The answer–as evidenced by the collapse of Synapse–is not necessarily. Here’s what you need to know.

By Emily Mason, Forbes Staff

Four years ago, Lauren Scott was scrolling through TikTok when she saw a video from EcommJess, a personal finance influencer with 750,000 followers, promoting Yotta Savings, a fintech app offering a chance to win cash and other prizes on top of regular interest. Scott liked the novel sweepstakes incentive and Yotta’s lack of fees, along with something way more traditional. “It was FDIC-insured, which was one of the main things that I looked for because you never know what to trust,” says Scott, 27, who lives in the Tacoma, Washington suburbs with her husband and seven-year-old daughter. Eventually, the couple moved all their money to Yotta.

Now the Scotts are among 200,000 or so fintech customers—including 85,000 from Yotta—who have been denied access to their “FDIC insured” accounts since mid-May, following the Chapter 11 bankruptcy of a fintech intermediary: San Francisco’s Synapse Financial Technologies. It’s unclear when they’ll get access to their money, and even whether they’ll get it all back; at a court hearing Friday, former FDIC Chair Jelena McWilliams, appointed as bankruptcy trustee in the case, said there’s a “shortfall” between Synapse’s records and those of the banks currently estimated at $65 million to $96 million. Significantly, she added that it’s looking increasingly likely that this isn’t just a case of bad bookkeeping but a real shortfall–i.e. missing money–that existed before the bankruptcy filing and could take time and extensive investigation to sort out.

“Listen, I’m not a PhD in finance, right? I’m not. I’m just an average everyman,” says David Schulzinger, a 40-year-old Phoenix insurance adjuster, who has been frozen out of the $50,000 Yotta account he had built up over four years for vacations and unexpected expenses–such as his wife’s recent surgery. “It was always advertised as FDIC-insured. If I had for a moment thought that it wasn’t, I would never have put any money in this account.”

U.S. Bankruptcy Court Judge Martin R. Barash, of the Central District of California, who is presiding over the Synapse case, has seemed equally flabbergasted by the regulatory black hole fintech “depositors” and their money have been sucked into. “I’m confident the end users thought they were protected from this kind of thing,’’ said the exasperated jurist, who has made getting ordinary folks their money back his top priority. But he’s limited in what he has the power to do. “This is a serious situation and people are in crisis,’’ he said at a hearing earlier this month. “People are suffering.”

The delay is all the more jarring when compared to what happened after California regulators shut down Silicon Valley Bank on Friday March 10, 2023. By the following Monday, customers had access to their cash and federal bank regulators had stated that all deposits—including those in excess of the normal FDIC insurance limit of $250,000 per depositor—would be covered to mitigate the risk of SVB’s failure setting off more bank runs.

In the Synapse case, the FDIC says it can’t act because there hasn’t been a bank failure. As it noted in a “consumer news” bulletin issued after the Synapse disaster: “FDIC deposit insurance does not protect against the insolvency or bankruptcy of a nonbank company. In such cases, while consumers may be able to recover some or all of their funds through an insolvency or bankruptcy proceeding, often handled by a court, such recovery may take some time.” In other words, not our job.

The situation is such a mess—with no money left in Synapse’s coffers to hire experts—that a lawyer for McWilliams publicly asked for volunteer forensic accounting help. Barash wondered out loud if the federal Consumer Financial Protection Bureau might pitch in.

So do fintech customers have any of the FDIC protection they thought they did? Turns out what most of them have is “pass-through” FDIC insurance—meaning their money is held in a FBO (for the benefit of) account at the bank, usually mingled with cash from the fintech’s other customers.

In the case of a bank failure, the standard depositor insurance applies to FBO funds, provided, the FDIC states, there are clear records showing who owns what. But get this: the bank itself isn’t necessarily responsible for maintaining such records—those records could be maintained instead by a fintech or an intermediary like Synapse, which functioned as a bridge between fintech startups and the small banks holding customers’ funds, and apparently in some cases combined funds from multiple fintechs in each of its FBO accounts.

Bottom line: If a bank itself fails, and a fintech (or other third party) has good records, the fintech’s customers should be able to collect their insured deposits fairly quickly. If a nonbank fintech, particularly one with deficient records, implodes, all bets are off. Meanwhile, it’s difficult, if not impossible, for consumers to discern how responsibly individual fintechs have set-up accounts promising FDIC insurance.

“There’s a huge gap, frankly, in the financial structure in many ways,” says Paul Clark, a senior counsel and financial regulation expert at Seward & Kissel in Washington. “Most people hold their financial assets through a broker, a bank, a trust company, somebody who’s robustly regulated and regulated for that purpose. The fact is you can be a custodian for people’s assets in certain contexts and not have to register as anything.”

While Synapse has only been around for a decade, the concept of pass-through FDIC insurance is an old one. The FDIC first adopted regulations in 1946 allowing the custodian of an account—say a third-party fiduciary—to pass through insurance to the beneficiaries of that account, according to a law review article by Clark.

In 1980, after Congress decontrolled interest rates and increased the FDIC insurance cap from $40,000 to $100,000, brokers like Merrill Lynch began offering market-rate CDs to retail customers using FDIC pass-through insurance. These “brokered deposits”– commonly derided as “hot money”– added fuel to the 1980s savings and loan crisis, which ended up costing U.S. taxpayers about $300 billion in today’s dollars. (Ironically, brokered CDs might actually be a relatively stable source of funding in today’s banking system, when depositors can stage a run on a bank like SVB with a flick of the mouse or tap on a screen.)

Then, in 2000, Merrill Lynch (with Clark’s help) innovated again, by offering to sweep money in customers’ cash management accounts into FDIC-insured pass-through accounts, instead of keeping it in money market mutual funds. Today, Merrill Lynch is owned by Bank of America, and bank sweep accounts are a mainstay of broker—and fintech—offerings.

For example, Fidelity Investments’ Cash Management account boasts such checking account-like features as free ATM access, online bill payment and a debit card, plus $5 million in FDIC insurance—which Fidelity provides by sweeping customers’ money into FBO accounts at 24 partner banks. Even The Vanguard Group, a cautious mutual fund giant, recently rolled out a Cash Plus Account that provides FDIC insurance of $1.25 million per person (or $2.5 million per couple) by sweeping money into FBO accounts at five different FDIC-insured banks. (Vanguard’s account offers fewer features and is more like a bank money market than a checking account. But it pays a higher annual interest rate—currently 4.6% to Fidelity’s 2.72%).

Fidelity and Vanguard are both overseen by the Securities and Exchange Commission. Each has more than 50 million customers and manages trillions of assets—all of which presumably should give comfort to those relying on them for pass-through FDIC insurance.

Sankaet Pathak cofounded Synapse and was CEO until a bankruptcy trustee took over this month.

Tim Pannell for Forbes

As the Synapse case demonstrates, the combination of tiny fintech startups, subject to scant regulatory oversight, working with small and sometimes unsophisticated banks, poses a different level of risk. During a bankruptcy court hearing last month, a lawyer for one of Synapse’s smaller bank partners (Lineage bank in Franklin, Tennessee), defended the effort it was putting into sorting out the mess by pointing out that it had just 45 employees.

On the fintech side, some players were even tinier, yet were able to market a range of bank-like services, including debit and credit cards and deposit taking through middleman Synapse, which was backed by prominent venture capitalists, including Andreessen Horowitz. Synapse’s primary bank partner was Evolve Bank & Trust, a West Memphis, Arkansas-based state chartered bank that leaned heavily into the business of sponsoring fintechs. Between 2019 and 2023, Evolve’s deposits more than tripled from $436 million to $1.5 billion. According to data from FedFis.com, just 139 of the nation’s 4,568 FDIC-insured commercial and savings banks and 4,572 credit unions insured by the National Credit Union Administration, work with fintechs. These 139 have an average of six fintech partners each. By contrast, Evolve works with 85 partners, including such big names as Stripe, Dave and Affirm.

On Friday, Evolve consented to a tough and sweeping cease and desist order from the Federal Reserve and the Arkansas State Bank Department which bars it from expanding its fintech partnerships (either with new customers or new products) without permission from bank regulators. The order said that examination reports issued last August and again in January, found Evolve’s Open Banking Division (OBD)–the one that deals with fintechs–was violating rules related to risk management, offshore foreign assets, money laundering and consumer compliance. Under the consent order, Evolve must submit plans to regulators to revamp procedures at OBD and hire an independent third party to review the division.

In a statement, Evolve said it “remains well capitalized” and that the order “does not affect our existing business, customers, or deposits.” It characterized the enforcement action as “similar to orders” received by other banks that work with fintechs.

Synapse, too, became an assembly line, connecting fintechs and their customers with bank services and FDIC insurance. Still, in April of 2020, Forbes reported that the startup, under the leadership of CEO and cofounder Sankaet Pathak, had management problems so severe they threatened its future. In a bankruptcy court declaration, Pathak said that at the start of 2024 Synapse had 100 fintech clients serving approximately 10 million users. By the time it filed for Chapter 11 bankruptcy this past April, many of those clients had fled to other intermediaries or established direct relationships with banks. Still, in addition to Yotta, customers of Juno Finance, Copper Banking, GigWage, Grabr, Gravy, IDT, Latitud, Mercury, Sunny Day Fund, Abound and YieldStreet have been caught up in the mess.

“When we first launched Mercury, at that point we were on Synapse, we had nine employees,” recalls Immad Akhund, CEO and cofounder of business banking startup Mercury, a member of the Forbes Fintech 50 for 2024. “Realistically you probably need twice as big of a team to launch directly working with the partner bank. That does mean you need to raise more money and be ready for that, but at the same time, it maybe shouldn’t be that easy to do these things.”

Last October, Mercury told Synapse it would be moving to a direct banking relationship with Evolve. Synapse has claimed in bankruptcy filings that as part of that move, Evolve transferred more funds out of Synapse’s FBO accounts than it should have—a claim Evolve and Mercury deny. Regardless, by the time Synapse filed for Chapter 11, its relationship with Evolve was ending amid litigation and unreconciled books.

“It erodes confidence in the banking industry to have missing money that’s not reconciled,’’ laments Chris Nichols, director of capital markets at Winter Haven, Florida-based SouthState bank. “This has proven to be the regulators’ worst fears that the banks are going to be held responsible here.” SouthState has $45 billion in total assets and has taken a cautious approach to its fintech partnerships, sponsoring three prepaid debit cards and one secured credit card (a setup where money is deposited in advance to back up credit card charges).

“Fintechs have arbitraged the industry in that they’ve had all the benefits of the bank without the risks and the cost,” Nichols adds. “Banks have allowed this to happen in the quest for greater fees and deposit balances. The solution is a set of factors–less complexity, better compliance, more transparency, increased governance and better technology.”

Evolve isn’t the first bank to take heat for how it has managed (or more accurately, failed to manage) its relationship with fintechs. Regulators have been pressuring the banks, through enforcement actions, to take more responsibility over their fintech partnerships, especially when it comes to complying with know-your-customer and Bank Secrecy Act rules. Blue Ridge Bank, Cross River Bank, Metropolitan Commercial Bank, Vast Bank, B2 Bank, First Fed Bank, Choice Financial Group, Piermont Bank, Sutton Bank and notably, the same Lineage Bank involved in the Synapse case, have entered into consent orders relating to their oversight of fintech programs.

In March, a report by The Information detailed how FDIC officials were concerned, in particular, about Choice Financial Group’s partnership with Mercury and how the startup had opened accounts for customers abroad, including in Russia, Pakistan and Myanmar. (A spokesperson for Mercury told The Information: “Despite the demand for our product, we only onboard customers that align with our robust risk framework.” The company declined to comment further on the matter to Forbes.)

Some of the regulatory response–and particularly the regulators’ rhetoric–has gone beyond after-the-fact enforcement on a bank-by-bank basis.

In November 2022, the Treasury Department presented a report to President Biden’s White House Competition Council calling for additional oversight of bank-fintech partnerships and warning of new risks to consumer protection related to regulatory arbitrage and data security. The report also praised the role fintechs have played in encouraging competition in core consumer finance markets. In a statement at the report’s release, Treasury Secretary Janet Yellen suggested that “with existing authorities, regulators can encourage competition and innovation while further safeguarding and protecting consumers” — in other words, they can do more to protect consumers even without Congress passing new laws.

A year later, the Consumer Financial Protection Bureau proposed a rule that would bring nonbank tech companies offering digital wallets or payment apps under the agency’s authority to conduct examinations to ensure compliance with consumer financial laws. The proposal is designed to apply to companies handling more than five million transactions annually.

Meanwhile, the FDIC has taken several swipes at making sure consumers understand what they’re getting when FDIC insurance is touted by the fintechs. In December 2023, it announced new guidelines that require non-banks, including fintechs, to clearly disclose that they are not themselves FDIC-insured institutions and that deposit insurance only protects against the failure of an FDIC-insured bank. In the case of pass-through insurance, the fintechs must also clearly disclose that certain conditions must be met for that pass-through insurance to apply. The rules have a final compliance date of January 1, 2025, but some fintechs, including Mercury and Current, have already updated the disclosures on their websites.

This past February, in a speech at Vanderbilt University, Acting Comptroller of the Currency Michael J. Hsu suggested that there could be a broader risk when bank services are bundled and sold by nonbanks (i.e. fintechs) outside of the bank regulatory structure. “From a financial stability perspective, the deposit-taking-like activity warrants the most scrutiny because of the vulnerability it creates to runs,’’ he said. “Any entity managing money on behalf of customers can face a run if those customers have doubts about the safety of their money.”

There’s no doubt fintechs have pushed innovation—forcing banks to up their game and providing services to moderate and low income folks the banks may have ignored. For example, Chime, the nation’s largest fintech bank, with seven million customers, pioneered such consumer friendly innovations as giving customers access to direct-deposited paychecks two days earlier than the banks did. Chime offers FDIC pass-through insurance through master accounts with two banks—Stride Bank and The Bancorp Bank. It says that within those omnibus accounts it has set up individual demand deposit accounts for customers and that it reconciles its records with the banks’ records on a customer by customer basis, daily. “When any account is out of balance the bank and Chime work to resolve it. Even a $1 discrepancy would show up on daily reporting,’’ Chime said in a statement to Forbes.

Lead Bank CEO Jackie Reses

Nate Ryan for Forbes

Meanwhile, some entrepreneurs have spotted a business opportunity in helping the fintech industry clean up its act. In 2022, Jackie Reses, the former head of Square Capital, and her partners, acquired Lead Bank, a 96-year-old Kansas-City, Missouri-based bank. Now they have about 30 technical employees working on a system that reconciles bank records instantly with its fintech clients’ ledgers. Its system looks for anomalies in real time and provides instant alerts if there is an issue. One example could be alerting the bank to potential violations of Office of Foreign Assets Control regulations designed to enforce U.S. sanctions. Just as crucial: Reses, who is chairman and CEO of Lead, says she’ll only work with fintechs with a certain level of sophistication. (Lead bank is on the Forbes Fintech 50 list and Reses herself is on Forbes’ list of the richest self-made women.)

“Fintechs need to have the ledgering system, the money movement tools and the compliance for ongoing monitoring,” Reses says. “Every fintech needs to have an exacting system around scalability and reliability. Full stop.”

That’s the opposite of Synapse’s approach, which offered the smallest and least sophisticated fintechs a path to launch without going to the trouble or expense of building their own systems and expertise. But it’s still tough for an ordinary consumer, without special knowledge of the players in the fintech or banking industry, to tell the difference.

Even after the Synapse fiasco, the move fast and break things mentality survives in some quarters of the fintech world. On LinkedIn recently, Adam Shapiro, cofounder of financial services consulting firm Klaros Group, reported a fintech CEO complained to him (after the Synapse bankruptcy), that a bank wanted too much information. That won’t do anymore, Shapiro told Forbes. Fintechs have to understand that banks are now going to be asked by their regulators to prove they know what’s going on with their fintech partners. Plus, he says, the fintech industry itself is going to need some standards— “something that gives consumers reasonable belief that when they’re being told they’ve got insurance, those records are being maintained in a (responsible) way and that someone is reconciling those funds and checking they’re there.”

“That is the new world,’’ he declares.

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