GAO Asks Regulators to Increase Fintech Protections

April 17, 2018

The Government Accountability Office (“GAO”) wants securities regulators to step up their efforts in safeguarding investors and consumers from financial technology (“fintech”) products. In its March 22 report, the GAO said fintech products present the same risks as traditional products, but current laws and regulations may not sufficiently address such risks.

How much fintech firms must comply with applicable federal laws differs. Regulators like the Securities and Exchange Commission (“SEC”) can supervise fintech investment advisors just as they do traditional advisors, but the GAO said that digital assets could create unique risks to investors. The SEC, however, believes digital assets can be regulated similarly to securities. Additionally, as a fintech firm grows and accumulates more consumer data, data security and privacy concerns increase. As a result, the firm’s overall financial stability could be impacted.

When it comes to fintech firms selling tokens to increase capital during initial coin offerings (“ICOs”), investors become exposed to fraud and theft. Both the Securities Act of 1933 and the Securities Exchange Act of 1934 protect investors from token sales that fall under the SEC’s description of “security.” Still, the SEC the GAO stated that investors lack protections if they purchase tokens that fail to meet the definition of “security.” Investors also might not be able to recoup all of their funds if parties necessary to token sales exist overseas or have illegal operations.

The GAO report also noted how challenging the regulatory structure is for fintech firms. Federal regulators, for instance, examine specific activities of fintech lenders or payment firms while supervising risks resulting from the firms’ relationships with banks or credit unions. In other situations, state regulators monitor fintech firms, but leave enforcement actions to federal regulators. Dealing with numerous regulators, therefore, makes it difficult for fintech firms to identify which laws apply to them. Fintech payment and lending firms also told the GAO that complying with state requirements can be expensive and time-consuming.

To improve consumer protections, the GAO advises U.S. regulators to engage in interagency collaboration. U.S. regulators must also encourage fintech innovation through regulatory sandboxes, a practice that is popular among foreign regulators. This practice allows fintech firms to provide products on a limited basis and offer valuable insight on their products and risks to firms and regulators.

Some U.S. regulators have already implemented sandboxes, but the SEC has yet to do so. In response, the GAO wants the SEC to consider adopting knowledge-building initiatives concerning financial innovation. SEC chairman Jay Clayton supports the government watchdog’s recommendation, saying that his agency has actively participated in such efforts. Clayton also said the SEC would continue to participate in interagency initiatives as well as coordinate with foreign regulators.