Compound Banc says it can guarantee a 7% APY on your savings

Compound Banc pays 7% on deposits – or at least things that look a lot like deposits. But it’s not a bank, and the deposits—technically, they’re risky bonds—are not insured by the FDIC or anyone else.

Why is this important: People looking for insanely high interest rates on their money have learned the hard way to avoid crypto. This has created an opening for dollar-denominated products by taking advantage of various regulatory loopholes — and the fact that Americans are increasingly comfortable handing over their money to digital institutions.

The big picture: Compound Banc’s product is marketed as a digital high-yield account. Savings begin to accrue immediately at an APY of 7% (annual percentage return); savers can withdraw their money at any time without fees or penalties. “No if and or but about it,” said the home page.

• The product is aimed at very small investors: the minimum investment is only $10.

The catch: Compound Banc is neither a bank nor a brokerage, and its savings bonds, if you read its filings with the SEC, are characterized by “a high degree of risk”. Compound Banc accounts are not insured by the FDIC, SIPC or any other government regulatory body.

• “We lend primarily to subprime mortgage borrowers,” Compound notes on page 7 of its circular offer.
• The company’s co-founder and chief strategy officer, Yuvraj Tuli, told Axios that he can find sound “prime secured mortgages” with a one-year maturity and a loan-to-value ratio of 60% or less, yielding between 13% and 14%. Some of them can be purchased on the secondary market; other compounds will occur on their own.

How it works: If the value of the mortgage investments declines, this does not affect the amount of money Compound owes its bondholders, which will continue to accrue at an annual rate of 7%.

Between the lines: “There is no source of reimbursement here,” says Saule Omarova, a law professor at Cornell who had been named by President Biden to be America’s primary banking regulator. “You just hope to God there’s no racing and all real estate assets are doing well.”

• If Compound Banc loses money on its subprime mortgage investments, it could become insolvent, owing more money to its bondholders than it has in assets. His most recent Filing with the SEC shows total assets of just $20,642 as of June 30, 2022, although since then he claims to have raised $5 million in equity from an obscure Bahamas-based store called 26 Capital.

“It’s the least risky investment anyone can do,” according to Compound’s Tuli, even though the official SEC circular offer says the opposite. In fact, the least risky investment anyone could make would be to put money in one of the FDIC-insured savings accounts that Compound compares to.

• “They are certainly misleading about the risks involved,” according to Pat McCoy, a Boston College law professor who specializes in financial regulation. “It’s seductive. It’s so well done, it’s so upbeat.”

💭 My thought bubble: Americans are increasingly comfortable with investing on the Internet, and it is unreasonable to ask individual savers to try to determine whether a given bank (or “bank”) can afford to repay what ‘she must.

• The fact that Compound Banc has managed to operate without real regulatory oversight – they say they have already issued some $1.5 million worth of bonds – demonstrates the limits of the existing US regulatory infrastructure.

Regulatory Arbitrage

How is Compound Banc legal? Well, that might not be the case, according to the experts Axios spoke to. (The FDIC and CFPB declined to comment on Axios.) But the first thing Compound tries to do is walk a fine line between resembling a bank and be a bank.

The background: Since 1933, only banks were allowed to take deposits. But the law has no clear definition of what counts as a deposit – and since the rise of money market funds, the financial services industry has pushed the boundaries of selling something akin to a deposit without having to be regulated like a bank.

• Compound Banc says it doesn’t take deposits – it sells bonds instead. “It’s a bond product, but the consumer experience behaves like a traditional savings account,” compound investor Sahibjeet Kaur of 26 Capital tells Axios.
• Also, enforcement of this particular law would fall under the purview of the Department of Justice, and “historically, the DOJ hasn’t been too keen on enforcing the statutory ban on filing,” as Omarova tells Axios. .

The Office of the Comptroller of the Currency, which regulates banks, responded to a question from Axios by simply saying that “the OCC does not regulate Compound Banc”.

• In other words: it’s not our problem.

You can’t call yourself a bank, unless you are a bank. But can we qualify as a “bench”? Not really, McCoy said.

• In some states this is explicitly prohibited, but in others, including Florida, where Compound is registered, the term may sometimes be used, if there is regulatory permission.
• This permission came, of Russell Weigel III, the Commissioner of the Florida Office of Financial Regulation. But in granting it, Weigel explicitly made it clear that “the company will not engage in any business pretending to be a financial institution.”
• Also, even if Florida allows Compound to use the word “bench,” that doesn’t mean federal regulators would be OK with it. “If the FDIC were to investigate, they would be very concerned about the impression generated by ‘bench,’” McCoy told Axios.

The compound sells up to $75 million in deposit-like bonds – the maximum allowed under Regulation Aa way for smaller companies to issue bonds without incurring the expense and scrutiny associated with a full public offering of securities.

• “They’re playing this multi-layered regulatory arbitrage game,” Omarova says.

And after: Compound has no plans to stop at $75 million. Kaur, the investor, tells Axios that as soon as Compound issues its first $75 million of bonds, it will launch a second issuance of $75 million, and so on. Eventually, he says, after two or three bids, it might be more economical to make an S-1 public offering because there is no cap on their size.

• In theory, the amount of money in Compound’s accounts could grow much faster than Compound’s own assets.
• Even clients who regularly check SEC filings will find only infrequent and outdated updates on the amount of Compound’s assets or the performance of those assets.

The two regulators Best placed to review Compound Banc are the FDIC and CFPB, both of which declined to comment on Axios. For now, however, only the SEC has the obligation to scan Compound.

• Both the FDIC and the CFPB have the authority to issue a temporary cease and desist order, McCoy says: “They could shut it down very quickly.” The idea would be to halt the solicitation of funds from investors, at least temporarily, while simultaneously issuing a press release warning clients of the risks involved.

Compound Banc website “raises a number of important questions that I think will quickly condemn this scheme,” says banking policy analyst Karen Petrou of Federal Financial Analytics.

• Petrou was one of two experts who used the word “Ponzi” in conversations with Axios. It’s not necessarily because they think Compound Banc East a Ponzi scheme, and more so because they fear its business model is prone to deadly Ponzi-style spirals like the one we saw at the now bankrupt crypto exchange, FTX.
• Here’s how it could happen: Compound Banc’s liabilities are continuously growing at a rate of 7%, while its assets are tied to volatile mortgage products. Clients only get rare glimpses of the value of these mortgage products – just as FTX clients had no visibility into the asset side of FTX’s balance sheet.
• As long as a business isn’t asked to return its customers’ money – meaning its inflows exceed its outflows – it survives, even if it’s insolvent. It’s only when customers collectively decide to withdraw their money that they find out what’s supporting it (or not).

Where is it : At the time of printing this bulletin, only in very small print at the bottom of the Compound Banc home page the company says its product is not FDIC-insured, even though above it explicitly compares its returns to the “FDIC national average.”

• The homepage, however, leads with the bond yield, expressed in “APY”. It is a legal term regulated under the Federal Truth in Savings Act, which means that the CFPB requires regulated banks to show their APYs on an apples-to-apples basis. Using that term “reinforces the impression that this is a regulated bank savings product,” according to McCoy.
• Products regulated under the Truth in Savings Act offer various consumer protections, none of which appear to be offered by Compound.
• There is also nothing on the website that clearly indicates the bonds are high risk, beyond a small link to the official SEC. circular offer. Indeed, Axios received an email from Compound with the subject “Avoid the risks and win big”.
• Compound Banc’s chief operating officer, Anoop Singh, told Axios in a statement that “investors should consider our many risk factors before making an investment.”

The bottom line: It’s incredibly easy these days to create a sleek website that looks like that of a regulated financial institution. It is the job of regulators to ensure that consumers are not misled.