A group of U.S. senators released a letter demanding that failed fintech company Synapse give its customers access to funds frozen since its mid-May bankruptcy.
Due to inaccurate record-keeping and noncompliance by Synapse, it’s estimated that consumers could be owed between $65 million and $96 million. The four senators placed nearly equal blame on Synapse’s partners and venture capital investors, saying they all misled customers into believing Synapse was a safe alternative to a bank.
The collapse of Synapse has raised substantial concerns because consumers increasingly rely on fintech solutions to bridge the gap between traditional and digital banking. Since fintechs aren’t regulated like banks, some critics argue that their security measures are a mirage.
“It’s a bit of an over-reach to paint fintech as an industry with the same brush,” said Don Apgar, Director of the Merchant Payments Practice at Javelin Strategy & Research. “In reality, there are many different business models of how new tech companies are making banking services easier to access by consumers.”
A Glaring Weakness
Banks must conform to strict FDIC guidelines, but the trade-off is that consumers’ money is protected in case of a bank failure. Even though banks have been partnering with fintechs for years, the FDIC places the onus on financial institutions to hold their partners accountable.
As the Banking-as-a-Service (BaaS) model has evolved, many banks have relied on fintech partners to share the compliance burden. According to the senators, that is a glaring weakness in the new model that, in this case, cost consumers dearly.
For Benefit Of
After Synapse lost its largest customer, Mercury, the company found itself in a cash crunch that ultimately led to its bankruptcy. However, since all customer funds were held in FDIC-insured banks, it shouldn’t have caused an issue for consumers.
Unfortunately, the company maintained customer funds across three banks, and funds were held in commingled For Benefit Of (FBO) accounts. The banks relied on Synapse to provide the accounting, or manage the subledgers, to know how much money belongs to each consumer.
“The core issue is that Synapse wasn’t maintaining accurate subledgers and Evolve failed to exert sufficient oversight over the process,” Apgar said. “Eventually a large discrepancy was uncovered where the FBO accounts at Synapse’s banks, primarily Evolve, held approximately $85 million less than what Synapse’s records showed. That led to accusations that Synapse was commingling consumer funds with operating funds and using the money to keep the company afloat after losing its top customer.”
Forensic Accounting
Since Synapse is now bankrupt, there is no money to hire a forensic accounting firm to reconstruct the subledgers and find out what happened. FDIC insurance won’t cover the shortfall because one of its requirements is customer funds must be held in an account under their name. Commingled funds in an FBO account are ineligible for insurance, and until more details are uncovered, the FDIC doesn’t know who to pay to cover the shortfall.
While Synapse’s failure should be a cautionary tale for all parties in the nascent BaaS model, it doesn’t mean the model is broken. Fintechs play a critical part in digitizing and democratizing banking services and as the world becomes more cashless, fintech services are sometimes the only way for customers to buy groceries, pay for parking, or order a ride-share.
“In summary, while the banking-as-a-service and fintech business models are new, they are not necessarily risky on their own,” Apgar said. “Ultimately, Synapse didn’t do what they were supposed to do, and Evolve was not exerting sufficient oversight to catch it.”