Transcription:
Penny Crosman (00:03):
Welcome to the American Banker podcast, I'm Penny Crosman. The lawsuit that Yotta, a savings app provider, filed against Evolve Bank and Trust in September has had a few new developments. Here to share her legal perspective on this case is Dara Tarkowski, managing partner at Actuate Law. Welcome, Dara.
Dara Tarkowski (00:23):
Hi. Thank you so much for having me.
Penny Crosman (00:26):
So for anyone who hasn't been following this case, it revolves around Synapse, a banking-as-a-service provider that provided a shared ledger for the fintech clients that it had and the bank partners that worked with those fintech clients to do things like hold deposits, things that fintechs can't do because they don't have a banking charter. And Synapse was responsible for providing the recordkeeping of all these fintech accounts. When Synapse went bankrupt and the ledgers were analyzed and compared against bank records, somewhere between $65 (million) and $95 million of customer money was determined to have gone missing, and a lot of people are quite upset about this. So Yotta, which is one of Synapse's fintech customers, filed a lawsuit against Evolve Bank and Trust, which was the bank that held the deposits of the savings accounts that Yotta users had, and it accused Evolve Bank and Trust of misappropriating customer funds. Then last week, after this case has been going back and forth with various legal proceedings, Yotta filed an amended complaint accusing Evolve of not only misappropriating funds but of running a Ponzi scheme and lying about it. Dara, did I leave anything important out from that little recap?
Dara Tarkowski (01:56):
I think that the only color that I would add based on the procedural history, which is important when we view the amended complaint through the lens that we're going to, is that Yotta's original complaint was dismissed, and the reason it was dismissed is because the judge felt that it did not allege sort of the who, what, when, where, why with enough particularity to survive a motion to dismiss, which means forgetting about the evidence, just the pleading on itself and the allegations which don't even have to be proven at that stage, were still insufficient to form an accurate basis for the causes of action that they were trying to bring. It is not atypical for plaintiffs to have this happen to them.
Penny Crosman (02:39):
So in other words, you believe that there are some legal flaws in Yotta's argument?
Dara Tarkowski (02:50):
Well, I can tell you that the judge in the district court of California absolutely did the first time around, and that's why she dismissed it. And it's very typical at early stages of pleading for the judge to give you a second bite at the apple. Some plaintiffs get thirds and fourths as well. So that's what this amended pleading was. It was essentially Yotta's second chance after the judge dismissed their original complaint for failure to state a claim.
Penny Crosman (03:15):
Now, as far as you know, does Yotta have access to actual communications that might prove one way or the other what Evolve actually knew about any missing customer funds in this timeline? We're talking about before they shifted a lot of money over to another fintech, Mercury. Do you have reason to think that Yotta has evidence in terms of communications and such that could back up this claim that Evolve knew exactly where this money was or knew money was missing before making another fintech customer whole?
Dara Tarkowski (04:07):
Well, I can tell you that I don't have any personal knowledge of that. I can tell you as a litigator, if I were the plaintiff Yotta's attorneys filing this complaint and I did have some of those communications, I probably would've included the specificity of those communications within my complaint because it would've made it stronger and less susceptible to dismissal. So I can infer that the failure to identify some of those communications in the amended complaint when this is already their second chance leads me to believe that they believe that they're out there, but they're not in physical possession of them. And hopefully they believe that they're out there because otherwise they were treading on sort of treacherous ground and some of the accusations and allegations that they're making using I think very hyperbolic phrases like Ponzi scheme. If you're going to call something a Ponzi scheme, you really should have reason to believe it. But I actually think that's one of the major weaknesses in the complaint as I read it, is that you can say it as many times as you want — 10, 12, a hundred times — but you need to be able to allege facts to support.
(05:21):
If you are claiming it's a Ponzi scheme structure, you better have good reason to believe that. And I think that that was, if it were me, I think that that's likely a misstep to characterize it that way.
Penny Crosman (05:32):
And as far as you know, has the discovery process been completed, or will they still have an opportunity to gather more evidence of this?
Dara Tarkowski (05:42):
We're still at the pleading stages right now, so we haven't even, no one's even answered the complaint at this point. So whether or not there was some discovery that was issued before, unfortunately Pacer gives us a lot of information, but it doesn't tell us every detail that's happened between the parties. I wouldn't be surprised if some discovery has taken place, but I would guess that it's less likely because you don't have a set of operative pleadings yet. And what I mean by that is a complaint that withstood the court scrutiny and has not been dismissed and an answer from the defendant. If I am guessing, I think Evolve is going to move to dismiss this complaint. Again, that's me with my betting hat on. I would be shocked if they didn't try to at least trim this down some, because one of my other sort of observations from the complaint is they threw a lot of crap at the wall.
(06:39):
Some of it might stick, but I don't think all of it's sticking. And if I were Evolve's attorneys, I would either try to get it again, dismissed in its entirety, they were successful the first time, or at a minimum I would try to narrow it significantly and get the Ponzi scheme allegations out. And one of the tricky things that I don't think the public has a full appreciation for is when you're filing certain claims in federal court, there are different pleading standards depending on what you're saying. So a notice pleading standard for a negligence claim is easier to get past a motion to dismiss than a fraud claim. A fraud claim has a heightened pleading standard in federal court, which means you need to allege more particularities. So it's not always apples to apples. Certain claims are held to a much higher standard than others. And when you start throwing around terms like fraud and Ponzi scheme, you're in heightened pleading standard land, not in the notice pleading land. And when you start jumbling those things together, that gives defendants a really good procedural opportunity to get cases kicked out of court.
Penny Crosman (07:52):
That's very interesting context. Thank you. And what about the fact that the bankruptcy trustee Jelena McWilliams is trying to shift this from a Chapter 11 to a Chapter 7, does that affect any of this? I mean, trying to shift Synapse's bankruptcy from Chapter 11 to Chapter 7, does that affect a lawsuit like this?
Dara Tarkowski (08:22):
I mean, Synapse wasn't named, so I don't think Yotta wanted to deal with the complexities of what the bankruptcy courts do to adverse litigation cases, which I actually, again, think is another sort of glaring issue. In the amended complaint, you have this sort of third-party actor who is this major, major player in — let's pretend they're right for a second and it's a Ponzi scheme. You've got a key figure in this scheme who's not a defendant in the complaint, who isn't, maybe they issue third-party discovery and try to work with the bankruptcy trustee to try to get some information into the case, but they didn't name them on purpose because they don't want to deal with the procedural headaches of bankruptcy court because that definitely adds a layer of complexity, time and money. So I think that they're trying to go cleaner, direct toward Evolve, but it does leave sort of a gaping hole in proving their allegations.
Penny Crosman (09:26):
Do you think any of the leaders of these companies involved may be held accountable like the leaders of Synapse, leaders of Evolve, leaders of the other banks involved? Do you see any sort of personal liability coming from any direction?
Dara Tarkowski (09:45):
I will say this, there's civil liability, then there's regulatory liability, there's all sorts of liability. Obviously criminal investigations are confidential. I have no information one way or another if there is any sort of criminal activity happening. So I'm not going to comment on that part one way or another. From a civil liability standpoint, it is absolutely possible that if they find communications or any information within the discovery process that would point to some sort of knowledge intent or a C-level executive sort of acting outside the scope of their duty, you can always try to ask the court to add a defendant. So I've seen situations where principals and executives are added in later, once the discovery reveals that you need permission from the court to do that, but it's absolutely possible. And then on the regulatory side, this is one of those cases where FDIC has rolled back a lot of rulemaking.
(10:52):
We all know this, they haven't rolled back this rule though, and I believe it's because they do not want to deal with another Synapse disaster. It's a giant mess for the FDIC as well. I don't think any regulator wants that. So I think the most likely candidates for holding individuals accountable would likely be on the regulatory side. They always have the ability to exert the most pressure. And that being said, our financial services regulators are in a weird space and time right now given the current administration and what their directives are and aren't. So I don't think it will happen quickly. That's my guess.
Penny Crossman (11:36):
And when you said the FDIC rule, is that the reconciliation rule that would require banks and fintechs to settle their obligations or to have a shared sense of where all customer money is at the end of every day?
Dara Tarkowski (11:54):
Yes, I think that that's absolutely the rule. I call it the ledgering rule. That's what I call it in my mind. But I think just to put a finer point on that, the Trump administration's FDIC has been busy withdrawing various proposed rules. They withdrew brokered deposits, corporate governance, the executive compensation rule, but this one is essentially the FBO recordkeeping rule. I call it the ledgering rule, but that one remains very much alive. The comment period was actually extended through Jan. 16th. And I do think there's been a little bit of industry pushback. The rule, I think, and I'm sure that you guys have covered this already, it can affect 600 to a thousand-ish banks if this rule actually goes forward. And the proposed rule does essentially, force banks to know exactly whose money they're holding at all times. So there was obviously a gap in the rules which the FDIC is trying to address. So the irony is that Yotta is saying Evolve should have been doing this the whole time. Well, if they should have been doing this the whole time, then the FDIC wouldn't need to be pushing this recordkeeping rule through. So it's a weird dichotomy between the two, which is, I don't know if I'm buying everything that Yotta is selling right now in their amended complaint. I don't know a nicer way to say that.
Penny Crosman (13:19):
Well, it's interesting. It seems like there aren't a lot of regulatory rules that are specific to bank fintech partnerships. I mean, there's third-party vendor management, but these partnerships are a little bit different than that, where the fintech is kind of an extension of the bank itself. Do you think we might see a number of new rules come as a result of some of these cases?
Dara Tarkowski (13:50):
If we were under a different administration? I'd say yes, for better or worse right now, I think that the recordkeeping rule is remaining live and and hopefully coming to fruition. I'm happy to be wrong about this in the future, but I think that we should take what we can get at this point. But I do not see any comprehensive sort of BaaS program rules coming out of any regulatory body right now. And by the way, Penny, I totally agree with you. There had been a dearth of rules. Everything was sort of shoved under this third-party oversight rule, which is why we had FDIC examiners around the country sort of regulating by enforcement. And it all sort of started with Cross River. It didn't really end there, and it had been very sort of gut check shoot from the hip.
(14:49):
How well can I work with my examiner in any given time to explain the program and why what we're doing is OK. I've been part of those conversations on behalf of my bank clients. And it's odd because as a lawyer, I like to have rules. I like to say, here's what we got, here's what we did, here's why it's OK. And we've been operating in a land of gray for quite some time with BaaS now. So the brokered deposit rule in connection with the recordkeeping rule, I think would've maybe more comprehensively addressed our BaaS dynamics. But we lost that one, but we kept the recordkeeping one, so we didn't lose everything. And my clients want to follow the rules, so we've got to know what the rules are. So clarity would be real nice.
Penny Crosman (15:40):
So yes, that makes a lot of sense. So are there any kind of overall takeaways, do you think, from this whole experience for banks and for fintechs, things they might want to think about doing differently going forward?
Dara Tarkowski (15:58):
So I think that I'll start with the fintech side. I think that most fintechs, at least the ones that I work with, are sort of hyper aware now that their entire livelihood, business model, ability to exist rests upon a lot of these banking relationships. Whether or not they want to admit it, Yotta didn't want to acknowledge it in their complaint, but they have oversight responsibilities to their customers as well. And it is also incumbent upon fintechs to ensure that everything is being done the way they are communicating to their customers. So I don't think that there's one party to blame here. I think there were failures across the board, and everyone wants to point the finger at one another. In the meantime, you've got customers who have lost millions and millions of dollars, and that's not OK. But I don't think the blame lies with any one party. It was absolutely a team effort to fail at this level. And the notion that you can sort of absolve yourself and pour all responsibility onto another party and say, well, the contract protected us, I just don't think goes far enough. So I think that's my takeaway. There is no absolution here. Everyone has to be responsible for their part of that customer interaction, those fiduciary responsibilities and the representations that they make to their customers and the public.
Penny Crossman (17:36):
Do you think these customers will ever be made whole? And if so, how?
Dara Tarkowski (17:43):
I think Evolve is trying. I think that they had been going through a lot of effort to try to locate and track down these funds. I think how will come more out of what we learned from the trustee through the Synapse bankruptcy, the trustee's literal job is to try to find and track down all of these assets. That's never a quick process. So the answer is maybe. Do I think that every customer is going to be made whole? No, I don't. The only way that that might change is if the FDIC steps in and tries to fill a gap. I don't know whether or not that's going to happen. I don't know that this administration has any appetite for it.
Penny Crossman (18:27):
Yeah, that makes sense. Well, Dara, thanks so much for joining us today. To all of you, thank you for listening to the American Banker podcast. I produced this episode with audio production by Wenwyst Jeanmary. Special thanks this week to Dara Tarkowski, managing partner at Actuate Law. Rate us, review us and subscribe to our content at www.americanbanker.com/subscribe. For American Banker, I'm Penny Crosman and thanks for listening.