Welcome to Wilson Sonsini’s Focus on Fintech quarterly newsletter. This quarterly newsletter provides ongoing analysis and commentary on regulatory developments impacting the fintech industry.

This issue of Focus on Fintech focuses largely on an increase in enforcement capacity across industries as well as various legislative and rule proposals that may impact the fintech, blockchain, and digital asset industries.

Consumer Financial Protection Bureau (CFPB)

New Office of Competition and Innovation

The Consumer Financial Protection Bureau (CFPB) announced the opening of a new Office of Competition and Innovation on May 24, 2022. The purpose of the Office of Competition and Innovation is to analyze obstacles in the broader financial services market facing new market entrants and encourage competition, which may have implications for fintech companies. Specifically, the new office will focus on 1) ensuring consumers can easily switch financial providers, 2) researching structural problems that create obstacles to innovation, 3) understanding how larger players gain competitive advantages, 4) identifying solutions to increase competition, and 5) hosting incubator events for industry entrepreneurs, professionals, and small business owners. The Office of Competition and Innovation replaces the Office of Innovation, which focused on allowing companies to apply for no-action letters and participate in regulatory sandboxes for testing new products without the threat of a regulatory action.

This shift may signal that the CFPB intends to more tightly regulate larger fintech industry incumbents, while promoting expansion opportunities for small startups hoping to break into a competitive landscape dominated by a handful of larger incumbents. As a result, we may see a tightening of new product offerings and/or a more careful regulatory compliance approach to new product offerings by existing fintech companies.

CFPB’s Dormant Authority

The CFPB has announced that it will utilize its “dormant” authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 to conduct examinations of nonbank financial institutions (such as companies engaged in the mortgage, private student loan, and payday loan industries) it believes pose risks to consumers. This examination authority will also extend to fintech companies that offer financial products and services that “the CFPB has reasonable cause to determine pose risks to consumers.” By regulating nonbank companies that provide financial products or services to consumers, the fintech industry is placed directly in the examination crosshairs of the CFPB.

Further, according to public sources, the CFPB has also announced plans to bolster its enforcement division by hiring 20 new full-time employees to increase its “investigations of repeat offenders and expand its authority over nonbanks and fintechs.” Fintech companies should expect to see increased examination requests, and increased enforcement actions based on these developments.

CFPB Regulation of Stablecoins

Since Director Rohit Chopra was appointed Director of the CFPB in 2021, there has been a growing focus by the CFPB on the digital asset market. In late 2021, Director Chopra emphasized the agency’s focus on monitoring stablecoin usage in consumer financial products. Following the collapse of stablecoin TerraUSD, Chopra reaffirmed the agency’s focus on digital assets and stablecoins in an interview with Bloomberg, stating that “stablecoins are something that all the regulators are looking at” and that he expects “a lot of movement this year” in the digital asset space from the regulators. The CFPB’s focus on the digital asset market, particularly as it relates to consumer protection, has been growing and more targeted in the last few months.

Financial Crimes Enforcement Network (FinCEN)

No-Action Letter Process

On June 3, 2022, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued its first Advance Notice of Proposed Rulemaking pursuant to the Anti-Money Laundering Act of 2020 (AML Act) to solicit public comment on questions relating to the implementation of the no-action letter process. A no-action letter is “generally understood to be a form of enforcement discretion where an agency states by letter that it will not take an enforcement action against a submitting party for the specific conduct presented to the agency.” Unlike other federal agencies, FinCEN has not had a no-action letter process but the AML Act requires FinCEN to assess whether a no action-letter process should be established. Currently, FinCEN relies on administrative rulings, and exceptive or exemptive relief for regulatory guidance. Himamauli Das, the Acting Director of FinCEN, explained in a press release that the “no-action letter process has the potential to spur innovation and enhance overall effectiveness of the AML/CFT framework and the implementation of financial institutions’ compliance programs.”

For fintech industry participants, a formal no-action letter process may prove beneficial to determining, among other things, whether certain business operations require fintech, crypto, or blockchain companies to register with FinCEN as financial institutions, such as money services businesses.

Additional Funding

FinCEN Acting Director Das recently asked Congress to provide funding for more resources to implement the AML Act and Corporate Transparency Act (CTA). Das requested $210.3 million for FY 2023, a $49.3 million increase from FY 2022. Das particularly leaned on the proposed beneficial ownership rules to help justify the request for increased funding. The potential for additional funding that would allow FinCEN to ramp up its regulatory efforts will likely have a direct impact on the fintech, crypto, and blockchain industries, particularly related to reporting obligations and anti-money laundering issues.

U.S. Securities and Exchange Commission (SEC)

Chair Gensler Notes Crypto Concerns

In a recent speech, the Chair of the U.S. Securities and Exchange Commission (SEC) Gary Gensler raised a number of concerns regarding the crypto industry and reiterated his position that most digital asset platforms are likely trading securities. Chair Gensler noted that he has asked SEC staff to focus their efforts on 1) registering and regulating crypto platforms as exchanges, 2) considering how best to regulate crypto platforms where the trading of securities and non-securities is intertwined, 3) working with crypto platforms to ensure the protection of customers’ assets, including by segregating custody of those assets, and 4) considering whether crypto platforms should segregate their market making functions from their exchange functions.

Chair Gensler’s speech suggests the SEC will be pursuing enforcement and providing additional guidance on the regulation of crypto assets in the near future.

Chair Gensler also raised concerns around stablecoins, noting their implications for financial stability and monetary policy and potential use for illicit activity, and he called for increased investor protection around stablecoins. He also reiterated his view that like other crypto assets, most stablecoins may be securities for purposes of the federal securities laws. It is unclear whether and how the SEC and the CFPB will coordinate their efforts related to stablecoins, and companies in this space should pay attention to related developments.

2022 Examination Priorities

In its stated examination priorities for 2022, the SEC included a focus on emerging technologies and crypto assets. In addition to focusing on examinations of market participants engaged with crypto assets, the report notes that the SEC will continue to focus on registered investment advisers and broker-dealers that offer new products and services or employ new practices in the fintech space. In making this a priority, the SEC cited the growth in robo-advisers and use of mobile apps by broker-dealers, as well as the increase in trading of crypto assets.

Expansion of the SEC’s Division of Enforcement’s Cyber Unit

Following its stated examination priorities for 2022, the SEC renamed the Cyber Unit within the Division of Enforcement as the “Crypto Assets and Cyber Unit” and added 20 new positions for a total staff of 50. Since 2017, the unit has brought more than 80 enforcement actions related to fraudulent and unregistered crypto asset offerings and platforms. The expansion of staff will likely lead to more and speedier investigations and enforcement activity for firms engaging in crypto businesses.

Rule Proposals

Definition of “Exchange”: The SEC issued a rule proposal in January that would significantly expand the definition of “exchange” under Rule 3b-16 of the Exchange Act (the Exchange Proposal). The Exchange Proposal expands (somewhat ambiguously) the definition of an “exchange” to include systems that “make available” non-firm trading interest and communication protocols to bring together buyers and sellers of securities. The Exchange Proposal may require many platforms, including DeFi platforms and other crypto platforms, that are not currently registered with the SEC to do so either as an exchange or an alternative trading system.

Definition of “Dealer”: The SEC also issued a rule proposal in March that would further clarify the statutory definitions of “dealer” and “government securities dealer” in the Exchange Act (the Dealer Proposal). The Dealer Proposal is intended to provide clearer standards to identify market participants that are engaged in buying and selling securities for their own account “as a part of a regular business” and which thus provide significant liquidity in securities markets. The Dealer Proposal will likely have an impact on high-frequency trading firms, as well as the DeFi industry.

Information Providers

The SEC has issued a request for information and public comment focusing on the regulatory status of index providers, model portfolio providers, and securities pricing services (together, the Information Providers). The SEC noted a number of concerns, including the degree of customization of the information provided; the extent to which Information Providers rely on the publisher’s exclusion; investment advisers’ use of model portfolios, which may affect their clients’ understanding of fees; services being performed by each party and potential conflicts; as well as other potential risks and conflicts of interests. Among other things, the proposed changes could result in the regulation of Information Providers and entities that partner with Index Providers to create indices used to manage funds or otherwise provide investment advice, and entities who otherwise provide reports, algorithms, and other services to fund managers or other investment advisers.

Reg BI Enforcement Action

The SEC filed a complaint against a registered broker-dealer and five of its registered representatives alleging violation of the Best Interest Obligations under Regulation BI (Reg BI), which requires broker-dealers to act in the best interest of their customers, in connection with their recommendation and sale to retail customers of unrated, high-risk debt securities. This could signal a new wave of enforcement against broker-dealers based on Reg BI, which was adopted in 2019.

Legislative Updates

Senator Cynthia Lummis, a Wyoming Republican, and Senator Kristen Gillibrand, a New York Democrat, introduced the Lummis-Gillibrand Responsible Financial Innovation Act (the Bill) outlining a plan for the regulation of crypto assets and crypto markets. The Bill provides for many digital assets to be regulated as commodities as long as the issuer makes the required SEC disclosures. The Bill also establishes reserve, asset type, and disclosure requirements for payment stablecoin issuers. While the Bill is an attempt to respond to longstanding demands for clarity from the crypto industry, it is unlikely to pass in its current form, if it passes at all.