Neobanks and FDIC Protection

Are FBO accounts eligible at all for FDIC insurance?

In a troubling trend, some neobanks are employing questionable account structures that leave their customers' funds in regulatory limbo, potentially without the federal protection many have come to expect. As I wrote yesterday, this is happening with Yotta now. I used Yotta for my family spending, and it was the only bank my daughter uses (used) at college for living expenses. All funds are frozen because of Synapse's failure, and the FDIC told the court on 5/17 that the FDIC insurance does not cover this arrangement.

Neobanks like Yotta and Synapse operate as fintech firms without bank charters and are not directly eligible for FDIC insurance. Yet these companies often partner with FDIC-insured banks and claim customers' money is just as safe as it would be in a traditional checking account. They represent to customers that deposits are FDIC eligible. I provided a summary of the Terms in yesterday's article and now I want to break down the statute more fully to understand it.

The FBO

A "for the benefit of" (FBO) account is a custodial account where funds are held by a custodian on behalf of one or more individuals who are the actual owners of the funds. Neobanks often use FBO accounts to pool customer deposits at partner banks. However, the fine print reveals a more complicated picture. By setting up FBO accounts that don't name individual customers and transferring funds in ways that muddy the chain of ownership, these neobanks seem to undermine the "pass-through" FDIC coverage completely they promise account holders.

Yotta's Terms of Service state that customer deposits are held in FBO accounts at partner banks like Evolve Bank & Trust and Thread Bank (Yotta TOS, p.12). While Yotta asserts these accounts are "eligible" for pass-through FDIC coverage up to $500,000, the Terms also caution that the FBO accounts may be aggregated with a user's other accounts at the partner banks for FDIC insurance purposes (Yotta TOS, p.12). Being "eligible" for coverage does not mean it's covered, in fact. The model the neobanks use contradicts the FDIC's notion of pass-through coverage, where each individual customer's funds should be insured separately.

Yotta partners with Synapse, now bankrupt, another fintech that spreads deposits across a "List of Program Banks" (Synapse TOS, p.18). There is no evidence that the Synapse FBO structure allows for the clear titling and tracking of individual ownership required by FDIC rules. I don't have any details on whether the banks maintain the necessary records of the agency relationships and each depositor's ownership interest. Consumers are left totally in the dark.

An "Insured Deposit"

The Federal Deposit Insurance Act defines "insured deposit" as the net amount due to any depositor for deposits in an insured depository institution (12 U.S.C. §1813(m)) Also, the FDIC allows certain custodial accounts to qualify for "pass-through" insurance, where coverage passes through the custodian to the underlying owners. However, there are specific requirements that must be met (12 C.F.R. § 330.7):

"The deposit account records of the insured depository institution must disclose the existence of the agency relationship and the ownership interest of the principal." (12 C.F.R. § 330.7(b)(1))

and

"The records of the insured depository institution or records maintained by the agent or other party must disclose the identities of the principals and the ownership interest of each principal in the deposit account." (12 C.F.R. § 330.7(b)(2))

The FDIC may not recognize pass-through coverage if these disclosure requirements are unmet. Are the neobanks meeting these requirements?

Enforcement by Cease & Desist

Recent FDIC enforcement actions underscore the risks posed by neobanks' misleading statements about deposit insurance:

• In an August 2023 letter to crypto firm Unbanked, the FDIC asserted the company falsely represented that FDIC insurance was available for cryptocurrency and would protect against crypto-related losses. The FDIC emphasized that FDIC insurance only covers deposits at insured banks and protects against losses caused by bank failure.

• In a March 2024 letter to neobank PrizePool, the FDIC stated PrizePool misrepresented its own insured status and falsely implied FDIC insurance would cover losses on its investment products unrelated to a bank failure. The FDIC noted that the proper disclosures regarding which banks held customer funds were not made.

1. In a March 2024 letter, the FDIC accused investment firms AmeriStar and HighLine Gold of falsely advertising their high-yield certificates of deposit as FDIC-insured. The FDIC clarified that FDIC insurance does not cover investment products and only applies to deposit accounts at insured banks.

You're Probably Not FDIC Insured

Based on my review, customers of neobanks probably do not have the FDIC coverage they think they have. Customers should be cautious about relying on pass-through coverage without more transparent disclosures on how neobanks' FBO accounts are documented and tracked to preserve the necessary principal-agent relationships. The FDIC could challenge any pass-through insurance claim if the proper formalities are not followed.

Without transparent compliance with the rules, the only prudent assumption is that these fintech FBO accounts do not qualify for full FDIC insurance. Consumers should press neobanks for detailed information on where their deposits are held and in what form before counting on FDIC protection. Simply put, if it sounds too good to be true, it probably is. This sleight of hand by neobanks puts consumers at risk and demands greater scrutiny.

If you know the rules for this situation, please comment on them and help me understand them better. I hope to see relevant statutes, rules, and decisions, not general opinions.