BankThink

Fintechs' culture must evolve as the sector matures

As fintech evolves because of market demands, COVID-19, and the calls for social and racial justice, so do the regulatory, enforcement, and litigation risks.

Although initially perceived by traditional brick and mortar banks as marketplace disruptors, fintech companies have shifted their approach to a mostly collaborative one. Both sides are looking at each other as service providers for their respective offerings. With fintech bringing new technology and priorities, longtime trusted banking institutions are able to offer traditional banking, such as savings and checking accounts with expanded lending options and resources (e.g., SoFi Money), and varying card programs (e.g., Wex Bank and Divvy).

Banks have heeded fintech’s consumer-driven focus, which is dictated by easy access, low cost entry, and convenience.

Once limited to millennials and Gen Z, in light of COVID-19, nearly everyone has shifted to shopping, budgeting and paying bills online or through mobile applications. For example, while in real estate “cash is king,” that old adage falls flat on daily transactions, prompting a rise in digital payment and contactless payment systems. This has led to more than 200 banks and credit unions partnering with the Zelle app via Fiserv this year, more than doubling the financial intuitions using the P2P platform in 2020 alone.

While the scope of product partnerships vary widely, so do the methods. Fintech companies are not always selling their software or being acquired. Rather, they are also involved in leasing programs under a software-as-a-service (SaaS) model, in which a bank can establish its own label for a product serviced by a host (e.g., Shopify, Palantir). Another method is through a basic referral service, especially in the lending space.

Due to the ever-changing regulatory environment, the success of the alliance between fintech and banks in part rests on compliance and risk management.

Equally important are data and privacy protection. Regulatory authorization and licensing, however, remains at the forefront of challenges faced by banks and fintech companies working together, especially where the regulatory framework lags behind fintech innovation.

Indeed, one of the primary challenges of keeping up with consumer demand through new technologies is maintaining regulatory compliance. For example, artificial intelligence is a powerful and increasingly ubiquitous tool in fintech. But companies keeping up with consumer demand and market forces by increasingly relying on AI must be vigilant to ensure regulatory compliance and reduce risk.

For example, utilizing AI to buy and manage investors’ portfolios brings risk of fiduciary duty litigation and enforcement actions. The SEC has noted that “robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act,” and cautioned that robo-investment companies must disclose to investors the AI’s capabilities, process, and risks, and meet the requirements of the Advisers Act such as implementing a compliance program and designating a Chief Compliance Officer. (See SEC, Guidance Update: Robo-Advisors, Feb. 2017.) The SEC has brought enforcement actions against robo-advisers for allegedly making false claims regarding their services.

AI is also susceptible to discriminatory decision-making. In 2016 Microsoft made headlines after its platform “learned” from the public, sent offensive messages and had to be removed in less than a day—just one example where AI has led to discriminatory outcomes. (See Li, Michael,Addressing the Biases Plaguing Algorithms, Harv. Bus. Rev., 2019.) Fintech companies making decisions with AI, such as to whom loans should be extended, must be cognizant of the risk of discriminatory outcomes when AI runs unchecked. (See FTC,Big Data: A Tool for Inclusion or Exclusion?2016).

In similar fashion, fintech companies are also incorporating many socioeconomic factors in making business decisions. For example, many fintech companies in 2021 are focused on Economic, Social, Governance, or “ESG.” This focus is primarily driven by a variety of issues deemed important to both consumers and investors alike, including global warming, racial and gender equality, as well as corporate social responsibility. As a result, many new and existing fintech companies are committed to operating within a sustainable business model which historically produce better returns. Many analysts predict ESG will become integrated into most future investment decisions. We anticipate ESG investing will have a major impact on the financial sector, including fintech companies this year and beyond.

In the midst of the COVID-19 pandemic, fintech companies are wise to consider the impact their services have on society and the critical nature of the same. In fact, many consumers and industry participants strongly believe fintech’s critical role in providing essential services during the global lockdown obligates the industry to take a leading role in adopting and promoting ESG investing and related social issues. Now more than ever, a fintech company’s culture and approach to regulation and compliance, including issues concerning diversity and inclusion, can and likely will have a huge impact on growth, profitability, and longevity.

Seyfarth Shaw lawyers Matt Catalano and Renee Appel contributed to this column.

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