A Washington Saga: The Strange, Winding Tale of Reserve Trust
Plus, Apple's BNPL plans are not a slam dunk.
Number of the Week: $3.5 billion (explanation below)
The Strange, Winding Saga of Reserve Trust
Nothing encourages Congressional regulatory scrutiny as much as a good partisan scrape. Americans who are concerned that a tiny, Colorado-based fintech company may have unduly received a government favor can sleep at night, knowing that Senator Pat Toomey (R-PA) is taking on the issue with bulldog tenacity. This crusade is a little surprising because Toomey, who is the ranking member of the Senate banking committee and is not running for re-election this fall, usually positions himself as a friend of financial innovation.
But, you see, the company in question—Reserve Trust, which has been neatly labeled “the Stripe for B2B payments”—has important ties to prominent Democrats. Toomey has been raising questions about Reserve Trust at least as far back as February, and to date the answers have been less than illuminating, even if the stakes are lower than Toomey’s hyperventilation suggests.
Let’s start at the beginning: Reserve Trust was founded in 2016, and very quickly applied to the Federal Reserve Bank of Kansas City for a “master account,” meaning that the company would have direct access to the Federal Reserve’s payment system, and can settle transactions with other member banks using the Fed’s money. Very few fintech startups bother to make such applications, because it’s pretty obvious they don’t qualify. Reserve Trust is a state-chartered trust; master accounts are typically meant for federally recognized banks, savings and loan associations, and similar institutions that handle deposits. Unsurprisingly, the Kansas City Fed rejected Reserve Trust’s application in mid-2017.
Around that time, some politically interesting things happened. When Donald Trump took office, Sarah Bloom Raskin stepped down from her position as Deputy Treasury Secretary (at the time she was the highest-ranking woman in Treasury’s history, and she had previously served as a governor of the Federal Reserve Board). Raskin began teaching at the University of Maryland, but also joined the board of Reserve Trust and received equity as compensation. According to Toomey, Raskin called Kansas City Fed President Esther George shortly after Reserve Trust’s application was rejected. The next year, the Kansas City Fed reversed its decision and granted Reserve Trust a master account—the first and apparently only nonbank to acquire that status.
All this surfaced earlier this year, when Raskin was nominated to be the Federal Reserve’s banks regulator. The Kansas City Fed, finding itself under Congressional fire, issued a statement saying that Reserve Trust “changed its business model and the Colorado Division of Banking reinterpreted the state’s law in a manner that meant [Reserve Trust] met the definition of a depository institution.”
It may not matter much, because it seems like the Fed has a fair amount of discretion in who it gives master accounts to, but as long as we’re keeping score: a) Reserve Trust to this day describes itself as a “non-depository, Colorado chartered trust,” and b) the Colorado banking regulator labeled the Fed statement a “misrepresentation.”
Raskin left Reserve Trust in 2019, and in late 2020 sold her stock in the company for $1.5 million. This created a headache for her husband, Representative Jamie Raskin (D-MD), because he didn’t disclose anything about her company role until eight months after the sale, a violation of Congressional rules. (Raskin has explained that his son committed suicide around the time the form should have been filed, but that doesn’t account for the failure to disclose her work for the company in the previous years.) All of this was a factor in Sarah Raskin withdrawing her nomination earlier this year.
But the story doesn’t end there. This week, Toomey revealed that the Kansas City Fed has now revoked Reserve Trust’s master account. FIN reached out to the company for confirmation, and received no reply. However, the Fed master account was prominently referenced on Reserve Trust’s Web site as recently as June 10; it has since disappeared and the site is now a single page with little information on it. One of the company’s founders, Dennis Gingold, told Bloomberg that he and other board members had sold their shares to one of the company’s largest investors, QED Investors. One of QED’s partners, Amias Gerety, worked for Sarah Raskin at Treasury. When QED led Reserve Trust’s Series A round in 2021, Gerety boasted that its relationship to the Fed was a big attraction. No one, including Toomey, is offering a public explanation for why the master account was apparently revoked, but it would be foolish to think that Toomey will let this issue go.
At the same time, it’s worth stepping back and figuring out what all this means.
Did the master account give Reserve Trust an advantage? Absolutely. It’s long been the first thing the company says about itself, it attracted customers that otherwise might go elsewhere, it was undoubtedly a factor that helped the company raise $35.5 million. If it’s been revoked, that may be a fatal blow to the business.
Was Sarah Raskin transparent about her contacts with the Kansas City Fed? No. While she never outright denied that she had contacted the Fed directly, she was given ample opportunity in her confirmation hearing to explain her role, which she sidestepped. It’s hard to imagine Raskin ever getting Congressional approval for another government role.
Was the Fed wrong to give Reserve Trust a master account? Morally or legally wrong? Probably not. If, as now seems likely, the Fed has determined that Reserve Trust doesn’t qualify, it certainly looks stupid, but there are rules for handling these applications, and as long as they were followed, there’s not much anyone can do to second-guess the decisions. Logistically wrong? Probably. Either the Fed gives such accounts to no nonbanks, or it gives them to some. The problem is that now there will be lots of nonbanks who think they are at least as qualified as Reserve Trust. On Friday, a Wisconsin-based financial firm called Custodia filed a legal complaint against the Fed and Kansas City Fed, arguing that they are unlawfully refusing to act on Custodia’s application for a master account.
Apple’s BNPL Plans Are Not a Slam Dunk
This post originally ran on Observer.com.
This week Apple made financial waves by announcing that it will begin offering Buy Now Pay Later (BNPL) services through Apple Pay. BNPL allows consumers to split purchases into multiple payments over time, typically with no interest, and is a fast-growing segment of the payments market. Companies like Klarna and Affirm focus almost exclusively on BNPL, while PayPal and other fintech companies have added BNPL services within the last two years.
There are many reasons for BNPL incumbents to fear Apple’s entry into the market, starting with hardware advantage: there are more than 1 billion active iPhones in the world. Moreover, while Apple Pay got off to a slow start after its 2014 launch, it currently enjoys more than a 90% market share of all US mobile wallet payments, according to Statista.
The number of consumers using BNPL has skyrocketed during the last two years, fueled in part by a pandemic-driven rise in contact-free payments, as well as a desire to avoid paying the high interest that credit cards charge. The 2021 global BNPL market was estimated to be $125 billion, and is projected to grow to trillions of dollars within the next few years.
While banks and financial companies have long feared that big technology firms could eat their lunch, there have been several false alarms in recent years. In 2019, Facebook shook the world by announcing it intended to create its own currency, originally known as the Libra. When regulators balked, the idea retreated to a kind of stablecoin called Diem, but that, too, was scrapped. Similarly, Google announced with great fanfare in 2020 that it was going to massively expand Google Pay into a service called Plex, which was to include banking accounts and Google-issued credit cards. A little less than a year later, Google killed the program.
Why do Big Tech financial efforts often falter? Silicon Valley companies like to operate under Mark Zuckerberg’s famous motto “Move fast and break things.” By contrast, banking and finance is a highly regulated industry. In addition, big tech companies usually have important relationships with banks, which can create awkward situations. When, for example, Google announced that it was not going forward with Plex, theWall Street Journal reported that a top Google executive “was concerned that Plex could make other banks think that Google was out to compete with them.”
While Apple Pay Later seems far more modest than Google’s Plex ambitions, it nonetheless shifts Apple’s relationship with some banks. The Financial Times reports that the Apple Pay Later loans will be made through a wholly owned subsidiary called Apple Financing LLC. In the past, Apple has worked with banks such as Goldman Sachs and Barclays to issue credit cards and offer financing to buy Apple products.
It's also possible that BNPL will not continue to grow at its recent feverish pace. Numerous surveys have indicated that BNPL consumers have missed payments, and in many cases have had to use credit cards to pay off their BNPL loans. Investors have begun to notice that the BNPL space is highly competitive; shares in Affirm are worth a small fraction of their value a year ago.
You Read It First in FIN!
FIN, June 5: “Within the last few years, several trading platforms—such as Forge and EquityZen—have emerged that allow private shares to be bought and sold, attracting hundreds of thousands of investors and billions of dollars a year in trades. But the IPO market has cooled considerably, and many tech startups that have gone public have witnessed dramatic drops in value. The moribund IPO market has created a new dynamic for would-be buyers and sellers. With many startups putting their IPOs on hold, people who own those shares face the prospect of tying up their potential wealth for longer than they’d originally planned, perhaps for years. For some, selling those shares now may look more attractive than waiting for an IPO that might never come.
‘You have an influx of shareholders, relative to before’ acknowledged Phil Haslett, EquityZen founder and chief strategy officer, in a FIN interview….In March of this year, San Francisco-based Forge became a public company …its SEC filings show…trading volume on the Forge platform nearly tripled between 2020 and 2021, from $1.15 billion to $3.2 billion. That growth, of course, took place in a favorable market and IPO environment. The same SEC filings also show that in the first quarter of 2022, about $418 million worth of trades took place on the Forge platform, down 45% from the same period in 2021.”
The Information, June 9: “With the market for initial public offerings all but dead this year and the likelihood of down rounds looming, startup employees have been racing to cash out of their shares. In theory, secondary markets dealing in private companies’ stock should give people a way to do that. There’s just one problem: Someone has to be willing to buy….In the first quarter of this year, secondary market broker Forge processed 596,000 trades, down 61% from the same period in 2021.”
🦈Number of the Week: According to a tally by The Block (paywalled), venture capital invested $3.5 billion in crypto projects during the month of May. While that is a lot of money, it’s the lowest monthly sum in six months.
🦈For decades, many observers have perceived a tremendous opportunity in enabling small businesses to communicate and cooperate with one another. This week, New York-based Codat announced it has raised $100 million to build out a universal API for small businesses to share data. Investors include JP Morgan, Shopify and Plaid.