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How Many Lawyers Does It Take to Save a FinTech?

Bank regulation is older than you think. The ancient Code of Hammurabi, which predates Moses and the Biblical legal code of the Pentateuch, includes rules for interest-bearing loans (not more than 30% interest for past due loan repayments!) Since then, review of the history of banking shows that regulation of financial services has become more and more complex and extensive.

In conversation yesterday with Bryan Cave regulatory lawyer Dan Wheeler, it struck me that many FinTech startups may be underestimating the value of hiring regulatory counsel. This is understandable. Lawyers aren’t cheap and they’re not generally quick – we all know the jokes.

When I was running a commercial mortgage company a few years back, I worked with all sorts of lawyers – litigation, bankruptcy, contract, employment, etc. But the most important long-term relationship was with our primary regulatory attorney. He knew all the regulations we were subject to (and there were many), was aware of changes, interpreted case law implications, and helped us when we were in disputes with investors, borrowers and regulators. He wasn’t cheap. But he was invaluable (and remains a good friend).

Banks know this of course. They all have internal and external counsel, and extensive budgets. They also know what happens when they don’t follow regulations – massive fines, reputational damage, and sometimes restrictions on their ongoing business (such as cease-and-desist orders).

But this applies to FinTech companies as well, particularly those that are offering services in competition with, or complementary to, the banks. For example, although Dodd-Frank is considered primarily to be banking regulation, marketplace lenders are now also under the purview of the Consumer Finance Protection Bureau. Prominent FinTech companies been recently been fined for misleading advertising, poor security practices, and failure to register as an MSB, among others.

But even FinTech companies looking to partner with banks need to be clear about the regulatory environment they are touching and playing in. Their bank customers expect it of them. And their investors should expect it too, since there are often regulatory risks for the FinTech itself.

What do regulatory attorneys do for FinTech companies?

  1. They advise on the legality of a proposed business model. Sometimes disruption is only possible because bank regulations don’t allow the banks to do what the FinTech is proposing to do. In this case, the FinTech itself will sooner or later be under equivalent regulation. A good example is the heightened attention paid by the US CFPB to marketplace lenders.
  2. They advise on the applicability of different regulations for particular businesses. There are 10 bodies regulating banking activities at the US Federal level, in addition to regulators in every state, and many differences from country to country around the world.
  3. They help certain FinTech companies navigate complex and time-consuming registration requirements with regulatory agencies (state of national).
  4. They help FinTech companies to understand the regulatory context in which their bank partners are operating. This allows the FinTech to speak to the real bank challenges surrounding a solution, and to partner with the bank to refine the solution as needed.
  5. They can help with the design of RegTech products, specifically focused at helping banks to address regulatory challenges like Anti-Money Laundering, sanctions checking, customer due diligence, capital adequacy reporting, stress tests, and transparency.
  6. They advise on specific regulations impacting product design (for example cyber security and privacy requirements for products and services in a particular jurisdiction).
  7. They represent FinTech clients when things go wrong (which can still happen with the best of up-front planning).

For some FinTech companies the need may be as little as a confirmation that they are not directly impacted by regulation, and that they are not partnering with banks in highly regulated activities. At the other extreme, it may be worth hiring a regulatory expert on a fractional basis to join the team. But for most FinTech firms, consulting with and retaining regulatory counsel now will have several benefits:

  1. Significantly reduce the risk that the FinTech itself falls foul of regulators.
  2. Provide the understanding necessary for a FinTech to take into account bank regulations when designing holistic solutions for a bank.
  3. Represent a FinTech when regulatory questions arise.
  4. Provide legal support in regulation-related litigation.

Worth checking out, surely?

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Comments: (11)

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 11 July, 2016, 18:381 like 1 like

We probably won't have a Uber today had its founders bothered to find out the complete legal standing of their proposed car ride service amidst the regulated taxi industry. Ditto for AirBnB vis-a-vis hotel regulation. I tend to believe that whatever few fintechs will emerge from the hype successfully will be ones that ignore legislation, gather enough traction and use that to shape legislation ex post facto to their own advantage.

Graham Seel
Graham Seel - BankTech Consulting - Concord 11 July, 2016, 18:43Be the first to give this comment the thumbs up 0 likes

Ketharaman, I respectifully disagree with your position. The most successful FinTechs in the long term will be those who understand and appropriately manage their regulatory risk, rather than hiding their heads in the sand. Managing risk may include accepting risk, as well as remediating, mitigating or transferring it. But risk acceptance (i.e. not doing anything about it) should be with full understanding of what the risk is, and determination that the company can handle future occurrence of the risked event. I think this is more like what Uber did, although perhaps not with analytic rigor. The lack of rigor in certain countries has been very painful for them (e.g. their need to retreat in Germany earlier this year).

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 11 July, 2016, 19:071 like 1 like

@GrahamSeel: Then we must agree to disagree. This whole concept of sensing risk, mitigating risk, etc., is enterprise world luxury. Even there, it mostly results in the enterprise doing nothing. So much so progressive enterprises are empowering their incubation units within their organizations to think out of the box and telling them "we'll think about regulation later". This whole legal awareness and risk sensitive approach is absolutely repugnant to the concept and style of startups. If Uber had followed this approach, it wouldn't be around in 459 cities today. AFAIK, Uber has retreated only one or two product categories in Germany - which is not a bad tradeoff for spreading to 75 countries. 

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 13 July, 2016, 17:091 like 1 like

I'm not the only one saying this. According to Fast Company article titled "The Food-Sharing Economy Is Delicious And Illegal—Will It Survive?"

"As startups launch in heavily regulated industries such as food, health, transportation, and housing, clashes with the law have become as common in Silicon Valley as office ping-pong tables. The MOST COMMON APPROACH to these regulatory battles—successfully embraced by lodging site Airbnb, ride-hailing app Uber, fantasy football site FanDuel, and DNA testing and analysis company23andMe— is to IGNORE THE TROUBLESOME LAW as long as possible. "For a long time, the advice was, just keep your head down, build the kind of network you need to be viable, and then once you have viability, NOBODY IS GOING TO BE ABLE TO SHUT YOU DOWN," ... "If Uber had gone to the regulators first, the entrenched interests would have crushed them in seconds. What might have been easy for regulators to squash in a startup is another matter after the offending business becomes one of the most valuable private companies in the world. When New York City Mayor Bill de Blasio threatened to limit Uber’s expansion last summer, the former startup, now months away from being declared a $62.5 billion company, orchestrated a campaign, complete with television ads, lobbyists, and even a "De Blasio’s Uber" feature in its app that showed users a dystopian world in which they must wait 25 minutes for a ride. The mayor backed down." (capitalization mine for emphasis).

Chetan Ghadge
Chetan Ghadge - Wipro - Pune 13 July, 2016, 17:581 like 1 like

@Ketha ..while you have made a valid observations and points about the start up DNA, don't you think these differ from industry to industry.  Banking and financial services is highly regulated and unlike other industries it has got a direct bearing on the performance of economy and governments. Add to that the reputation that bankers have earned post the 2008 financial crisis everyone in this industry is under scrutiny.

Having said that I am hoping that regulations don't kill innovation. However it just takes one shock for the whole system to come down. I am anxiously watching the fate of alternative lenders as I believe they are operating on the edge without much regulation and they might just trigger events like the sub prime crisis . 

 

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 13 July, 2016, 19:031 like 1 like

@ChetanGhadge:

TY for your comment and nice to hear from you!

Well, my examples of the approach used by startups to get ahead of the law are all from other highly regulated industries viz. food, health, transportation, and housing.

The purpose of regulation is to protect consumer's interest. In theory, it can coexist with innovation. But, regulation happens via regulators. In actual practice, I've rarely seen a regulator who asks the consumer how they wish their interest to be protected. Instead, most regulators assume they know best how to protect the consumer's interest and regulate away in a manner that puts a brake on doing things differently from status quo aka innovation. So regulation does kill innovation far more often than it facilitates innovation in the real world.

2FA regulation for online payments in India created an entire industry of prepaid mobile wallets that succeeded by finding a way to circumvent 2FA. Not sure whether you'd call that an example of regulation facilitating innovation!

IMO, while some law breaking startups will be forced to shut down, I doubt if many startups that go out of the way to find out the legal position of their offering will ever take off.  

As for subprime crisis, TBH I haven't seen any regulation from any regulator that would guaranteee a non-recurrence of the crisis - even by traditional banks, let alone online lending marketplaces!

Alexander De Lange
Alexander De Lange - Aurelia Financial Consultants cc - Johannesburg 14 July, 2016, 05:391 like 1 like Absolutely agree, Ketha!
Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 14 July, 2016, 19:21Be the first to give this comment the thumbs up 0 likes

TY for your kind words @AlexanderdeLange!

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 17 July, 2016, 11:41Be the first to give this comment the thumbs up 0 likes

This Economic Times article profiles many alt-lending fintech startups. Not surprisingly, the only fintech that tries to assess its legal standing - altflo - gets confused by the ambiguity and shuts down! 

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 17 July, 2016, 12:57Be the first to give this comment the thumbs up 0 likes

Sorry the correct link to the ET article is http://economictimes.indiatimes.com/small-biz/money/meet-the-alternative-lending-startups/articleshow/53244587.cms

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 19 July, 2016, 20:11Be the first to give this comment the thumbs up 0 likes

According to American Banker, it's not clear how many of 50+ regulators have jurisdiction over US fintechs! Amidst this confusion, fintechs can't be blamed for staying away from lawyers!!

Graham Seel

Graham Seel

Principal Consultant

BankTech Consulting

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This post is from a series of posts in the group:

Innovation in Financial Services

A discussion of trends in innovation management within financial institutions, and the key processes, technology and cultural shifts driving innovation.


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