Federal Bank Regulators Won’t Rescue Fintech Customers Caught In Synapse Bankruptcy

Federal bank regulators are not coming to rescue the thousands of fintech customers who have lost access to their money during the unfolding bankruptcy of banking-as-a-service provider Synapse Financial Technologies or the millions more who are at risk.

That was the grim news delivered in a five-hour hearing today before U.S. Bankruptcy Court Judge Martin R. Barash, of the Central District of California. Earlier this week, he’d urged federal regulators to step in to protect “everyday people’’ and avoid a “potential disaster.”

The most immediate cause of pain for individual consumers is a dispute between bankrupt Synapse and one of its bank partners, Arkansas-based Evolve Bank & Trust. That disagreement has left customers of fintechs Yotta Technologies, Juno Finance and Copper Banking unable to access the money in their accounts or use the credit and debit cards tied to them since May 11th.

But Assistant U.S. Attorney Elan Levey, representing the U.S. Trustee (the arm of the Justice Department that can intervene in bankruptcy cases), said she had investigated Barash’s idea and federal banking regulators couldn’t intervene. “It’s my understanding that the FDIC insurance coverage is only available in the event of a bank failure,” she said.

While as a state-chartered bank, Evolve does come under the Federal Reserve’s regulatory purview, the Fed, Levey noted, “does not supervise or regulate fintech companies such as the debtor, nor does it mediate or have the authority to mediate disputes among commercial entities.” The Fed did, however, say in a statement that Levey read to the court that it “is actively monitoring this situation and will help ensure that Evolve complies with all legal requirements related to the debtor’s accounts at Evolve, including any applicable consumer protection laws and is appropriately prioritizing this matter.”

That provided little solace to customers who have been cut off from their accounts and spoke during the bankruptcy hearing. Yotta customer Patrick Ryan, addressed his comments to the FDIC. “I can’t believe that the FDIC is standing here and saying that there’s absolutely nothing that they can do,” he said. “With all the people that are at stake here, the FDIC needs to step up and just cover these accounts and offer its insurance.”

Another customer gave the court a firsthand account of the impact the fund freeze is having. “I’m a single mom. I just bought my first home, my first mortgage payment is due in a few days. I’m terrified. Why are they pointing fingers at each other?” she said. “I just want to know when I can pay my mortgage. That’s the only question I have for anybody involved in this situation.”

Colin Tindall, a Juno Finance client with more than $50,000 locked on the platform raised to the court a report from Fintech Business Weekly quoting Synapse CEO Sankaet Pathak speculating about a bank run at Evolve during an internal meeting at the company. “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,” Pathak reportedly said.

Responding to the speculation, Evolve lawyer Caroline Stapleton, a partner at Orrick, Herrington & Sutcliffe in Washington, directed Tindall to the bank’s call reports for reassurance of Evolve’s capital position. “There is not a capital issue at this bank,” she emphasized.

The Synapse platform is an intermediary that allows fintechs–which aren’t themselves banks–to provide bank and bank-like services such as checking accounts, credit and debit cards, and in some cases FDIC insured savings accounts. According to Synapse, as of the start of the year, it had 100 fintech clients with about 10 million customers.

Since filing for Chapter 11 debtor-in-possession bankruptcy late last month, Synapse has essentially run out of money to pay its employees. In front of the court on Friday was an emergency motion from the United States Trustee to convert the bankruptcy to a Chapter 7 liquidation under their office’s control. Alternatively, the motion asked that if the case is not converted, a Chapter 11 trustee be appointed to oversee operations instead of Synapse’s current management. “The Debtor 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 motion states.

But Barash put off ruling on the motion until next Friday after Synapse bankruptcy lawyer Ron Bender, of Levene, Neale, Bender, Yoo & Golubchik in Los Angeles, argued in favor of giving current management more time to address the problems preventing fintech customers from accessing their money. He added that Synapse is receiving inquiries from possible purchasers and that current management is best positioned to navigate those discussions. “A Chapter 11 trustee would have an extremely difficult time trying to figure out anything in this case,” Bender said. “If current management quit, a Chapter 11 trustee would be completely lost.”

Meanwhile, some of Synapse’s fintech clients–desperate to avoid a disorderly shutdown that could leave their own customers cut off from their money–have offered to give Synapse money to pay employees. “These customers are just sending in money, effectively gifting it, to minimize disruption,’’ Bender said. Lawyers for secured creditors TriplePoint Capital and First Citizens Bank did not object to gifted funds being used to pay employees and maintain operations.

The hearing brought no end to the dispute that led Evolve to block customer access to funds, after, it says, Synapse cut off its access to a 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. Synapse says that access was restored this past Monday, but Evolve insists it still doesn’t have what it needs.

Barash did what he could to force a resolution. He ordered Synapse to provide settlement and ledger reports that Evolve Chief Technology Officer Christopher Staab testified the bank had not received. He also ordered executive and technical team members from Evolve and Synapse to meet and confer by Monday to discuss how to restore consumers’ access to their funds. The parties agreed to hire a private mediator. Synapse’s other bank partners, including Lineage Bank, AMG Bank and American Bank are allowed, but not required, to attend the meeting, Barash said.