The SEC’s Strategic Hub For Innovation And FinTech – Part 2




Posted by on January 16, 2019

The SEC’s Strategic Hub For Innovation And FinTech – Part 2- Today is the second in a Lawcast series talking about the SEC’s new Strategic Hub for Innovation and Financial Technology (FinHub).

In mid-October the SEC launched a Strategic Hub for Innovation and Financial Technology (FinHub).  The FinHub will serve as a resource for public engagement on the SEC’s FinTech-related issues and initiatives, such as distributed ledger technology (including digital assets), automated investment advice, digital marketplace financing, and artificial intelligence/machine learning.  The FinHub also replaces and consolidates several SEC internal working groups that have been working on these matters.

The FinHubwebsite itself is broken into four categories: (i) blockchain/distributed ledger; (ii) digital marketplace financing; (iii) automated investment advice; and (iv) artificial intelligence/machine learning.  Under each category the SEC has tabs with information such as regulations, speeches and presentations, opportunities for public input and empirical information.  In the last Lawcast in this series I have some information on the blockchain/distributed ledger areas of the website.

Digital marketplace financing refers to fundraising using mass-marketed digital media – i.e., crowdfunding.  In this category, the SEC includes traditional Title III Crowdfunding under Regulation CF and platforms for the marketing of Regulation D, Rule 506(c) offerings for the offering of debt or equity financing.  Under the Regulation tab the SEC includes Regulation CF and the SEC’s Regulation CF homepage, including investor bulletins.

The SEC does not include a link to Rule 506(c) or Section 4(c) of the Securities Act, which provide an exemption for advertised offerings where all purchasers are accredited investors, and the platforms or web intermediaries that host such offerings, respectively.  However, many securities token offerings are being completed relying on these exemptions from the registration provisions – in fact, more so than Regulation CF which is limited to $1,070,000 in any twelve-month period.  In my opinion, this is a miss on the site layout.

This area of the FinHub website also provides a link to one of the first published SEC investor bulletins on initial coin offerings, including some high-level considerations to avoid a scam.  Finally, this area provides a link to a Regulation CF empirical information page published by the SEC.  Unfortunately I do not find the data to be user-friendly and could not determine how many, if any, Regulation CF offerings have included digitized assets or FinTech-related issuers.

Automated investment advisers or robo-advisers are investment advisers that typically provide asset management services through online algorithmic-based programs. Since their introduction, the SEC has been involved with regulating these market participants.  Under this section, the SEC provides links to guidance related to robo-advisors.

Robo-advisers, like all registered investment advisers, are subject to the substantive and fiduciary obligations of the Advisers Act. However, since robo-advisers rely on algorithms, provide advisory services over the internet, and may offer limited, if any, direct human interaction to their clients, their unique business models may raise certain considerations when seeking to comply with the Advisers Act.  In particular, the Advisors Act requires that a client receive information that is critical to his or her ability to make informed decisions about engaging, and then managing the relationship with, the investment adviser. As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to, and to employ reasonable care to avoid misleading, clients. The information provided must be sufficiently specific so that a client is able to understand the investment adviser’s business practices and conflicts of interests. Such information must be presented in a manner that clients are likely to read (if in writing) and understand.

Since robo-advisors provide information and disclosure over the internet without human interaction and the benefit of back-and-forth discussions, the disclosures must be extra robust and provide thorough material on the use of an algorithm.   The SEC’s guidance on the subject contains a fairly thorough list of matters that should be included in the client information.

Machine learning and artificial intelligence refer to methods of using computers to mine and analyze large data sets.  The SEC includes links to a few speeches and presentations under this tab.  The SEC uses machine learning and AI in numerous ways, including market risk assessment and helping identify risks that could result in enforcement proceedings such as the detection of potential investment adviser misconduct.