Suit Against Synapse Partner Banks Spotlights Risks of Commingled Funds

The eventual resolution of the key question in the wake of the Synapse bankruptcy — namely, where the money went — will take time.

And those seeking answers are turning yet again to the courts.

To that end, the class action suit against Synapse’s four partner banks — a quartet that includes Evolve Bank & Trust, Lineage Bank, American Bank and AMG National Trust, along with Evolve’s parent company Evolve Bancorp — shines a light on the complexities of the relationships between FinTechs and partner banks, and for-benefit of (FBO) accounts, too.

The suit seeks a jury trial.

The plaintiffs, as detailed in the filing last week in the U.S. District Court in Colorado, are a collection of individuals, who in the suit describe themselves as customers of FinTechs Juno and Yotta.

The suit alleges “gross mismanagement” of the deposits that had been tied to the FinTech platforms, where the individuals said they’d lost “access to their holdings” after Synapse filed for bankruptcy in April. Roughly $85 million in customer funds across 100,000 customers “had gone missing,” the filing pointed out.

Failure to Safeguard Funds

Per the suit, the individuals allege that the partner banks “failed to adequately maintain and safeguard customers’ funds. Significant ledger irregularities were discovered by the Partner Banks indicating the account balances set forth in Synapse’s account ledger were materially inaccurate and, therefore, could not be used as the basis for distributing funds to end users. As a result, many customers’ funds were either lost, stolen, or misplaced, with one Partner Bank blaming the next.”

Evolve, as reported here last week, has said in an open letter directed to Synapse users said that the “vast majority” of the more than $300 million in funds that it had held were moved by Synapse to other banks. Evolve said that it had begun disbursing $24.5 million to end users.

The suit noted that “most” end user funds were held in “omnibus for-benefit-of” accounts; the remainder had been held at the four partner banks in demand deposit accounts. We note that omnibus accounts, generally speaking, are accounts that “pool” funds from several end users into a single account.

When reached by PYMNTS Monday (Dec. 2), Evolve said it had no further comment on the open letter and also stated that it does not comment on active litigation.

As PYMNTS reported in June, Synapse’s former CEO Sakaet Pathak allegedly stated at a creditor hearing that “Synapse may have co-mingled end-user funds, FintTech programs’ reserve & operating funds, and Synapse’s own operating funds in FBO accounts at Evolve.”

Ledgers and Contingency Plans

As for the discussion of the actual record keeping — and keeping track of it all — the plaintiffs detailed last week in the suit that Synapse functioned “as a middleman between traditional banks and FinTechs,” opening deposit accounts for around 100 FinTechs and end users at the partner banks, while Synapse managed the account ledgers.

As demand deposit accounts and omnibus FBO accounts were operated, “Synapse combined data received from Partner Banks with its own customer transaction data and delivered that data to the FinTechs. This meant that FinTech users relied on the FinTechs and Partner Banks to account for users’ funds; and the FinTechs and Partner Banks, in turn, relied in part on Synapse to keep track of users’ funds.”

Additionally, the suit contends that banks are “expected to maintain contingency and business continuity plans that address the potential failure of critical third parties. Synapse was clearly such a critical third party, and yet none of the Partner Banks had a plan in place for what to do in the event of operational issues at Synapse—let alone failure,” adding that lack of contingency planning, and the partner banks’ failure to maintain their own respective copies all led to their coming up short in efforts to “fulfill the most fundamental responsibility in banking: to keep track of the money.”

The court filing is only one of the latest developments in a long running story that is sharpening its focus on FBO accounts and banks’ record keeping. In September, the FDIC proposed a rule that would mandate that FDIC-insured banks holding certain custodial accounts ensure that accurate records are kept to determine the individual owner of the funds and to reconcile the account for each individual owner on a daily basis.