that hasn’t happened yet. Getting consensus from the banks has proven difficult, and the bankruptcy judge has openly mused about which regulator or body of government can force them to act. The case is “uncharted territory,” Judge Martin Barash said, and because depositors’ funds aren’t the property of the Synapse estate, Barash said it wasn’t clear what his court could do. Evolve has said in court filings that it has “great pause” about making any payments until a full reconciliation happens. It has further said that Synapse ledgers show that nearly all of the deposits held for Yotta were missing, while Synapse has said that Evolve holds the funds. “I don’t know who’s right or who’s wrong,” Moelis told CNBC. “We know how much money came into the system, and we are certain that that’s the correct number. The money doesn’t just disappear; it has to be somewhere.” In the meantime, the former Synapse CEO and Evolve have had an eventful few weeks. Pathak, who dialed into early bankruptcy hearings while in Santorini, Greece, has since been attempting to raise funds for a new robotics startup, using marketing materials with misleading claims about the extent of its ties with automaker General Motors. And only days after being censured by the Federal Reserve about its management of technology partners, Evolve was attacked by Russian hackers who posted user data from an array of fintech firms, including social security numbers, to a dark web forum for criminals. For customers, it’s mostly been a waiting game. Craft, the Indiana FexEx driver, said she had to borrow money from her mother and grandmother for expenses. She worries about how she’ll pay for catering at her upcoming wedding. “We were led to believe that our money was FDIC-insured at Yotta, as it was plastered all over the website,” Craft said. “Finding out that what FDIC really means, that was the biggest punch to the gut.” She now has an account at Chase, the largest and most profitable American bank in history.