Synapse Hearing Highlights Frustration With Banking-as-a-Service Complexities

The drama surrounding the Synapse Financial bankruptcy continued Friday (June 7) with an afternoon court hearing in California’s Central District Bankruptcy Court, although the case appeared no closer to a resolution. As a result, the hearing set the stage for what will be a complex series of events that will stress-test the very concept of banking-as-a-service and challenge the business models that have put millions of consumers’ assets at risk.

“This is a crisis, and I would like to see a resolution, but I’m not sure if people are looking for court orders, what I can provide in terms of court orders,” said Judge Martin Barash Friday.

What the Report Found

The centerpiece of the hearing was the status report filed early on June 7 from court-appointed trustee Jelena McWilliams. By way of background in that report, McWilliams uncovered significant discrepancies in customer funds, with Synapse facing a shortfall of approximately $85 million. The report reveals a complex network of fund flows, bank accounts and ledgers, which she said makes restoring access to customer funds challenging. The lack of liquidity and the inability to hire a forensic accountant further complicate the situation. The report also showed that Synapse’s business model, which involved using multiple partner banks for different functions, has made reconciliation difficult. Evolve Bank and Trust, one of Synapse’s partner banks, has apparently struggled to reconcile its deposits against Synapse’s proprietary ledger system due to its complexity and the absence of knowledgeable personnel.

In other words, a big mess. And as became apparent from the court hearing Friday afternoon, weeks, if not months, of work remain before any clarity can be gained from the situation. Even the partner banks involved, which go beyond the Evolve Bank and Trust, are looking for a way forward as they try to figure out how their customer assets that were connected to Synapse became caught in the fray. Even McWilliams, who has made a high-level career out of untangling financial messes as former chairperson of the FDIC, didn’t have any easy answers to identifying the causes of the reconciliation issues and finding a solution to unfreeze customer accounts.

However, the status report and subsequent hearing did produce information regarding the principals in the case that will be important going forward. Among them are Judge Barash, Lineage Bank and the consumers caught in the middle.

What’s at Stake

Judge Martin Barash: Background on Judge Barash shows him to be a cautious judge who may appear to be tentative in court, but decisive when he needs to be. He expressed frustration with the “follow the money” game that the case is presenting. And while he was appreciative of McWilliams’ efforts, he expressed doubt that her trusteeship would yield results without more funding or subpoena power. It is well within his pattern, as analyzed by several legal firms, to work slowly toward settlements rather than issue hard-to-enforce court orders. As stated in a report by California legal firm Sulmeyer Kupetz, Judge Barash does not always issue tentative rulings in advance of hearings, and he sometimes states the tentative only after taking the bench.  “He posts a tentative when the issues are clear or when the answer has crystalized in his mind before the hearing,” the firm’s site states. “Judge Barash likes having a dialogue with attorneys in his courtroom.  Although he often sticks to his tentative rulings, he sees oral argument as a valuable part of the process and has been swayed by oral arguments on occasion.  Such courtroom dialogue often tests the judge’s analysis of the issues, often confirming his pre-hearing analysis.”

Lineage Bank: Evolve Bank & Trust has been the most notable player in the accusations against Synapse and is among the biggest partner banks in the FinTech ecosystem. However, Lineage had not been mentioned in most of the analysis of the Synapse controversy, and a quick look at its recent history shows a bank that has had its share of chaos, including a new leadership team last year and a consent order from the FDIC on February 23 of this year.

The consent order drew a warning about risks in the FinTech ecosystem from Dallas-based consultants Endurance Advisory Partners, whose CEO Stephen Curry wrote: “Based on what we have seen in our practice, FinTechs and their technology vendors often lack the robust controls and effective risk management practices that have been developed in the banking industry. Banks have tended to underestimate these risk factors when assessing FinTech relationships, often leading to unrealistic expectations of their operational resilience. Some FinTechs also experience volatile funding, have opaque operations, or excessive leverage. In some cases, while a FinTech may have risk management in place, the underlying data management discipline is deficient, rendering risk management ineffective. Irrespective of the maturity of risk management in a FinTech, the sponsoring Bank retains the second line oversight responsibilities.”

Consumers: If social media is any indication, partner banks are not communicating with their customers (only Evolve has posted an explanation and defense of its position online), and those customers are pessimistic about recovering their funds, which McWilliams has committed to recovering. As a typical Reddit post stated: “I really doubt the DA or AG is going to do anything. It’s already in the bankruptcy court and being worked on getting people access to their money. Anyone else getting involved is simply going to slow the process more than it already is slowed.”

McWilliams posed several potential solutions on Friday, but again, none were immediate. In terms of potential paths forward, as outlined in the legal document submitted to the court, assets held in the Synapse Brokerage account designated “for benefit of” (FBO) could potentially be consolidated into a singular account, with the appointed trustee and overseeing court determining the appropriate disbursement amounts to each individual end user. The standard Synapse FBO accounts maintained at other institutions may witness fractional disbursements or remittances to FBO accounts that can be thoroughly reconciled. Alternatively, there exists the possibility that no funds will be released until such time as every account has been reconciled in its entirety.