Consequences of Failing to Comply with Laws and Regulations

Failing to Comply: Fintech Firms: Don’t underestimate regulation

Its easy for high growth Fintech firms to get so caught up in what is fueling their growth, that its easy to overlook detail.  Regulation is one of these details that can be missed, if these firms don’t have a solid foundation and systems to ensure that they always stay on top of a complex and ever evolving regulatory landscape in the world of finance.

Regulatory compliance can often seem to be boring and not contributing to the bottom line.  Getting this wrong however knock of many zeros from the bottom line profit and in a worst case scenario, can also close down the firm, no matter how profitable or asset rich it is.  So don’t ignore the vital importance of regulation.

Take health benefits broker Zenefits for example.  They were recently fined a whopping $7million by the California Department of Insurance early November, for failing to comply with several of its licensing regulations.

The department ordered Zenefits to cease the free distribution of its insurance software by employees who did not have the correct pre-licensing education and study requirements.  The department went on to say, “Our enforcement action has resulted in Zenefits paying substantial monetary penalties for their licensing violations and ensures Zenefits complies with all of California’s insurance laws and regulations or they will face additional automatic penalties and sanctions.”

Zenefits were originally allowing its salespeople to act as insurance brokers and they didn’t have the licenses to do so – a significant oversight.  In February this year, Zenefits CEO Parker Conrad, who wrote the software program, exited the company during the company’s compliance and regulation battle.

Apart from regulatory risk, Zenefits may also lose confidence with their customers and investors.  This could result in lower profits and a drop in the company’s valuation.

Important lessons to learn from the Zenefits sagga

  1. It’s important to get the operations right from the get go.  Especially for fast growing firms, because once momentum takes off, it’s difficult to back track.  Build your Fintech firm on a sound foundation, and then its easy to scale without being dragged down by unnecessary burden, such as regulatory censure, just because you didn’t pay attention to detail.
  2. Do not underestimate the importance of checks and balances and regulatory compliance.  Failing in this area can not only dent the bottom line, but also leave you with no business at all, if the regulator decides to shut you down.
  3. Even during the early stages, governance, systems, processes and accountability is crucial.  Start building your business as if you were already a big business.
  4. Founders should ensure they make the right decisions and hire the right people early on.  Building the right compliant culture is crucial and will allow the firm to scale without friction.
  5. Don’t ignore laws and regulations.  A range of business models have emerged in the alternative finance and fintech sectors.  Choosing the right model is critical, as it will not only determine what regulations apply, but it will also dictate the types of customers and competitors you attract, the revenues you will earn and how the business is run on a day to day basis.

Many tech minded entrepreneurs entering the Fintech landscape may erroneously launch thinking that their business model doesn’t require a regulatory license.  Its always worth checking this out.

Of course there are business models that you can quite legitimately start without requiring regulation.  This can be a long term strategy, in which case, you may have to accept that you will tap into a smaller market segment.  Operating in an unregulated space may also be a strategy that you use for early market entry.  Regulatory licensing is a long and complex process and in this fast moving market, you can’t afford to wait until the license is granted.  In this case, an unregulated business model is the first entry point into the market.

Of course, some types of business models are not possible without regulation.

Launching without the need for an FCA Authorisation

Any financial services firm can launch without FCA Authorisation, as an early market entry strategy, and there are ways in which you can start trading sooner, whilst awaiting your full regulatory authorization.

The alternatives to being fully regulated may very well not be open to everyone, depending on the nature of your business. However, here are some ways in which you can start trading whilst preparing for full FCA authorisation:

  1. Regulatory Exclusions – The regulation provide many valid exclusions and exemptions that can allow you to start trading in a legitimately unregulated fashion. Now, it can be a minefield to work through and understand the regulation to the level of depth needed to be able structure the business operations to avoid regulation. Once you figured this out, you need to ensure that the business continue to meet the conditions imposed by the regulatory exemptions.
    Failing this will easily stray the business into the regulated space and you will have the regulator knocking fiercely on your door.
  2. “Borrow a License” – You can quite legitimately trade under someone else’s license in what is known as a Principal / Appointed Representative relationship. This is like a franchise model, where the Principal will take care of your compliance requirements. However, choosing the right Principal is crucial, as they will become your regulator. The wrong partner is likely to constrain your business significantly as they are mainly driven to minimise their regulatory risks, whilst you are looking to build a business.

So my advice to you is to before embarking on a fully regulated path, first take a step back, get into a strategy session and explore ways in which your business can either – at least initially – trade without a license, or borrow somebody else’s license.

This exercise will require an iterative approach to realigning the business strategy and operations. Sometimes it may help to get outsiders involved in helping you shape this strategy, as you may be too close to the business to see alternatives. This is where Vedanvi can certainly help you.

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