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Q&A with Troy Paredes: How the SEC Regulates Silicon Valley (Part 2)

RegulationInvestorSECFintechLegal

Shriram Bhashyam   April 13, 2017

The change in administrations at the White House has multifold ramifications for startups. Important among those areas is the Securities and Exchange Commission’s (“SEC”) posture towards Silicon Valley and how that agenda may shift under incoming Chair Jay Clayton. We’ve tapped friend of EquityZen, and former Commissioner at the SEC, Troy A. Paredes to shed some light. You can read Part 1 here.



Shri Bhashyam: I’m glad you raised your views on where regulation needs to go.​ Under most recent SEC Chair Mary Jo White, it seemed the drumbeat had grown steadily. It started with Theranos, and then Chair White gave a friendly warning of sorts to Silicon Valley, and then controversies at Hampton Creek and Lending Club came to light, and finally some shareholder lawsuits. How would you contrast a prospective SEC agenda under Chair Jay Clayton (assuming he is confirmed) to that of most recent Chair Mary Jo White?

Troy A. Paredes: SEC Chairs (as well as Commissioners) take enforcement very seriously, even if they have different ways of going about it.  Each and every part of the SEC’s mission – protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation – requires the regulator to identify misconduct and hold wrongdoers accountable. 

In an environment where there often is a lot of disagreement, one item stands out to me for the bi-partisan support it gets – namely, there is widespread agreement that the SEC should use data and technology as part of its examinations, inspections, and enforcement.  Data analytics has become an important part of how the SEC goes after fraud and manipulation.  I expect that to continue, regardless of the SEC’s political makeup.  It will be particularly interesting to see how things like artificial intelligence and machine learning end up factoring in.

Stepping back a bit, I expect this SEC to focus on economic growth by taking sensible steps to make it easier for companies to raise capital – in other words, by giving new life to the SEC’s capital formation mission.  It will take some time to see which exact rules and regulations may be up for reform.  But generally speaking, I think the effort should include a “retrospective” review that evaluates whether and how the regulatory regime has proven too costly and burdensome, working against the best interests of both companies and investors. 

SB: What will the change in administrations mean generally for financial regulation?

TAP: One place to look is the President’s recent Executive Order on Core Principles for Regulating the United States Financial System.  In short, I think attention be will paid to how regulation, notwithstanding the best of intentions, can end up being counterproductive, disadvantaging our markets, companies, investors, and taxpayers.  Cost-benefit analysis and data-based regulatory decision making can help ensure that we do more good than harm.  I advocated for both during my time at the SEC.

SB: What are some big regulatory topics fintech firms should pay attention to in 2017?

TAP: Across our economy – indeed, across our lives – technology will continue to give us new opportunities and new ways of doing things faster and cheaper.  That’s good.  At the same time, precisely because it can be disruptive, innovation can cause dislocations as machines and software are used instead of people to do certain jobs.  We need to take seriously the difficulties people face when they are displaced by technology, even as we appreciate the new jobs that technology creates.

As for fintech specifically, I think we’re still in the early days, with much more ahead of us.  Part of what lies ahead is how regulators respond.  Financial regulators, including the SEC, have been paying more-and-more attention to how fintech affects how parties transact, how capital flows, how advice is given, how trading occurs, how markets are interconnected, and how personal information is vulnerable.  While regulators welcome innovation and the choice, competition, and cost-savings it spawns, they still have to ask a simple question:  Do we need to adapt our rules and regulations to account for the changes fintech is bringing about?  The SEC, for example, held a roundtable on this very question last year.  That was just the beginning of the SEC’s focus, not the end of it.  Fortunately, the predilection isn’t necessarily for more regulation.  In the minds of many, rules and regulations should be updated to facilitate innovation – 21st century regulation for 21st century technology.

In addition, regulators are themselves users of fintech.  Financial regulators will increasingly use technology – algorithms, machine learning, artificial intelligence – to detect misconduct and to develop their enforcement actions.   For those the regulators regulate, then, technology should become a more robust part of their compliance programs.  Traditional written policies and procedures soon will not be enough.  This is the fast-growing field of regtech.  I encourage companies to get on board by evaluating how they can take advantage of technology to bolster compliance.  

Troy A. Paredes is the founder of Paredes Strategies LLC and is a Senior Advisor at CamberView Partners, LLC.  From 2008-2013, Paredes was a Commissioner of the U.S. Securities and Exchange Commission, having been appointed by President George W. Bush.  Paredes advises companies on financial regulation, corporate governance, compliance, political risk, and government investigations.  Before becoming a Commissioner, Paredes was a professor of law at Washington University in St. Louis.  Currently, he is a Distinguished Scholar in Residence at NYU School of Law and a Lecturer on Law at Harvard Law School.  And he is the co-host of a fintech podcast called “Appetite for Disruption.”


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Q&A with Troy Paredes: How the SEC Regulates Silicon Valley (Part 1)

RegulationSECInvestorLegal

Shriram Bhashyam   April 05, 2017

The change in administrations at the White House has multifold ramifications for startups. Important among those areas is the Securities and Exchange Commission’s (“SEC”) posture towards Silicon Valley and how that agenda may shift under incoming Chair Jay Clayton. We’ve tapped friend of EquityZen, and former Commissioner at the SEC, Troy A. Paredes to shed some light.



Shri Bhashyam: There has been an uptick in media attention and shareholder lawsuits related to possible securities fraud at big, later stage (“Unicorn”) startups, such as Theranos and Hampton Creek  (whose investigations by the SEC and Department of Justice were recently dropped). First, what are the main legal issues underlying these controversies?

Troy A. Paredes: The typical securities fraud case, whether it is brought by investors or the government, alleges that there was a material misstatement or omission – in other words, that information provided to investors was wrong in an important way.  Investors need accurate information to make informed decisions; they can’t be misled.  So protecting investors from fraud is key.  That’s true whether investors are investing in private companies or public ones.  At the same time, there’s a difference between fraud, on the one hand, and things simply not going as well as expected at a company, on the other.  Indeed, courts have consistently cautioned against so-called “fraud by hindsight” – a caution that matters a lot for startups and other emerging companies for which there often are genuinely high hopes that just don’t pan out.

SB: To what extent can startups rely on the fact that the investors coming in to their funding rounds are sophisticated folks or entities who can fend for themselves?

TAP: Routinely, private securities offerings are limited to “accredited investors” – certain institutional investors and people who meet income or wealth qualifications under SEC Regulation D. The idea is that if the investors buying into an offering can “fend for themselves,” then the government is justified in easing up on its regulation.  In practice, this means that a valid private placement under Reg D doesn’t have to meet the many Securities Act requirements that a public offering does.  Along these lines, two points are worth noting. 

First, even when a company raises money only from accredited investors, the company is still subject to the antifraud provisions of the federal securities laws.  Reg D may exempt a company from having to file a registration statement with the SEC, but it does not exempt a company from Rule 10b-5 prohibiting fraud. 

Second, the SEC has been reconsidering the definition of accredited investor, which has been on the books for years.  I’d like to see the definition modernized to help startups and other early-stage companies more easily raise the capital they need to grow and prosper.  Furthermore, if you’re not “accredited,” the law effectively puts you on the outside looking in when it comes to getting in on the ground floor, to mix my metaphors.  So changing the definition of accredited investor to give more investors more opportunity to invest in emerging companies can be good for investors too.  People who today don’t qualify as “accredited” but who would under an updated definition – if the SEC ends up adopting one – would have more freedom in deciding for themselves how to invest since private offerings would be more open to them.  That said, there are no guarantees when investing, and the chance to earn outsize returns can come with the potential to lose a lot.

SB: Are there any common threads among the Unicorn stories that are tied to securities fraud?

TAP: Compliance has to be taken seriously.  Integrating compliance, along with reputational risk, into a firm’s overall risk management framework can help ensure that it’s front-and-center.  Even for a startup, let alone a Unicorn, you should have good governance and sound controls.

That said, one size doesn’t fit all.  Policy makers should avoid over-regulating new and emerging companies.  In fact, what we need to do is continue promoting small business capital formation.  The reason is simple: entrepreneurs help drive economic growth and job creation.  Their ideas lead to breakthroughs that make our lives better.  That’s why I focused on helping small business when I was in government, including by supporting the JOBS Act.  While we’re at it, we should also adopt common-sense reforms to spur the IPO market.

Troy A. Paredes is the founder of Paredes Strategies LLC and is a Senior Advisor at CamberView Partners, LLC.  From 2008-2013, Paredes was a Commissioner of the U.S. Securities and Exchange Commission, having been appointed by President George W. Bush.  Paredes advises companies on financial regulation, corporate governance, compliance, political risk, and government investigations.  Before becoming a Commissioner, Paredes was a professor of law at Washington University in St. Louis.  Currently, he is a Distinguished Scholar in Residence at NYU School of Law and a Lecturer on Law at Harvard Law School.  And he is the co-host of a fintech podcast called “Appetite for Disruption.”

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FinTech Outlook: Five Developing Issues to Watch in 2017

RegulationFintechInvestor

Lee Schneider   January 26, 2017

FinTech investment, innovation, and media attention has grown steadily in recent years, and do not look to abate any time soon.

We’ve tapped friend of EquityZen, and FinTech lawyer, Lee A. Schneider, to opine on FinTech regulatory trends to watch in 2017.

Each new year comes with a sense of excitement and anticipation.  Let's wipe the slate clean from last year and focus on five trends FinTech companies and investors should monitor in 2017.

1. OCC FinTech Charter

The Office of the Comptroller of the Currency took a methodical approach to announcing its proposed limited bank charter.  In the spring of 2016, OCC issued a white paper on FinTech and responsible innovation.  They followed with public statements about FinTech, meetings with FinTech firms and a proposed rulemaking, later finalized, on winding up uninsured banks (that is, those without FDIC insurance, including FinTech firms with a limited charter).  Then came the FinTech charter rule proposal in late fall, with the deadline for comment letter on January 15th.

Some key points:
  • Eligibility:  Firms that engage in banking activities such as lending, deposit-taking and payments would be eligible for the charter.
  • Single Regulator:  Having the charter likely means a firm is subject to supervision and regulation by one national regulator (the OCC) instead of individual state regulators with differing standards depending on where the firm does business.
  • Brokerage Activities?  The charter also probably makes the FinTech firm a bank under the Securities Exchange Act of 1934, which opens up the possibility of engaging in certain broker-dealer activities without SEC or FINRA registration.
  • Discount Window?  A FinTech chartered firm also would become a member of the Federal Reserve System, possibly with access to the discount window, which could make borrowing much easier.

Those last two items bear special attention.  Having the FinTech charter may be great for a number of reasons, but if it also means that you can conduct brokerage activities and access the discount window, then that opens up a big, wide world. 

2. The Consumer Financial Protection Bureau

When the circuit court ruled that the CFPB was unconstitutional and required that it be reorganized, people started to wonder what would happen to the agency.  Statements by the President and the new Congress further call into question where the agency is headed.  

Some key points:
  • UDAAP:  The CFPB's power to go after unfair, deceptive and abusive acts or practices has been a powerful, if somewhat subjective, enforcement tool that may be used less in future.
  • Disparate Impact:  The CFPB has also gone after racial and other discriminatory practices using a disparate impact theory some consider too broad.
  • Rulemaking Priorities:  CFPB has Rule proposals on mandatory arbitration provisions and payday lenders.

Each of these areas could see changes in 2017 that reduce enforcement and regulatory burdens on the financial services industry, including FinTech firms.

3. Securities and Exchange Commission.

At its FinTech Forum in November 2016, the SEC sought to show its leadership as a regulator of FinTech.  It has the benefit of extensive experience with a diverse array of firms.  Brokerage and financial advisory firms, particularly in the realm of trading, have been driving technology forward for many decades.  Rulemaking like Regulation ATS, Regulation NMS, the market access rule and Regulation SCI all focus on technology and the changes it had wrought in the way broker-dealers and exchanges conduct their business.  Even the granting of exchange status to IEX had technology at its core, as did the tick size pilot.

Some key points:
  • Technology Rulemaking:  The SEC continues to make rules about the development, implementation and monitoring of technology and systems.  For example, the proposed amendments to Regulation ATS would require, among other things, SEC approval prior to the implementation of new trading and other features on an alternative trading system.
  • Capital Raising:  Crowdfunding and Reg A-plus offerings are highly driven by technology and the SEC continues to be interested in how they aid capital formation.
  • Blockchain:  With an entire panel devoted to it at the FinTech forum, the SEC is keenly aware of blockchain and its many potential uses.  We think blockchain tokens (or coins or whatever you are calling them) represent a new frontier for fundraising and a key area to watch, not just from a corporation finance perspective but also from a trading and "investment" perspective.

With all of its experience evaluating technology and its impacts, and its willingness to experiment, the SEC is a regulator to watch in 2017.

4. Competition from Traditional Players

If predictions about the loosening of regulation come true in 2017, it may give traditional financial services companies more time and resources to devote to creating new technologies.  For example, the larger banks have devoted huge technology and personnel resources to Basel III and Dodd Frank compliance since 2008.  A rollback by Congress and the President, or at their behest by banking regulators, could reduce these heavy compliance burdens, allowing these resources to spend time on product development and customer experience.  And of course they can still think about strategic partnerships and acquisitions.

5. Cybersecurity

Everyone's favorite buzzword from 2016, cybersecurity concerns will continue to grow in 2017 in response to all of the issues reported in 2016, not least the DNC hack.  Every financial services regulator is thinking about and monitoring these issues.  Many have published rulemakings, guidance and standards.  The insurance industry has started honing cyber-insurance offerings.  Cybersecurity is an issue ripe for a separate post, so stay tuned.

* * *

Wishing you all a FinTech-y 2017.

Lee A. Schneider
Lee Schneider is Counsel at Debevoise & Plimpton, where he heads the broker-dealer regulatory practice and also focuses on FinTech issues.  Lee is a co-host of the Appetite for Disruption, a FinTech-focused podcast which explores business and regulatory developments and technology trends impacting the industry. Appetite for Disruption is available on iTunes or Stitcher and other podcast platforms.

Relevant Resources:





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