Last year, a fintech company called Synpase went bankrupt, affecting bank accounts of over 100,000 clients. This bankruptcy sent shockwaves through the financial technology sector, raising profound concerns among investors, especially those relying on modern fintech custodians. The key problem is the decision by the Federal Deposit Insurance Corporation (FDIC) not to backstop Synapse’s account holders, a move with significant implications well beyond Synapse itself. This decision raises serious questions regarding investor safeguards and custodial protection mechanisms within the broader fintech ecosystem, particularly for robo-advisors and similar services that have garnered sweeping popularity in recent years.
I’ll go ahead and put my main conclusion at the top for this one. Previously, I have been very positive on robo-advisors for certain clients that are willing and able to self-direct investments. Based on the FDIC response and discussion around Synapse, I don’t think any investors should have any money with robo-advisors. Furthermore, I don’t think investors should use any fintech intermediary at all, at least until the FDIC and SIPC catch up to the times.
Your savings should go directly into a real, regulated bank. Your investments should go directly into a real, regulated custodian. Until the FDIC and SIPC say different, if the people you deal with for customer service aren’t the ones getting audited, you are not protected.
Overview of the Synapse Bankruptcy Crisis
Synapse, known as a “banking-as-a-service” fintech provider, offered its infrastructure to numerous fintech startups and neo-banks, allowing them to provide banking, payment, and lending services without directly interacting with traditional banking systems. Synapse’s innovative model attracted significant venture capital funding and startup clients, positioning itself as a lynchpin within the fintech ecosystem. However, this rapid rise was followed by equally rapid unraveling, culminating in Synapse filing for bankruptcy protection amidst mounting financial losses and regulatory scrutiny.
The core purpose of the FDIC is to create a trust in banking institutions that doesn’t require a ton of financial expertise on the part of savers. This FDIC decision, while technically correct, undermines that core purpose.
FDIC’s Decision: A Troubling Precedent for Modern Fintech
Clients of fintech firms that utilized Synapse had, in most cases, signed up for an account that claimed it was FDIC insured. But when Synapse went bankrupt, many of these fintech firms couldn’t locate client funds. These firms asked the FDIC to step in, and the FDIC basically said, “What’s Synapse?”. “All of our regulated banks have all the money they are supposed to have, so there is nothing for us to do.” The FDIC position was that the FDIC guarantees banks and banks only. If you hire a fintech middle-man to deposit your money at a bank, you are not insured.
The FDIC’s reluctance to step in and protect Synapse account holders has shattered assumptions that fintech deposits would enjoy the same level of protection as traditional bank deposits. Typically, FDIC insurance covers deposits up to $250,000 per account holder, provided the accounts are held with FDIC-insured banks. Synapse’s structure, however, relied on intricate and layered custodial relationships, often obscuring precisely who held what assets, and under what conditions.
Unlike conventional banks that clearly hold customer deposits on their balance sheets, fintech platforms often utilize omnibus accounts and custodial relationships that aggregate client funds into pooled accounts held by third-party banking partners. These structures, while efficient and cost-effective, significantly complicate regulatory oversight and the clarity of asset ownership. This opacity contributed significantly to the FDIC’s hesitation to extend traditional protections, leaving account holders exposed to significant losses.
In Synapse’s case, the FDIC determined that the complexity and indirect nature of the custodial arrangement effectively broke the chain of direct FDIC protection. The result is that investors and depositors who operated under the reasonable assumption of FDIC coverage now face the stark reality of potentially losing uninsured funds. This landmark decision sets a concerning precedent, one that investors in modern fintech solution, such as robo-advisors, cannot afford to ignore.
Robo-Advisors and the SIPC Safety Net: False Confidence?
While Synapse primarily impacted depositors and fintech banking solutions, the implications extend significantly further. Robo-advisors, automated investment platforms that manage client portfolios using algorithmic strategies, have surged in popularity, attracting billions in assets under management (AUM). Many robo-advisors prominently advertise their membership in the Securities Investor Protection Corporation (SIPC), reassuring investors that their assets are safeguarded against brokerage insolvencies, typically up to $500,000 per customer, including $250,000 in cash.
However, the Synapse incident raises a critical question: Could robo-advisors face a similar fate in the event of custodian failure? Just as the FDIC declined to backstop Synapse’s fintech deposits due to the indirect custodial relationships, SIPC might similarly decline to step in if robo-advisor custodial relationships prove insufficiently transparent or fail to meet clearly defined regulatory standards.
Understanding the Limits of SIPC Protection
To fully appreciate the risks, investors must understand precisely what SIPC coverage entails—and, crucially, what it does not. SIPC protection does not safeguard investors against market losses, investment fraud, bad advice, or poor investment performance. Instead, SIPC exists primarily to return investors’ securities and cash held by brokerage firms that fail or become insolvent. Its role is to ensure investors recover their securities—or their equivalent value—in the event of custodian bankruptcy or brokerage insolvency, provided the brokerage firm is a SIPC member and holds assets in clearly designated client accounts.
Yet, SIPC protection hinges upon the clarity and transparency of custodial relationships. Robo-advisors typically rely on third-party custodians or brokerage firms to hold assets, executing trades and managing customer funds through omnibus accounts or aggregated custodial arrangements. This structure, while efficient, can introduce precisely the sort of ambiguity that led the FDIC to deny Synapse coverage. If robo-advisors’ custodial arrangements fail to meet SIPC’s stringent requirements for transparency, segregation, and clear ownership delineation, investors may find themselves without the expected safety net.
The Hidden Risks of Modern Fintech Custodianship
The Synapse bankruptcy vividly underscores a fundamental risk inherent in modern fintech custodianship: opacity. Fintech startups frequently prioritize convenience, cost-efficiency, and customer experience, often at the expense of transparency, regulatory compliance, and custodial rigor. This inclination toward complexity and indirect custodial relationships introduces latent vulnerabilities, which can surface dramatically during financial distress or insolvency.
Investors, particularly savvy ones accustomed to thorough due diligence, must recognize that the fintech industry’s rapid innovation frequently outpaces regulatory frameworks and the development of robust investor protections. While innovation-driven platforms offer undeniable convenience, lower fees, and ease of use, investors must weigh these benefits against the hidden risks associated with indirect custodianship structures.
Why Traditional Custodians Offer Greater Security
Given the risks illuminated by the Synapse bankruptcy, investors concerned about asset protection and regulatory clarity should reconsider the merits of traditional custodial arrangements. Established brokerage firms and custodians—such as Charles Schwab, Fidelity, Vanguard, Pershing, or Bank of New York Mellon, and my favorite, Interactive Brokers—have decades-long track records of regulatory compliance, transparency, and clearly delineated custodial structures explicitly designed to comply with SIPC requirements.
Traditional custodians offer clear segregation of client assets, robust regulatory oversight, and transparent reporting requirements. These characteristics significantly reduce the risk of SIPC or FDIC declining coverage in the event of insolvency.
Steps Investors Should Take to Protect Themselves
For investors currently utilizing or considering fintech robo-advisors and digital investment platforms, the Synapse bankruptcy serves as a cautionary tale. To mitigate custodial risks, investors should:
- Scrutinize Custodial Relationships:
Demand transparency from fintech providers regarding how client assets are held, managed, and protected. Ask pointed questions about custodial structures, segregation of funds, and how SIPC or FDIC coverage would apply. - Diversify Custodians and Platforms:
Avoid placing all assets with a single fintech custodian, particularly those with opaque custodial frameworks. Diversifying custody across multiple providers—including traditional custodians—can mitigate systemic risk. - Consider Traditional Custodians:
Recognize the value of traditional custodians who employ clear custodial structures, robust regulatory oversight, and demonstrably reliable SIPC coverage. The assurance of investor protection often outweighs minor cost savings or convenience offered by fintech alternatives. - Stay Informed and Vigilant:
Monitor regulatory developments, enforcement actions, and custodial transparency initiatives closely. Investor protection frameworks evolve, and informed investors are best positioned to anticipate and mitigate risks.
Looking Ahead: Regulatory Scrutiny and Investor Vigilance
The Synapse bankruptcy will likely prompt increased regulatory scrutiny and potential legislative action aimed at clarifying fintech custodial arrangements and strengthening investor protections. However, regulatory responses often lag significantly behind innovation-driven industries. Investors cannot afford to wait passively for regulators to catch up.
In the interim, investors must proactively evaluate their investment custodians, particularly fintech-driven solutions like robo-advisors. The allure of innovation, convenience, and lower fees must be balanced against the very real risk of inadequate investor protections, opaque custodial frameworks, and potential denial of SIPC or FDIC coverage.
Why I think the FDIC Got This Horribly Wrong
The FDIC, in denying coverage to Synapse’s indirect clients, was technically correct. They are a bank regulator, and the banks all had all the money they were supposed to have. But technical correctness means nothing here. Regular Americans should not have to perform due-diligence on their banking institutions. If something looks like a bank, and claims FDIC coverage, the FDIC needs to protect that something’s clients. And the FDIC also needs to bring the hammer down HARD on any institution it catches incorrectly claiming coverage.
The core purpose of the FDIC is to create a trust in banking institutions that doesn’t require a ton of financial expertise on the part of savers. This FDIC decision, while technically correct, undermines that core purpose.
The Simple Conclusion: Don’t Use Fintech Services Until FDIC/SIPC Catch Up
The bankruptcy of Synapse serves as a stark reminder that fintech innovation, while transformative, carries hidden vulnerabilities that investors cannot afford to neglect. The FDIC’s refusal to backstop Synapse’s depositors demonstrates that indirect, opaque custodial relationships can—and do—compromise investor protections.
Robo-advisors and other fintech custodial platforms, while convenient and cost-effective, may inadvertently expose investors to similar risks if their custodial arrangements fail to satisfy SIPC’s stringent requirements. Savvy investors, attuned to risk management and asset protection, should strongly consider traditional custodians with proven track records of regulatory compliance, transparency, and SIPC protection.
I think it’s simple– modern online banking services (Chime, Cash App, etc) and robo-advisors (Betterment, Wealthfront, etc) simply shouldn’t be used, by anyone, until the FDIC and SIPC come to their senses about this.
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