FinTech: Who Regulates It and Why It Matters

BrianKnight

April2016

Introduction Financialtechnology,or“FinTech,”referstotheuseoftechnologytofacilitatefinancialservices.Whiletechnologyhascomplementedfinanceformillennia(earlyexamplesbeingtheintroductionofcurrency,theabacus,andwritingmaterials),thiscenturyhasseenanexplosiveproliferationofhightechnology.Tech-centriccompetitorsseektodisruptthestatusquoinareasasfar-rangingasinvestmentandretailpayments,andtheverynatureofmoneyitself.Suchchangeholdsgreatpromisebutmaycarrysignificantrisks.

Thisisnotthefirsteraoftechnologicaldisruptiontooccurinthefinancialservicesindustry,butpeopleseemunusuallyexcitedor,dependingupontheirperspective,anxious.Whatisdifferentaboutthiscycle?In2014,ChrisBrummer,alawprofessoratGeorgetownUniversity,andDanielGorfine,thendirectorofFinancialMarketsPolicyattheMilkenInstitute,identifiedthemoredisruptivecharacteristicsofFinTech.1

! Rapidinnovationandadoption:Financialtechnologiesmakeiteasiertoiterateanddeploynewfinancialservicesbroadly.

! Increaseddisintermediation:FinTechallowsnewserviceproviderstobypasstraditionalintermediaries.

! Convergenceofindustries:FinTechallows(orforces)differentindustries,includingtraditionalfinance,technology,andtelecommunications,tocompeteandcollaborateastheyprovideservices.

1.ChrisBrummerandDanielGorfine,“FinTech:Buildinga21st-CenturyRegulator’sToolkit,”MilkenInstitute,October2014.www.milkeninstitute.org/publications/view/665.

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! Lowercosts/fewerbarrierstoentry:Thedecreasingcostsoftechnologyallowsmallercompaniestoprototypeanddeployservicesthatwerepreviouslytoocapitalintensive.

! Borderlessplatforms:Theuseoftechnology,especiallytheInternet,reducesoreliminatesthecostsofgeographicdistance,allowingserviceprovidersthecapability(ifnotthelegalright)toofferfinancialservicesglobally.

! Democratizationofopportunity:Lowercostsandgreaterscalabilityallowforthewideavailabilityofservicesthatwereonceprohibitivelyexpensiveorscarce.

InJune2015,aparticipantataMilkenInstituteroundtableexplainedtheongoingregulatoryuncertaintywiththefollowingpoints:2

! Powerful,inexpensive,“customer-facing”technologies,suchasthosefoundinsmartphones,areexpandingpotentialmarketsizeforservicesthatwereonceprohibitivelyexpensiveforallbuttheverywealthy;groupsthatpreviouslycouldnotaccessoraffordtheseproductsandservicesmaybelesssophisticatedthantraditionalcustomers.

! FinTechinnovationiscuttingacrossregulatoryjurisdictionsbecausedifferentbusinessmodelsordeliverymethodsforservicesdonotconformtoexistingregulatorystructures.

! Technologyeliminatesthedistancebarrierandallowscompetitorstoofferproductstonewmarketsonnationalandgloballevels.Thiscanputpressureonregulatorysystemsthatassumeamaterialgeographiclimitation.

! Regulatorsareseeingentrantstomarketswholackthetraditionalbackgroundsandworldviewstypicallyassociatedwithincumbents,callingintoquestionregulators’owntraditionalassumptionsaboutmarketparticipantsandpractices.

! Regulatorscontendwiththeincreasingpaceofinnovationastechnologyenablesfasteriterationandexperimentationoffinancialservicesandproducts.

ThesethemesbecomeevidentwhenoneconsiderssomeofthemostprolificFinTechinnovations.Non-bankmarketplacelending,forexample,disintermediatesbanksbymatchingborrowersandlendersworldwide.Mobilepaymentservicesacceleratethepaceofpaymentsrelativetotraditionalservicesandallowtransactionstotakeplacebymeansofaphonewhosecomputingpowerusedtobeprohibitivelyexpensiveforallbutlargeinstitutions.

Inaddition,companiescanusesophisticatedandself-improvingalgorithmstoparsecopiousamountsofdatatoinforminvestmentandlendingdecisions,enablingthosewhowerepreviouslyunabletobescoredforcredittogainaccesstoit.Perhapsthemostpotentiallydisruptiveinnovationistheriseofvirtualcurrency.Whileithasusesfortraditionalfinancialservices,italsopresentsthepotentialtocompetewithgovernment-backedcurrenciesintheglobaleconomy.

2.Theroundtable,“FinTech:InnovationandRegulation,”wasaclosed-doorsessionheldJune25,2015,inWashington,DC,andattendedbyregulators,academics,lawyers,andFinTechcompanies.

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Financialservicesisnottheonlyindustrytoseemanyofthesedynamicsplayout,butitisoneofthemostcomprehensivelyregulatedindustries,andtechnologyisstrainingitsexistingregulatoryframework.Forexample,theinherentscopeofInternet-enabledlendingandpaymentsystemsischallengingassumptionsaboutwhetheracompanyshouldberegulatedprimarilyatthefederalorstatelevel.Likewise,regulatorswhousedtorelyonintermediaries,likebroker-dealers,aspointsofcontrolarefindingthoseintermediariesbypassedbynewplayers.3Evenbasicassumptionsabouttheregulatoryprocess,andhowquicklytheregulatorydecisionlooptakes,arebeingchallengedasfinancialserviceschangeandproliferatefarmorequicklythannewrulesarewritten.

Thesepressuresmaynecessitatesignificantchangestofinancialregulation.Whilenon-banklending,forexample,hasbeenprimarilyregulatedatthestatelevel,theinherentlyinterstatenatureofonlinemarketplacelendingmayjustifyfederalpreemptionofstateregulationsinordertoprovideaconsistentregulatoryenvironment.Additionally,ifthepaceofinnovationandcomplexityofthetechnologypreventregulatorsfromcreatingadequaterules-basedregulations,theymayconsidermovingtomoreprinciples-basedrules.4Finally,regulatorsmayfindthattherulescreatedtobenefitconsumersareinfactcounterproductiveiftheyprevententrybystartupswhomaylacktheresourcestomeetsignificantcomplianceburdensandwho,byinnovativecompetition,couldserveasaneffectivemeansofregulatingmarketparticipantbehavior.

Giventheveryrealpotentialforsignificantchangeinboththefinancialandregulatorysystems,itisimportantforstakeholders—electedofficials,regulators,andmarketparticipants—toevaluatewhetherthecurrentregulatorysystemisadequateorinneedofreform.TheMilkenInstituteCenterforFinancialMarket’sFinTechProgram,recognizingthevitalimportanceofafinancialsystemthatisinnovative,dynamic,inclusive,andthatprovidesadequateprotectionagainstfraudandmisuse,seekstohelpinformthisdiscussionthroughresearch,analysis,andforumswithleadingstakeholdersinthespace.WhatfollowsisananalysisononeofthemostimportantquestionsregardingFinTechregulation:Whoshouldregulate?

Thispaperseekstoexaminetheimplicationsofthatquestion,andhowtheanswermayaffectbothcompanyandconsumeruseoffinancialservices.GiventhescopeanddiversityofFinTech,thepaper’srepresentationoftheregulatoryenvironmentisbynecessitysimplifiedanddoesnotpurporttoprovidespecificanswers.Instead,itseekstooffergeneralpointsthatstakeholdersmaywishtoconsider.ItwillbrieflydiscusstheunderlyingpurposeofregulationandthenhighlightthreedynamicsthataffecttheregulationofFinTech—thedifferencesbetweengovernment,private,andmarketregulators;theissuessurroundingvariouslevelsofgovernmentalregulation;andtheimpactsofhavingmultipleregulatoryagencieswithinagovernmentoverseeingdifferentaspectsofatransaction.Itwillclosewithsomegeneralrecommendationsforhowthequestionshouldbeevaluated.

3.Forathoroughtreatmentofthisdynamicinthesecuritiesindustry,seeChrisBrummer,“DisruptiveTechnologyandSecuritiesRegulation,”FordhamLawReview84,977(2015),http://ir.lawnet.fordham.edu/flr/vol84/iss3/6.4.Foradiscussionofthecostsandbenefitsofprinciple-,rule-,andperformance-basedregulations,seeBrummerandGorfine,pp.6−8.

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What is Regulation? Itisimportant,andsurprisinglydifficult,toexplainwhatwemeanby“regulation.”Whileregulationisgenerallyconsideredthepurviewofgovernment,withlegislaturesandadministrativeagenciesestablishingstatutesoradministrativerulesthathavetheforceoflaw,otherpowerfulforcesandplayersarealsoabletoinfluencetheactionsofindividualsandcompaniesintheFinTechspace.Forexample,non-governmentalself-regulatoryorganizations(SROs)cancreaterulesandenforcedisciplineincertainindustries;companiescanbeconstrainedbycontractandlitigation;andmarketcompetitioncanenforceunwrittenstandardsofserviceonpainofbankruptcy.Votersandpolicymakersalikeshouldunderstandthesenon-governmentaleffects,whichwillbeinfluencedaswellbyanylaw,rule,orenforcementaction.

Thispaperusesabroaddefinitionofregulation,andofwhoorwhatcountsasaregulator:Regulationsarerules(whetherenshrinedinofficiallaw,foundinprivatecontract,orenforcedbythemarket)thatgovernhowanactivityisconducted,andprovideameansofredressorenforcementiftherulesareviolated.Regulatorsareanyactorswhoenforcethoserules.

Regulationcanberoughlydividedintotwoparts—thecreationandpromulgationofarule;andtheenforcementofarule.Incaseslikeformallegislationoradministrativerulemaking,thecreation,promulgation,andenforcementofaruleishighlyformalized,withexplicitprocedures(e.g.,anotice-and-commentperiod,passageofalawbyCongress,orformaltrialoradministrativeproceeding).Inothercasesthecreationandenforcementmaybemoresubtleandinformal(e.g.,thecreationofacontractbetweentwoprivatepartiesorcompetitionforcingcertainbehaviortomaintaincustomers).

What Purpose Does Regulation Serve? Havingdefined(forthepurposesofthispaper)whatregulationis,itisworthaskingwhyregulationisnecessary.Whileopinionsamongconveningparticipantsdifferedaboutthescopeofregulation,itsform,andwhoshouldregulate,therewasconsensusthatsomeamountofregulationisessentialtofunctionalmarketsforfinancialservices.Amongthereasons:

! Theneedfororderlyandreliablemarketstoattractcustomersandprovidecertaintytomarketactors:Amarketthatlacksintelligiblerules,andfailstoprovideareasonablebeliefthatthoserulescanbereliedonandenforced,isunlikelytosurvive.Likewise,entrepreneursarelesslikelytoenteramarketiftheyareunsurewhattherulesareandwhethertheirrightswillbeenforced.

! Provisionofameansofredress:Theprovisionofamechanismforredress,particularlyforconsumersand/orsmallbusinessestolimittherisktheyfacefrombadactors(asopposedtomarketrisk),isalsovitaltoobtainingsufficientbuy-in.

! Alevelplayingfield:Firmswanttotrustthattheircompetitionwillbeheldtosimilarrules,andthatbadactorswillbepunished,beforeallocatingresourcestoamarket.

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! Systemicsecurity:Transactionsorproductsthatarenotthreateninginthemselvesmay,intheaggregate,posearisktothirdpartiesorthebroadereconomy.Regulationshelplimittheriskandpotentialspreadofsuchrisk.

! Lawenforcement:Transactionsmayposeariskoutsidethefinancialsystem.Forexample,anti-money-laundering/combatingthefinancingofterrorism(AML/CFT)regulationsseektopreventcriminalandterroristorganizationsfromusingthefinancialsystem,eveniftheirtransactionsdonotposeriskstothepartiestothetransactionsortothebroaderhealthofthefinancialsystem.

Who Regulates, and Why Does It Matter?Thequestionofwhowillregulateisbothimportantandchallenging.Differenttypesofregulatorshavedifferentlevelsofauthority,procedures,meansofenforcement,andjurisdictions.Theyalsotendtooperateatdifferentspeedsandmaypossessdifferentlevelsofsophistication.Finally,thenumberofregulatorswithwhichamarketparticipantmustdealcansignificantlyaffecttheregulatoryburden.Thesedifferencesoftype,speed,andnumbercanberelevanttoquestionsaboutwhichregulatorisbestsuitedtoaddressaparticularissue.TypesofRegulatorsBecauseofthescope,scale,anddynamismofFinTech,thesectorisoftenregulatedbymultipleregulators,bothwithincertaintypes(e.g.,multiplegovernmentregulators)andacrosstypes(e.g.,governmental,self-regulators,andmarketregulators).

1. Governmentregulators:Thegovernmentiswhatmostpeoplethinkofwhentheythinkofaregulator.Whileelectedgovernmentscanregulateanindustryoractivitydirectlyvialegislation,theyfrequentlyempoweraregulatoryagencytocreateandenforcerules.Legislationmaysettheagency’sjurisdiction(thoughitsjurisdictionmaybeillorbroadlydefined),structure,andprocedures.Aparticularagencymayhaveexclusiveauthorityoveranindustry,ortheremaybemultipleagencieswithoverlappingauthority.TheUSfederalsystemmeanstheremaybestateandfederalregulatorsoverseeingthesameissuesattheirrespectivelevels.Additionally,governmentmayenterintointernationalagreementstoharmonizeregulationsandcreateinternationalagenciescapableofrespondingtomultinationalentitiesandcross-bordertransactions.Thiscanprovidegreaterconsistencyforinternationalmarketsbutaddadditionallayersofcostandcomplexity.

Regulatoryagenciesgenerallypromulgateregulationsviaanotice-and-commentprocessthatallowsthepublictoreviewaproposedruleforaperiodoftimeandprovidefeedback.Agenciesmayholdopenmeetingsonaproposedregulationtoreceiveadditionalpublic(includingindustry)input.Theagencyisrequiredtoconsiderthefeedbackasitfinalizestherule.Thisprocessprovidesbroaddemocraticaccessbutcanbetimeconsumingandtaxingonregulatorresources.5Additionally,the

5.Forexample,ittooktheSecuritiesandExchangeCommissionthreeandahalfyearstofinalizeTitleIII,RegulationCrowdfunding,afterthepassageoftheJumpstartOurBusinessStartups(JOBS)ActinApril2012.

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regulationmaybeatriskofbecomingobsoleteduetorapidlyinnovatingtechnologiesorchangingmarketconditions.6

Onceregulationsarefinalized,agenciescanprovideguidancetomarketparticipantsonareasofambiguityviavariousformalandinformalmeans,includingno-actionletters(negotiatedlettersthatlayoutasetoffactswheretheagencystaffwouldnotrecommendanenforcementaction);“frequentlyaskedquestions”guidance;andpublicstatements.Additionally,regulatorscancreatespecificprogramsinwhichtheymakethemselvesavailableforquestionsfromcompaniesandprovidenon-bindingguidance,orevencreateregulatory“sandboxes,”whereentrepreneurscantryinnovativebusinessmodelsundertheregulator’sguidance.ExamplesincludetheConsumerFinancialProtectionBureau’s(CFPB)ProjectCatalyst7andtheFinancialConductAuthority’s(FCA)ProjectInnovateintheUnitedKingdom.8

Insomecases,suchasbankregulation,regulatorsmayconductongoinginspectionsofmarketparticipantstoensurecomplianceandpreventproblemsfromdeveloping.Theseinspectionsarenotinresponsetoallegedviolationsbutaredesignedtoprotectthestabilityofthemarketandensurecompliancebyregulatedentities.9

Governmentregulatoryenforcementactionscaninvolveadministrativeorjudicialproceedings,andrequiresetprocesses,usuallyincludingtheabilitytopresentevidenceandarighttoappealadecision.Insomecases,thegovernmentmaypursuecriminalconvictions.Theseproceedingstendtoberelativelyslow-moving,althoughagencieswilloftenenterintoagreementswiththepartyagainstwhomtheyhavebroughttheenforcementaction,andwillassesssomesortofpenaltystipulatingthatthetargetedpartywillchangeitsbehavior.

Enforcementactionsmayserveasanexampletofirmsinthesameindustry.Whiletheseenforcementactionscanprovidenecessarycorrectives,thereisalsoaconcernthatagenciesmayusethemtocoercechangesinbehaviorthatshouldproperlystemfromformalchangesintherules.10

Whileregulationviaagencyisthemostobviousversionofgovernmentregulation,thegovernmentalsoservesasaregulatorviathejudicialsystem,whichallowsprivatepartiestoassertclaimsagainsteachotherandenforcetheresultingjudgments.

6.Rule504ofRegulationDundertheSecuritiesActof1933,forexample,limitsthesizeofanofferingacompanycanraiseannuallyto$1million.Inflationhaserodedthatvalue,leadingtheSECtoproposeraisingtheamountto$5million.BecausethischangerequiresamodificationtoRegulationD,theSECmustundertakeanewnotice-and-commentperiod.7.ConsumerFinancialProtectionBureau,www.consumerfinance.gov/projectcatalyst/.8.FinancialConductAuthority,https://innovate.fca.org.uk/.9.See,forexample,FederalDepositInsuranceCorporation,“BasicExaminationConceptsandGuidelines,”RMSManualofExaminationPolicies,Section1.1,p.2.www.fdic.gov/regulations/safety/manual/section1-1.pdf.10.See,forexample,RachelWitkowski,“HowCFPBReshapesMarketwithEnforcementActions—NotRules,”AmericanBanker,postedonlineFebruary1,2016.www.americanbanker.com/news/law-regulation/how-cfpb-reshapes-market-with-enforcement-actions-not-rules-1079137-1.html.

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Privateactorsalsoserveassignificantregulatorsviacontracts,aswillbediscussedlater.Thesecontractsareultimatelyadjudicatedandenforcedthroughthejudicialsystem.Likewise,common-lawobligations,likethedutyofcare,areenforcedviathecourts.

Benefitsandcostsofgovernmentregulation:Governmentregulationcanbethemostpowerfulformofregulation.First,itcaninvokethepowerofthestateandimposepenaltiesrangingfrommonetaryfinesonuptoimprisonment.Second,ithastheabilitytoregulateanentireindustrydirectlyandproactively,whilemanyformsofprivateregulationtendtoberesponsiveandfirmspecific.Finally,itincorporatestheviewsofthebroadestspectrumofstakeholders,bothdirectly,throughthesolicitationandconsiderationofpubliccomment,andindirectly,throughelections.Thistransparencyandinclusivenesscanprovideabroadfoundationforlegitimacy.

Governmentregulationisnotwithoutcosts,however.Ittendstobetheslowestmodeltoadapttochangesinthemarketandamongregulatedactorsbecauseofprocessrequirements,leadingtoahigherriskofrulesbecomingobsolete.Intheneedtoaddressnewdevelopments,governmentsmayfailtomakechangestooldrulemaking,thusleavinginplacelegacyregulatoryframeworksthatareinsufficientorincompatiblewiththeproductsandservicesofferedbyfirmsinthe21stcentury.

Additionally,regulators’broadjurisdictions,budgetconstraints,andlimitedabilitytohireandfireemployeesmayleadtoalackofspecializationinnewandemergingmethodsofprovidingfinancialservices.Finally,governmentregulationsmayreflectpoliticalpreferences—includingoverreactiontocrises,protectionism,orregulatorycapturebyspecialinterestsormarketparticipants—insteadofthebestinterestsofcitizens.

2. Privateregulators:Thereisalsoasignificantamountofprivateregulationbywhichmarket

participantsregulateeachother’sbehavior.Privateregulationcanincludeformalself-regulatoryorganizations(SROs)empoweredbystatutetoservearegulatorfunction;sophisticatedcontractualregimesamongmarketpartners;andprivatelitigationbyconsumersorcompetitorsfortheenforcementofcommonlawrules.

(a) Self-regulatoryorganizations:SROsareprivateorganizationsthatregulatepartofagivenmarket.Theorganizations’membersarelargelyorexclusivelydrawnfromtheindustrybeingregulated,andfrequentlyhaveamorenarrowfocusthanthatoftheircomparablegovernmentregulators,11whichcanresultingreaterspecialization.

MembershipinanSROcanbecompulsorybylaworrule;theSEC,forexample,requirescertainsecuritiesindustryparticipantstobecomemembersoftheFinancialIndustryRegulatoryAuthority(FINRA).Membershipmayalsobevoluntary;forexample,membershipinNACHA,theSROthatco-managestheAutomatedClearingHouse,orACH,systemwiththeFederalReserveisvoluntary,butonlymembersmayvoteonsystemrules.

11.Forexample,whileNACHAoverseesACHpaymentsystemrules,andFINRAoverseescertainsecuritiesmarketparticipants,theFederalReserveandtheSEChavebroadresponsibilityforthebankingsystemandsecuritiesmarketsgenerally.

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WhileSROsgenerallyhaveformalproceduresforcreatingorchangingrules,anddiscipliningmembers,theseprocedurescanbelesstimeconsumingandonerousthangovernmentalprocedures.ThiscanallowSROstomovemorequicklythangovernmentregulatorsincertaincircumstances.Additionally,whileSROsgenerallyhavemorelimitedjurisdictionsthandotherelevantgovernmentregulators(e.g.,jurisdictiononlyovertheirmembersoroveraparticularsystem),totheextentthattheSROcaneffectivelydisciplineitsmembers,thiscanfreeupgovernmentalregulatoryresources.

(b) Partnerregulation:Marketparticipantsmayalsohavetheirconductregulatedbytheirpeers,eitherbecausetheyareobligatedtodoso,haveafinancialinterestindoingso,orwishtoprotecttheirreputations.Partnerregulationmayrelatetoformalrequirements(suchascompliancewithanti-money-launderinglaws)orinformalbusinessnorms(e.g.,promptresponsetocustomercomplaints),andtaketheformof(sometimesquitesophisticated)contractualregimes,theuseofmarketpower,orlitigation.

Insomecases,marketparticipantsareunderanaffirmativelegalobligationtopolicetheirpartners.Banks,forexample,areobligatedbytheirregulatorstoperformsignificant“vendormanagement”onfirmstheypartnerwithtoensurethatthebanks’customersareprotected.12Likewise,broker-dealersarerequiredbytheSECandFINRAtoperformduediligenceandmonitoringofthecompaniesthatusetheirplatformstosellprivatesecurities.13

Inthosecases,marketparticipantsmayutilizecontractstograntthemtheabilitytostipulatecertainbehaviorsandmonitortheirpartnerstoensurethatthetermsarecompliedwith,ortheymayalsorefusetodobusinesswiththepotentialpartnerfirm,denyingitaccesstoapoolofcustomers.Forexample,broker-dealerscancontrolwhatissuerstheyrecommendtoclients,orwhatissuershaveaccesstothebroker-dealers’salesplatforms.Ifabroker-dealerdoesnotfeelcomfortablewithanissuerbecausetheissuerisnotconductingitselfproperlyorprovidingsufficienttransparency,itcandenytheissueraccess.

Inothercases,thepartnerregulationmaybedrivenbyregulatoryoreconomicincentivesthatfallshortofalegalmandate.Forexample,theTruthinLendingAct(TILA)14andElectronicFundsTransferAct15limitconsumerliabilityforfraudulentactivityincreditcard16

12.SeeOfficeoftheComptrolleroftheCurrency,Bulletin2013-29,availableatwww.occ.gov/news-issuances/bulletins/2013/bulletin-2013-29.html;andFederalDepositInsuranceCorporation(FDIC),FinancialInstitutionLetter44-2008,availableatwww.fdic.gov/news/news/financial/2008/fil08044a.html.13.Broker-dealersthatrecommendasecuritycanbefoundliableunderrule10b-5iftheyfailtoperformareasonableinvestigationoftheissuingcompanyandthecompany’srepresentationstopotentialinvestors.SeeFINRARegulatoryNotice10-22,availableatwww.finra.org/sites/default/files/NoticeDocument/p121304.pdf.14.PublicLawNo.91-508.15.PublicLawNo.95-630.16.15USC§1643.

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andelectronicfundtransactions.17Thisliabilityshiftawayfromthecustomerandtothemarketparticipants(banks,cardnetworks,andmerchants)hasledmarketparticipantstocreateanetworkofprivatelawtoallocateriskandpolicebehaviortominimizetheriskoffraud.18

PrivateregulationcanbeenforcedformallyviaSROenforcementproceedingsorthroughlitigationforbreachofcontractandcommonlawtortclaims,andinformallyviamoralsuasionandthethreatofdamagingbusinessrelationships.However,giventhenatureofprivateregulation,theeffectivenessofinformalregulationmaydependontherelativemarketpoweroftheparticipants.

(c) Regulationbylitigation:Inadditiontolitigationbypartners,litigationbycustomersandcompetitorsmayenforcecontractualrequirementsandcontrolbehavior.Companiesthatviolatearegulatoryrequirement(e.g.,customerdatasecurity)mayfindthemselvessuedbytheconsumerstheyharmed.Likewise,competitorsmaysueincaseswhereacompany’sactivitiesviolatealaworregulationthatgovernscompetition,includingantitrust,andunfairanddeceptivetradepracticelegislation.

Evenifthereisnospecificstatuteorregulationproscribingacompany’sactivities,thefirmmaystillbesuedundercommonlawprinciples;forexample,onecompanythatthroughnegligenceharmsanothermaybeliableintort,evenifthereisnostatuteorregulationprohibitingtheaction.

Benefitsandcostsofprivateregulation:Privateregulationcanbemoreresponsivethangovernmentalregulationbecauseitisnotasboundtoformalprocesses.19Itmayalsobemoreefficientbecausetheprivatestakeholderscouldhavemorespecificknowledgeandinformationregardingthemarket,technology,andservicesthanregulatorswithbroaderjurisdictions.20Itcanalsotargetbadactsandbadactorsmorepreciselythancanindustry-wideregulators.Forexample,alawsuitagainstaspecificcompanywouldonlytargetthatcompany(althoughtheresultsofthatsuitwilllikelyinfluencesimilarlysituatedmarketparticipantstochangetheirbehaviors),ratherthancreatearegulationthatmaysweeptoobroadly.21

Yetthereisalsoconcernthatincentivesmaynotresultinoptimalregulation.Forexample,totheextentthatSROsfundthemselvesviafines,thereisariskthattheywillover-regulatetoboosttheirbudgets.22Thereisalsoariskthattheywillunder-regulatetopleasetheirconstituents.23Thereisyet

17.15USC§1693g.18.MarkEdwinBurge,“ApplePay,Bitcoin,andConsumers:TheABCsofFuturePublicPaymentsLaw,”67HastingsLawJournal,2016,forthcoming.AvailableatSSRN:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2702101(accessedDecember10,2015).19.Id.at45.20.Id.at46.21.Foranargumentinfavoroftortlawasameansofpro-innovationregulationinthebroadertechnologycontext,seeAdamThierer,PermissionlessInnovation(Virginia:MercatusCenter2016)122-124.22.HesterPeirce.“TheFinancialIndustryRegulatoryAuthority:NotSelf-RegulationafterAll.”

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anotherrisk,thatSROscouldbecomecapturedbyincumbentsandcreaterulesthatbenefitthosefirmsattheexpenseofnewentrants.Finally,privateregulationholdslesscertainty.Forexample,meritorioussuitsmaynotbebroughtduetoalackofresourcesbytheaggrievedpartyandmaynotprevail.Likewise,individualsuitsmaybelesseffectiveatchangingindustrybehaviorthanbroadpreemptiverules.

3. Marketregulators:Companiesoperateinandrelyonamarketfortheirsurvival.Assuch,othermarketparticipants,includingcompetitorsandpotentialcustomers,havesomeabilitytoregulateacompany’sbehaviorviacommercialchannels.

Ifacompanyprovidesapoorproductorservice,itinvitescompetitorstoofferitscustomersbettertermsinanefforttowinthemover.Thisinturnshouldincentivizethecompanytoimproveitsproductorrisklosingbusiness.ApossibleexampleofthisisthecreationoftheInvestors’Exchange(IEX)alternativetradingsystem24asaresponsetotheriseofcertainhigh-speedtradingtechniquesandtheirallegedlyanti-consumereffects.25

TheIEXexiststoservewhatitperceivestobeamarketneedforconsumerswhoareillservedbymarketincumbentsandthepreexistingmarket.26Many(thoughbynomeansall)investors27andacademics28agreewithIEXthatconsumerinterestscanbebetterservedbyIEXthanitscompetition.IfIEX(andsubsequententrants)willinfactservetheneedsofcustomersbetter,itislikelythatcompetitorswilladapttheirproductsandservicesinordertocompetelesttheylosecustomers,effectivelyminimizingthescopeofimpactforsuboptimalofferings.

Theeffectivenessofmarketregulationdependsonthenatureofthemarketandwhethercompetitorscan,giventhemarket’slimits(e.g.,regulations,marketsize,andprofitmargins)provideabetterproductorservice—oriftheunsatisfactorylevelofserviceisthemarket’s“naturalstate.”Theanswerisnotstatic;changestoregulation,suchasloweringorraisingbarrierstoentry,and

MercatusWorkingPaper,MercatusCenteratGeorgeMasonUniversity,Arlington,VA,December2014.http://mercatus.org/publication/financial-industry-regulatory-authority-finra-not-self-regulation-after-allatPg.22n.109.23.Burgeat46.24.IEX,www.iextrading.com/.25.TheMilkenInstitutetakesnopositiononthemeritsofhigh-speedtrading.26.LettertotheSECfromSophiaLee,generalcounselofInvestors’ExchangeLLCre:Investors’ExchangeLLCForm1application(ReleaseNo.34-75925;File10-222)November23,2015,www.sec.gov/comments/10-222/10222-26.pdf.27.LettertotheSECfromBrittHarris,chiefinvestmentofficerandBernieBozzelli,managingdirector,trading,oftheTeacherRetirementSystemofTexasre:Investors’ExchangeLLCForm1application,undated,www.sec.gov/comments/10-222/10222-320.pdf;lettertotheSECfromO.MasonHawkins,chairmanandCEOofSoutheasternAssetManagementInc.etal.,re:Investors’ExchangeLLCExchangeApplication(FileNo:10-222),September30,2015,www.sec.gov/comments/10-222/10222-3.pdf.28.LettertotheSECfromProf.EricBudish,professorofeconomics,UniversityofChicagoBoothSchoolofBusiness,re:Investors’ExchangeLLCForm1application(ReleaseNo.34-75925;FileNo.10-222),datedFebruary5,2016,https://www.sec.gov/comments/10-222/10222-371.pdf;LettertotheSECfromProf.JamesE.Upson,AssociateProfessorofFinance,UniversityofTexasatElPasore:Investors'ExchangeLLCExchangeApplication(FileNo:10-222),datedJanuary14,2016,www.sec.gov/comments/10-222/10222-324.pdf.

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changesintechnologyallowingfornewcompetitorsorsubstituteservices,canchangethecompetitivenessofthemarketand,withit,theeffectivenessofmarketregulation.29Benefitsandcostsofmarketregulation:Marketregulationiseverpresentandconstantlyapplied,whichmayallowittobethemostadaptable.Italsoprovidesaclearincentiveforimprovedbehavioramonglegitimatemarketparticipants.Finally,itispro-innovationbecauseitdoesnotprohibitorplacedirectbarriersinfrontofnewproductsorservices.

Unfortunately,marketregulationcanbelimitedinitseffectiveness.Thelesscompetition-friendlyamarketis—whetherbecauseoflimitedroomforinnovation,inherentlylimitedeconomics,orhighregulatorybarrierstoentry—thelessanymarketcompetitioncanaffectthebehaviorofincumbents.

Additionally,whilelegitimatecompaniesmaybehighlysusceptibletomarketregulation,outrightfraudsarelikelytobemuchlessso.Itisunlikelythatashamcompanyseekingtobilkthepublicandrunwillcarethatitisbeingoutcompeted.Further,whilemarketregulationcanregulatebehaviorovertime,itcannotprovidetheretributivejusticeanddisgorgementofill-gottenprofitthatgovernmentormoreformalprivateregulationcanprovide.

How Does the Level of Government Regulation Matter? Inadditiontothetypesofregulators,the“level”ofgovernmentregulationcanalsohavesignificanteffectsonmarketparticipants.IntheUnitedStates,governmentregulationoffinancialtransactionsisprimarilyexercisedatthefederalorstatelevel.Additionally,regulationcanbetheproductofinternationalagreementbetweennationalgovernments.30

Governmentregulators,whomaybeelectedorappointed,areaccountabletodifferentconstituencies.Generallyspeaking,the“lower”thelevel,thefewerpeoplearesubjecttoarulesetandthegreaterthenumberof“equal”rulemakerstherewillbe.Forexample,eachofthe50stategovernments,aswellasthegovernmentsoftheDistrictofColumbiaandvariousUSterritories,hasequalauthoritytoregulatemarketswithinitsjurisdiction,andnolegalauthoritytoregulateitbeyondthatjurisdiction.

29.Arguablythemostdramaticcurrentexampleofcompetitionthatregulatesmarketparticipantbehaviorcanbeseen,albeitoutsideofFinTech,inthetransportationmarket,wheretheriseofappslikeUberhavechangedtheserviceleveloftaxis.Whiletaxisgenerallydonotcontroltheirrates,thereisevidencethataftertheintroductionofUberandsimilarservicestoamarket,thequalityoftheservice(asmeasuredbycustomercomplaints)hasimproved.See,generally,ScottWallstein,TheCompetitiveEffectsoftheSharingEconomy:HowIsUberChangingTaxis?June2015,www.ftc.gov/system/files/documents/public_comments/2015/06/01912-96334.pdf.30.WhilethissectionprimarilydiscussesthetopicfromaUSperspective,theEuropeanUnionanditsmemberstatesalsohaveasystemthatpresentsasomewhatsimilardynamic.

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FIGURE1.Regulatorylevelsvaryintheirscaleandnumberofrulemakers

Thesegovernmentsareelectedby,andaccountableto,thecitizensoftheindividualstates.Thefederalgovernmentrepresentsandis(tovaryingdegrees)accountabletoallcitizensandhastheauthority,subjecttoconstitutionallimitations,toregulatemarketsacrossthecountryandtopreemptconflictingstateregulations.Butitcannotlegallyimposeregulatoryrequirementsonothercountriesor,incertaincases,onpurelyintrastatemarkets.Internationalagreementsreflecttheworkofandbindmultiplenationalgovernmentsandarenegotiatedbygovernmentsaccountabletothepopulationsofthosecountries.

Thisdynamiccanleadtotradeoffsbetweenthe“fit”andconsistencyofregulations.Stateregulatorsfrequentlycreaterulesthatreflecttheuniquecharacteristicsofastate’smarketandthepreferencesofitscitizens,whilefederal(orinternational)regulatorsrepresenttheinterestsofalargergroupofpeopleandmorediversemarkets.Conversely,federalregulationoffersthepotentialforgreaterconsistency,whilestateregulationscanvarysignificantly.

Thelevelatwhichregulationismadecanhaveimportantimplicationsfortheimpactofaregulationonthemarket,aswellasthedemocraticlegitimacyoftheregulation.IntrastateRegulationMarketsortransactionslimitedtoasinglestatearegenerallyregulatedbythatstateexclusively.Incaseswhereallthepartiestoatransaction,includingthecitizenstowhomtheregulatorisultimatelyaccountable,arewithinasinglestate,thestateregulatorscancreateregulationsthatmatchtheneedsandpreferencesofthosecitizensandprovidecompanieswithasinglesetofrequirements.

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FIGURE2.PureIntrastateMarketInatrulyintrastatemarket,transactionsarekeptpurelywithinastate(notesolidlinesbetweenstates),usuallybecauseitisnoteconomicallyfeasibletoexpandbeyondthestatemarket.Thefederalauthoritydoesnotregulatethemarket(eitherbecauseitlacksjurisdictionorelectsnotto).Thecitizensofastate,throughthedemocraticmethodsofthestategovernment,createregulatoryrequirements,whichareenforcedagainstcompaniesprovidingaparticularservice.Theserviceasofferedinthatstatecomplieswithandconformstothoserequirements.Multi-StateState-LevelRegulationHowever,evenifatransactionisinherentlyintrastate,manymarketparticipantsmayoperateinmultiplestatesandmustcomplywithdifferentstatelaws.Thuslargerstateswithmarkethubsmaydistorttheregulatoryenvironment.Forexample,becauseofthesizeofitsmarketanditsroleasafinancialcenter,NewYorkholdssignificantpowerovertheconductoffirmsthatwanttoworkwithbanksandotherfinancialservicesfirms.ThispowercanforcecompaniestocomplywithNewYorkregulations,regardlessofwhetherthoseregulationsareconsistentwithotherstates.31Consumersmay

31.Thereisconcern,forexample,thatpossiblenewregulationsoncybersecurityproposedbytheNewYorkDepartmentofFinancialServices(DFS)willforcecompaniestomakesignificantstructuralandprocesschangesthatwillimpactthenationalmarket.See“BankersFearNY'sToughStanceWillDictateCyberRulesforAll,”AmericanBanker,November18,2015,www.americanbanker.com/news/law-regulation/bankers-fear-nys-tough-stance-will-dictate-cyber-rules-for-all-1077897-

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findthemselvesdefactoregulatedbythegovernmentsofotherstatesascompaniescomplywiththerequirementsofallthestateswhosemarketstheywishtoenter.FIGURE3.OverlappingRegulatoryBurdens

Havingtocomplywithmultiplestates’lawscandistortthemarketsaswell,bypreventingcompanies,especiallystartupsthatmaylacktheresourcesforsuchcompliance,fromenteringstateswhosesmallermarketsdonotjustifytheadditionalregulatoryburden.Itmayalsoleadcompaniestostructureactivitiestoaltertheirregulatoryprofiles.Somenon-banklenders,forexample,partnerwithbankstooriginateloansinordertoavoidhavingtoregisterwith,andadhereto,thelendinglawrequirementsofeverystate.Thisarrangementisanartificiality,whichwhilenotpernicious,haslittlecompetitivebenefitbeyondeasingregulatorycompliance.

1.html.Likewise,virtualcurrencycompanieswillneedtoperformstate-specificactivitiesunderNewYork’sBitLicenseregimeforcertaintransactions,includingaNewYork-specificanti-money-launderingregimethatwillaffecttheirservicesnationwide.NYComp.CodesR.&Regs.tit.23,§200.15(a)(2-3),availableatwww.dfs.ny.gov/legal/regulations/adoptions/dfsp200t.pdf.

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FIGURE4.InterstateMarketswithNoFederalRegulation

Inaninterstatemarket(notedashedlinesbetweenstates),theultimatepartiestoatransactioninvolvinggoodsorservicesarelocatedindifferentstate.Interstatecommerceisdefinedbroadlyforthepurposesofgrantingthefederalgovernmenttheabilitytoregulate,althoughthefederalgovernmentisnotrequiredtoregulateineverycaseithastheabilityto.Inacasewherecitizenspreferstatetofederalregulation,theywill,throughthedemocraticmethodsofthestategovernment,createregulatoryrequirements,whichareenforcedagainstcompaniesprovidingtheservice.Serviceproviderswhowanttoaccessmultiplestateswillneedtocomplywiththerequirementsofallthestatestheywanttoaccessandmaynotenterstatemarketsthatareinsufficientlylargeorlucrativetojustifycomplyingwiththosestates’specificrequirements.FullFederalPreemptionFederalregulationcanalsoexistasthesolesetofrulesthatgovernamarketortransaction.HereCongresscreatesrequirements,orempowersfederalregulatoryagenciestocreaterequirements,thatapplytoallmarketparticipantsnationwide.Theserequirementsmaybedenovoifthemarketortransactionisnew,butcanalsopreemptexistingstateregulation.

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FIGURE5.InterstateMarketswithFullFederalPreemption

Insomecasesthecitizensmaywantfederallawtocompletelypreemptstatelaw.Inthatcasetheregulatoryrequirementswillbecreatedatthefederallevelbaseduponwhatcangetsufficientconsensusamongallthecitizensandwillapplyacrossstatelines.Federalpreemptionusuallyoccurswhenthereareenougheconomiesofscaletoallowforasinglesetofrules.Thiscanoccurwherethemarketisnaturallyunconstrainedbygeography,orwherebarrierstoentry,orregulatorycomplexitiescreatedbymultiplestateregulations,arehigh.Forexample,TitleIIIoftheJOBSAct32createdanewcrowdfundingexemptionthatsubstantiallypreemptsstatesecuritieslawtoallowbusinessestoleveragetheInternettoattractinvestorswithouthavingtocomplywiththelawsofeverystatewherethesebusinessesoffersecurities.TheInternet’scapabilitytoovercomedistancehasmadesmall-dollar,multi-stateofferingsfeasible,butthecostsofcompliancewitheachstate’srequirementswouldhavedefeatedthisgoal.

32.15USC77d(a)(6).

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Fullpreemptionmayalsobeappropriatewheresomestatesexercisedisproportionateinfluenceonthemarketthroughmarketconcentration.Federalregulationprovidesalmosteveryone33withsomerepresentation.

Whileexclusivefederalregulationhasthevirtueofprovidingaconsistentsetofrulesandbroaderinput,itisnotwithoutitsweaknesses.First,itcreatesa“onesizefitsall”rulesetthatmayworkbetterfor,orreflectthepreferencesof,somestatesoverothers.Statelegislaturesandregulatorswilloftenhaveabetterunderstandingoftheirlocalmarketsandmaybeabletocraftmoreaptregulations.Second,itmaytakelongerforfederalrulestoadapttochanges(thoughchangesattheaggregatestatelevelcanalsotakeconsiderabletime).Third,state-levelregulationcanprovideforexperimentationandcompetition,allowingforthetestingofnewideasandapproachesonasmallerscalebeforebroaderadoption.Federalpreemptioncanpreventthis.Finally,federalpreemptionmayplacesignificantstrainonfederalregulatorstoaddressissuesviaenforcementthatmightbebetterlefttothestates.HybridRegulationInhybridregulationaninterstatemarketortransactionisgovernedbybothfederalandstatelaw.Howtheresponsibilitiesaresplitcanhaveasignificanteffectonhowtheregulationimpactsthemarket.

COEXTENSIVEREGULATIONHybridregulationcantaketheformofthefederalgovernmentregulatingsomeaspectsofthetransactionandthestatesregulatingothers,orwithboththestatesandfederalgovernmentexercisingcoextensivejurisdiction.Frequently,thefederalgovernmentservesasa“floor”(whichpreemptsstatelawstotheextentthattheyarelessrestrictivethanthatfloor)andallowsthestatestocreateadditionalrestrictions.

IntheUnitedStates,forexample,whilemoneytransmittersmustcomplywithfederalanti-money-laundering(AML)rules,moneytransmittalisprimarilyregulatedatthestatelevel,withstateregulationsrequiringstatelicensinganddeterminingmostofthesubstantiverequirements.Assuch,toenterthemarketacompanymustbelicensedbyandcomplywiththelawsof48statesandtheDistrictofColumbia.34Likewise,NewYork’sBitLicenseplacesstate-specificAMLrequirementsondigitalcurrencybusinessesoperatinginNewYork,inadditiontothefederalrequirements.35

Whilecoextensiveregulationprovidesforvoterinputonboththestateandfederallevels,andmayallowformorepreciseregulationbythestateswithinabroaderfederalconstruct,italsoriskscreatingasystemthatsuffersfrommanyoftheflawsofstate-by-stateregulation.First,statesmaycreateconflictingorredundantrequirements,forcingmarketparticipantstosolvethesameproblemseveral

33.IntheUnitedStates,sixnon-votingmembersofCongressrepresent,respectively,theDistrictofColumbia,PuertoRico,theUSVirginIslands,AmericanSamoa,Guam,andtheNorthernMarianaIslands.34.SouthCarolinaandMontanadonotcurrentlyregulatemoneytransmittal.SeeThomasBrown,“50-StateSurvey:MoneyTransmitterLicensingRequirements,”http://abnk.assembly.ca.gov/sites/abnk.assembly.ca.gov/files/50%20State%20Survey%20-%20MTL%20Licensing%20Requirements(72986803_4).pdf.35.NYComp.CodesR.$Regs.tit.23,§200.15(a)(2-3).

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differentwaysundermultipleregulators,thusincreasingtheircompliancecostsandraisingbarrierstoentry.36FIGURE6.InterstateMarketswithHybridStateandFederalRegulation

Amixoffederalandstatelawcanalsoregulateinterstatemarkets.Inthesecasesthecitizens,throughthedemocraticmethodsoffederalgovernment,createregulatoryrequirementsatthefederallevelthatapplytotheservicenationwideandareenforcedbyfederalregulators.(Notethatamongthethreestatesamajorityofcitizenswantregulatoryrequirements,whichiswhythoseprovisionsareinthefederalrequirements).Citizensalsoutilizethedemocraticmethodsofstategovernmenttocreateregulatoryrequirementsthatareenforcedagainstthecompanyprovidingtheservicebystateregulators.Serviceproviderswhowanttoaccessmultiplestateswillneedtocomplywiththerequirementsofallthestatestheywishtoaccess,aswellasthefederalrequirementsandmaynotenterstatemarketsthatareinsufficientlylargeorlucrativetojustifycomplyingwiththosestates’specificrequirements.

36.Thecomplexityandcostofcomplyingwithdifferentstaterequirements,inadditiontothefederalrequirements,wascitedasapotentialreasonfortheunder-useofRegulationAofferingsbyUSbusinesses.GovernmentAccountabilityOffice.FactorsthatMayAffectTrendsinRegulationAOfferings,GAO-12-839,July2012,www.gao.gov/assets/600/592113.pdf.

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Second,whilestateregulatorsmaybemoreresponsivethanthefederalgovernment,intheaggregateitmaybeharderforthemtoadapt,whichcanslowregulatoryprogress.Finally,differencesinmarketinfluenceamongthestatesmaymeanthatsomestatescandefactoimposetheirpreferences,whileotherstatesmaynothavethemarketsignificanceforcompaniestotakeonthenecessarycompliancetodobusinessthere.

Inadditiontoformalcoextensiveregulation,theremayalsobecaseswherefederalpreemptiontechnicallyexists,butwherestategovernmentshavesufficientleewayintheapplicationoftherulesthatthisamountstostatemodification.Thisso-called“gold-plating”canreflectgood-faitheffortstomakefederalrulesworkinastate’suniqueenvironment,oritcanservetounderminethepreemptionandactuallyraisethebarrierstoentryforexternalfirms,protectinglocalincumbentsfromcompetition.FIGURE7.InterstateMarketswithFederalPreemptionbutLocalModification

Federalpreemptioncansometimestaketheformoffederallawsthatallowstatessomecontroloverimplementationtosuittheneedsofthelocalenvironment.Thisallowscitizenstocreatefederalrequirementsthatapplytoallstates.Citizenscanalsousethedemocraticmethodsofstategovernmenttocreatelocalimplementationrequirementsthatinfluencehowcompaniesmustcomplywiththoserequirementstooperateinthestate.Whilethiscanbebeneficial,excessivelocalrequirementscanfrustratethepurposeofpreemptionif

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complianceistoocostlyrelativetothemarket.Excessivelocalimplementation(sometimescalled“goldplating”)maybeusedasaformofprotectionismtopreventnationalcompetitionforlocalmarkets.REGULATORYEXPORTAnotherformofhybridregulationisregulatoryexport(or“passporting”).Federalrulescanrequireastatetopermitacompanytooperate,eitherinwholeorinpart,undertherulesofthecompany’shomestate.Thisallowsforstatestocompeteandexperimenttocreateoptimalrulesandincreasedconsistencyofrulesascompaniesrelocatetothestateswiththoserules.However,thereisariskthatthisdynamicwillcreatea“racetothebottom”assomestatescreaterulesperceivedtobeoverlypermissiveorinsufficientlyprotective.FIGURE8.InterstateMarketswithFederalLawandStateLawExport

Insomecasesthereexistbothfederalrequirementsandtheabilitytoexportcertainstatelawrequirements.Inthesecasestheregulatoryrequirementsagreedtoatthefederallevelapplyacrossstatelines,whiletheregulatoryrequirementsnotcoveredatthefederallevelaredeterminedatthestatelevelbythecitizensoftherespectivestates.Becauseoftheexportingprovisionsofthefederallaw,however,companiesmaymovetothestatewiththeleastonerousregulatoryrequirementsandexportthoserequirementstotheotherstates.

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AnexampleofregulatoryexportistheabilityofnationallycharteredbankstoexporttheinterestratetheyareallowedtochargebythelawsoftheirhomestatetootherstatesundertheNationalBankAct.37Thisabilitywasputinplaceinparttohelpfacilitateaconsistentnationalmarketforcredit.38

Theprovisionhasresultedinbanksthatoperateatanationallevelbasingthemselvesinstateswithoutalimitoninterestrates,suchasDelawareandSouthDakota.39Thisallowsthemtooffercreditnationallywithoutregardfortheusurylawsofstatestheyenterandoperatein.Whilethismayhelpthedevelopmentofarobustnationalconsumercreditmarket,italsoarguablyfrustratesthedesiresofvotersinstatesthatmaintainusurylawstolimittheinterestratesoncreditofferedintheirstate.

Does the Number of Regulators Matter? Inadditiontothedifferentlevelsofgovernmentinvolvement,multipleregulatorswithoverlappingjurisdictionsatthesamelevelmayhaveoversightovertransactionsandmarketparticipants.Thiscanfrequentlyoccurincaseswheresomeregulatorshavejurisdictionoverspecificactors,whileothershavejurisdictionoverspecificconsumersortheirproperty,suchastheDepartmentofLabor’s(DOL)authorityoverworkplaceretirementaccounts40;overarchingissues(e.g.,theUSTreasury'sFinancialCrimesEnforcementNetwork’s(FinCEN)responsibilitytopreventcriminalsusingthefinancialsystem);ortheauthoritytoregulatehowtransactionsoccur(e.g.,theFederalTradeCommission’sauthoritytoprevent“unfairanddeceptiveactsorpractices”41andtheCFPB’sauthoritytoprevent“unfair,deceptive,orabusiveactsorpractices”42).

Whilemanycountrieshaverelativelyfewregulatorswithbroadandlargelyexclusivejurisdictions,43theUnitedStateshasmultiplefederalregulatorswithoverlappingjurisdictions.Theseincludeeightpurefederalfinancialregulators,44withothergovernmentorganizations,includingtheDOL,FTC,andFinCEN,exercisingsomeregulatoryfunctionoverfinancialservices.Theresultisacomplexenvironmentforaparticulartransactioninwhichactionsbytherelevantregulatorsmaybeunpredictable.45

37.12USC§85.State-charteredbanksandcreditunionshavesimilarpowersundertheFederalDepositInsuranceAct12USC§1831(d)(a)andFederalCreditUnionAct12USC§1785(g),respectively.38.Tiffanyv.NationalBankofMissouri,85US409,413(1874).39.Forexample,ChaseandPNCBankarebasedinDelaware(http://www.ibanknet.com/scripts/callreports/fiList.aspx?type=statebank&state=10)andCitibankandWellsFargoarebasedinSouthDakota(http://www.ibanknet.com/scripts/callreports/fiList.aspx?type=statebank&state=46).40.KarenDamato,“WhyLaborDepartmentGetsaSayonIRAAdvice,”WallStreetJournalblog“TotalReturn,”April23,2015,http://blogs.wsj.com/totalreturn/2015/04/23/why-labor-department-gets-a-say-on-ira-advice/(accessedFebruary2,2016).41.15USC§45(a)(1).42.12USC§5511(b)(2).43.Forexample,theUnitedKingdomhasthreefinancialservicesregulators:thePrudentialRegulatoryAuthority(PRA),anagencywithintheBankofEnglandthatservesastheprudentialregulatorforbanks,insurers,andotherlargefinancialinstitutions;theFinancialConductAuthority(FCA),whichregulatesfinancialinstitutions’conducttoprotectcustomers;andthenewPaymentSystem’sRegulator(PSR),whichregulatestheconductofpaymentsystemsparticipants.44.CongressionalResearchService,“WhoRegulatesWhomandHow?AnOverviewofU.S.FinancialRegulatoryPolicyforBankingandSecuritiesMarkets,”p.2,January30,2015,www.fas.org/sgp/crs/misc/R43087.pdf.45.Forexample,theGovernmentAccountabilityOfficehasfoundthatthefragmentationandcomplexityoftheUSfinancialregulatoryregime“doesnotalwaysensure(1)efficientandeffectiveoversight,(2)consistentfinancial

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Forexample,theFederalReserveBankofBostonhasidentifiedeightfederalregulatorsthatmayhaveauthorityovermobilepayments,dependingonthedetailsofaparticulartransaction,inadditiontopossiblestate-levelregulatoryjurisdiction—andnosingleregulatorservesastheleadregulatorforthemarket.46

Likemultileveledregulation,multipleoverlappingregulatorscanaffecttheregulationofamarketinsignificantways.Havingmultipleregulatorsatasinglelevelofgovernmentmayprovideforcompetitionandexperimentationamongtheseregulators,aswellastransparencyandincreasedopportunitiesfordemocraticengagement,butitmayalsocreateconfusion,frustrateregulatoryinnovation,shacklemarketparticipantswithinefficientprocesses,andleadtoforumshopping.AdvantagesofMultipleRegulators

! Competitionamongregulators:Regulatorshaveincentivestocompetetobethemostefficientandeffectiveatregulatingamarket.Thisisparticularlytrueincaseswheretheregulatedentitieshavesomechoiceastotheirregulator(suchasbankcharteringregulators),yetevenincaseswheremarketparticipantshavenochoice,regulatorswanttoavoidthepoliticalcostsofareputationforinefficiency.Theseincentivescanleadregulatorstotrynewandinnovativeprocesses.

! Transparency:Multipleregulatorsoperatinginamarketmayallowforgreatertransparencybyexposingdisagreementsabouttheregulatoryprocessandphilosophiesthatmightotherwisehavebeensubmergedwithinaunitaryregulator.Thistransparencycanhelpvotersandpolicymakersevaluatepolicies,andregulatorscanadaptthemifnecessary.

! Broaderdemocraticengagement:Thereisapersistentconcernthatregulatorsmaybecomecapturedbytheindustrytheyregulate,eitherconsciouslyorinadvertently,sincetheyfrequentlyhavehadsimilarexperiences,education,andculturetotheindustrytheyregulate.Thecapturemayleadtopolicychoices,includingarefusaltoact,thatbenefitstheindustryoverthepublic.Havingmultipleregulatorswithcontroloveramarketmaymitigatetheriskofcaptureandcouldallowelementsofthepublicwholackappropriateinfluencewithoneregulatortobeheardbyanother.

AnarguableexampleofthisistheDOL’sfiduciarydutyruleforfinancialadvisors.Section913oftheDodd-FrankActtaskedtheSECwithstudyingwhetherthelegalstandardofcareapplicabletobroker-dealersandinvestmentadvisorswasappropriate,butitdidnotrequirethattheSECchangethestandard.47WhiletheSECrefusedtochangethestandard,theDOL,whichhas

oversight,and(3)consistentconsumerprotections.Asaresult,negativeeffectsoffragmentedandoverlappingauthoritiespersistthroughoutthesystem”GovernmentAccountabilityOffice.ComplexandFragmentedStructureCouldBeStreamlinedtoImproveEffectiveness,GAO-16-175,February2016,executivesummary,http://www.gao.gov/assets/680/675400.pdf.46.FederalReserveBankofBoston,“EvolvingMobilePaymentsLandscape:AnMPIWUpdate,”December4,2013,slide19,www.bostonfed.org/bankinfo/payment-strategies/presentations/2013/pandy12-04-2013.pdf;seealsoPewCharitableTrusts,“MobilePayments:Regulatorygaps,ambiguities,andoverlap,”issuebrief,findingthattheregulatoryenvironmentformobilepaymentsisfracturedandinconsistent.www.pewtrusts.org/en/research-and-analysis/issue-briefs/2016/02/mobile-payments.47.PublicLawNo.111-513,§913(2010).

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authorityoverretirementaccountsgovernedbytheEmployeeRetirementIncomeSecurityAct(ERISA),proposedchangingthestandardforadviserstothoseaccounts,makingthemafiduciary.Whilethischangeisbroadlyopposedbythefinancialservicesindustry,itissupportedbyinvestoradvocateswhofeelthattheSEChasbeendilatoryinactinginthepublic’sinterest.

DisadvantagesofMultipleRegulators! Inconsistentphilosophyormethods:Varyinglevelsofexpertise,regulatoryphilosophies,and

preferredmethodsamongregulatorsmayleadtoinconsistentorsuboptimaloutcomes.Regulatorstaskedwithoverseeingaspecificindustry(e.g.,theSEC)maydevelopanuancedunderstandingofthemarketthatisnotsharedbyregulatorswhointeractwiththemarketinamorelimitedorinfrequentmanner.Likewise,regulatorsmayviewtheirrolesandresponsibilitiesindifferentwaysandsetdifferentprioritiestoconsumerprotection,structuralconcerns,andaccesstoservices.48Finally,differentregulatorsmayusedifferentmethods,suchasrulemakingvs.regulationbyenforcementaction.Thisinconsistencycancreatediscrepanciesinhowmarketparticipantsareregulated.

! Uncertainty:Onemajorpotentialdownsidetothefragmentationofregulatoryresponsibilityisuncertainty.Thisuncertaintycanaffectmarketparticipantsbymakingitharderforthemtoknowexactlywhotheirregulatorsareorwhichone(ifany)hasthefinalword.Thisproblemcanbeparticularlyacuteincasesinwhichmultipleregulatorshaveconcurrentjurisdictionanddifferentinterpretationsoftherules.Additionally,smaller,younger,andlesssophisticatedcompaniesmaybeleastabletocopewithidentifyingandworkingwithmultipleregulators.

Likewise,multipleregulatorsmaycreateuncertaintyastowhichagencyhasresponsibilityandaccountabilityformonitoringcertainmarketsandbehaviors,leadingtogaps,loopholes,andstrugglesforturf.AsformerFederalReserveChairmanPaulVolkernotedinthecontextoftheimplementationofDodd-Frank,thenumberofregulatoryagenciesatthefederallevel“isarecipeforindecision,neglect,andstalemate,addinguptoineffectiveness.”49

! Controlbythemostrestrictiveregulator:Whilemultipleregulatorsmayleadtocompetition,itmayalsoleadtostagnationasmarketparticipantswouldneedtocomplywiththemostrestrictiveregulatororriskanenforcementaction.Thiswouldpreventmarketparticipantsfromhavinga“one-stopshop”forcomplianceandcannegatesomeofthevalueprovidedbypro-innovationregulatorytoolslikeno-actionlettersbecausetheletteronlyappliestotheagencythatgrantedit.

48.AdamJ.Levitin,TheConsumerFinancialProtectionBureau:AnIntroduction(April26,2013).GeorgetownLawandEconomicsResearchPaper(forthcoming);seealsoReviewofBankingandFinancialLaw,Vol.32,pp.321−369,3302013;GeorgetownPublicLawResearchPaperNo.13-006.Availableat:http://ssrn.com/abstract=2199678orhttp://dx.doi.org/10.2139/ssrn.2199678(arguingthatprudentialbankregulatorsprioritizedthesafetyandstabilityofthebankingsystemoverconsumerprotection).49.LizMoyer,“Volcker:U.S.ShouldHaveFewerFinancialRegulatoryAgencies,”WallStreetJournal“MoneyBeat”blog,May29,2013,availableat:http://blogs.wsj.com/moneybeat/2013/05/29/volcker-u-s-should-have-fewer-financial-regulatory-agencies/?mod=wsj_nview_latest.

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! Lackofspecializationandill-suitedprocesses:Whilethereisariskthatregulatorsmaybecomecapturedbytheirindustries,thereisalsothebenefitthatregulatorscandevelopspecializedexpertiseandbuildprocessesthatbettermatchthelegitimateneedsofthemarkettheyregulate.Otherregulatorswhomayhaveamoretangentialrelationshiptothemarketmaylackthatexpertiseandprocess,creatingneedlessinefficiencies.Theseefficienciescanbeespeciallydamagingfornewerorsmallercompaniesthatmaylacktheresourcesorexistingstreamsofrevenuetoweatherthedelay.

! Forumshopping:Aframeworkofmultipleregulatorsmayprovidemoreavenuesofdemocraticengagement,butitmayalsoallowforforumshoppingasactivistsfrustratedbyafailuretoachieveapolicygoalwiththeprimaryregulatorseektoinfluenceamarketthroughasecondaryregulator.Thiscanleadtoinconsistentorsuboptimalregulationiftheprimaryregulator’sinitialdecisionwascorrectorifthesecondaryregulatorhasincompletejurisdictionorinsufficientexpertise.Itmayalsoresultinaregulatortakingactionthatwasnotcontemplatedorsupportedbythelegislaturewhenitdraftedtheenablinglegislation.

TheDOL’sfiduciarydutyrulearguablyrepresentsthisdynamic.Brokersanddealerswhosellsecuritiestoinvestorsindiscreettransactionswererequiredtohaveareasonablebasistobelieveasecuritytheyrecommendforpurchaseissuitableforthepotentialbuyer.50RegisteredInvestmentAdvisors(RIAs),whoadviseclientsandmanagetheirassetsonanongoingbasis,arerequiredtoavoidpotentialconflictsofinterestandactinthebestinterestsoftheirclients.51TheSEChasauthorityoverbothbroker-dealersandRIAsasmembersofthesecuritiesmarket,buttheDOLhasoverlappingauthoritywithregardtocertainemployer-sponsoredretirementaccountsservicedbybothbroker-dealersandRIAs.

WhiletheDodd-FrankActdirectedtheSECtoconductastudytoevaluatetheobligationsofbrokers,dealers,andinvestmentadvisers,itdidnotdirecttheSECtochangethestandardorcontemplatethatDOLwouldmakeachangepursuanttoitsownauthorityunderERISA.52

50.FinancialIndustryRegulatoryAuthority(FINRA)Recommendations.http://finra.complinet.com/en/display/display_viewall.html?rbid=2403&element_id=9859&print=1.51.RegulationofInvestmentAdvisersbytheU.S.SecuritiesandExchangeCommission,staffoftheInvestmentAdviserRegulationOffice,DivisionofInvestmentManagement,USSecuritiesandExchangeCommission,March2013,p.22,www.sec.gov/about/offices/oia/oia_investman/rplaze-042012.pdf.52.Forexample,thefollowingexchangeoccurredbetweenRep.DavidScott(D-Ga.)andSECChairMaryJoWhiteataHouseFinancialServicesHearingonNov.18,2015:SCOTT:Thankyouverymuchoverhere,Chairlady.Chairlady,areyouaware,whenwewroteDodd-Frank,thatinSection913,wegaveexclusiveresponsibilitytotheSecuritiesandExchangeCommissioniftherecameatimewhenweneededto—toputtogetherabest-intereststandardforthefiduciary?You'reawareofthat,aren’tyou?WHITE:I—I’mcertainlyawarethat913givestheSECauthoritytoproceed.Doesn’tmandateit.Yes.SCOTT:Well,letmeaskyouthis:whyareyouallowingtheLaborDepartmenttotakeoveryourterritorythatweputinDodd-Frank,thatwasapprovedbytheHouse,approvedbytheSenate,andsignedbythepresidentoftheUnitedStates?WHITE:Well,I—Idon'tviewit—andI’veheardthecommentsbefore—Idon’tviewitthatway.Imean,Ithinkthat—again,weareseparateagencies.Theydohaveresponsibilityinthe—andstatutoryauthorityintheERISAspace.Imean,evenaswesithere...SCOTT:Letme...WHITE:...sitherenow,youknow,brokershavetocomply,ifthey’reintheERISAspace,withthe

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FrustrationwithSECinactionledtolobbyingfortheDOLtoactwhereitcould,butthiscreatedaninconsistentstandard.Additionally,theSECwilllikelymoveforwardwithitsownfiduciarydutyrule,potentiallyfurthercomplicatingtheprocess.53Afiduciarystandardmayormaynotbeappropriate,buttheinconsistencyandconfusionarelikelyharmfultoinnovationandaccess.

Recommendations Whoregulatesanindustrycanbeasimportantaswhattheregulationisorhowitisputtogether.Assuch,itbehooveslegislatures,regulators,andmarketactorstostructureregulationsothatitisundertakenbytheregulator(orregulators)thatcanbestmaximizethebenefitsofit,whileminimizingthecosts.Unfortunately,theanswerisrarelyobviousandwillvaryaccordingtotheuniqueneedsofthemarket.Itwillalsochangeasinnovationoccurs,andwilloftendependonweighingcompetingvalues.GiventhediversityandscopeofFinTech’simpact,thissectioncontainsgeneralrecommendationstobeconsideredwhencraftingregulatorystructuresandregulations,andinconsideringhowrulesshouldbeenforced.Legislatures(1) Legislatorsshouldunderstandthatgovernmentregulationisnotalwaysnecessary—itisapowerful

toolbutcanbecostly,cumbersome,andslowtoadapt.Ifotheractors,suchasmarketcompetitors,areabletosufficientlypolicemarketparticipants,governmentactionmaynotbecalledfor.

(a) Ifgovernmentregulationisnecessary,trytostructureitinawaythatbestharnessestheotheractors.Theycanhelpyouleveragetheirstrengthsandavoidduplicativeorburdensomeregulation.

(b) Wherepossible,regulationsthatassignliability,ratherthanstipulatehowaprocessisdone,mayprovidethecorrectincentivestomarketparticipantstominimizeriskstoconsumers,withoutsubjectinginnovationtotherelativelyslowandinefficientgovernmentregulatoryprocess.

(c) Self-regulatoryorganizationscanbequickertorespondtoemergingissuesinamarket,buttheymustbepolicedtopreventthemfrombecomingtoolsofincumbentsagainstcompetitionorinnovation.

(d) Considerwhetherregulationispreventingentrytonewcompetitorswhocouldimproveserviceforconsumers.Itispossiblethatsomeconsumer-protectionregulationsare

DepartmentofLaborrulesandours.SCOTT:Letmerespondtothat,please.Iwashere.IhelpedwriteSection913.TherewasareasonwhytheSecuritiesandExchangeCommissioncametosetandletusdothis—becausetheyweretheregulatoryagency.Now,youmentionERISA.Notonce—notonetime—didtheLaborDepartmentcomeoverandsaid,“Holdon,letushandletheretirement.”No.Therewasnodiscussionofthat.Thatisjusthappeningnow.…53.InvestmentNews.“SEC’sMaryJoWhitesaysagencywilldevelopfiduciaryruleforbrokers,”May17,2015.www.investmentnews.com/article/20150317/FREE/150319919/secs-mary-jo-white-says-agency-will-develop-fiduciary-rule-for.

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counterproductive,andthatconsumerswouldbebetterservedbyhavingmoreoptions,insteadofhavingchoiceslimitedbyregulation.

(2) Wheretheyhavetheappropriateconstitutionalauthority,federalregulatorsshouldconsiderwhethermarketshaveevolvedsufficientlythatthecurrentdivisionsofregulationbetweenstatesandthenationalgovernment,orbetweennationallawandinternationaltreaty,arenolongeroptimal.Whileeachcircumstancewillbedifferent,thefollowinglistofferssomecriteriatoconsider:

(a) Isthecurrentdivisionofregulatoryresponsibilitypreventingbeneficialtransactionsfrom

beingcompletedorundertaken?

(b) Arepeoplebeingdefactoregulatedbyrulestheyhadnorepresentationincreating?

(c) Aremarketparticipantsresortingtoeconomicfictionstomovefromoneregulatoryregimetoanotherinordertopursueregulatoryconsistency?

(d) Isthereanunjustifieddifferenceinregulationbetweentwotypesofcompetitorsbasedon

regulatorystatus?

(e) Wouldnationalizingregulationdepriveconsumersofappropriateprotectionsatthestatelevel?

(f) Wouldnationalizingregulationpreventbeneficialexperimentationamongstateregulators?

(g) Canregulatoryjurisdictionbesplitbetweenstateandfederalregulatorsinawaythatavoidsunnecessaryorburdensomeduplication?

(h) Canstateharmonizationbeeffectivelyencouraged,andcoulditrealisticallyaddressanyproblemscreatedbyinconsistency?

(i) Willallowingforaregulationexportregimeprovidenecessaryconsistency,orwoulditcreateaninappropriateweakeningofregulation?

(j) Willpermittingstateregulatorstoaddtoregulations,ortocreatetheirownuniqueinterpretationsoffederallawsandrules,allowforappropriatetailoringtomeetlocalneeds,orwillitpreventconsistencyandfosterprotectionism?

(3) Ifanevaluationoftherelevantfactorsindicatesthatthecurrentallocationofresponsibilitiescreatesanundueburden,andthelegislatureisconstitutionallyempoweredtoact,thelegislatureshouldconsideraclearandtransparentreallocationofauthority.Thiscouldinclude:

(a) Fullfederalpreemption:incaseswheretheeconomicrealityofthemarketistrulyinterstate,andwherestate-levelregulationleadstodistortions,unjustifiedinefficiency,inconsistentregulationofcompetitorsbasedoncharterstatus,ordefactoregulationofpeopleunderrulestheyhadnorepresentationincreating.

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Forexample,onlinelendersareregulatedatthestatelevelorutilizeabankpartnershipmodeltotakeadvantageofthefederalinterestrateexportprovisionsthatbanksenjoy.Giventheinterstatenatureofonlinelendingandtheinconsistenciesandartificialitiesofthecurrentmodel,afederalchartermaybemoreappropriate.

(b) Theuseofexportregimes:formatterswherestatecompetitionandexperimentationarevaluablebutwhereconsistencyofrulesisnecessaryforefficientandinclusivemarkets,orwhereprotectionismthrivesundertheguiseoflegitimateregulatoryconcern.However,thisshouldbemonitoredtopreventanundulyharmfulracetothebottom.

(c) Thejudicioususeoflocalauthority:toadaptgeneralrequirementswhilelimitingtheuseof“gold-plating”toerectbarrierstoexternalcompetition.

(4) However,whilereallocationofauthoritymaybeappropriate,legislaturesshouldalsoresistthetemptationtoimpose“onesizefitsall”rulesincaseswheretheeffectsofregulationarereallylimitedtothejurisdictionthatcreatestheregulation.Thiswillavoidunnecessarycosts,inaptregulation,anddilutionofrepresentation.

(5) Likewise,legislaturesshouldconsiderwhetherthedivisionofresponsibilitiesbetweenregulatorsisunnecessarilyhamperinggrowth,innovation,andaccessinamarket.Whilethecreationorremovalofregulatoryagencies,orthechangingofjurisdiction,isapoliticallydifficultaction,itcanbejustifiedandshouldbeconsideredwhentheregulatorystructurebecomesanundueimpedimenttoinnovationandmarketfunction.

Additionally,legislaturesmaywanttocreatestructuresthatrequireformalcoordinationbetweenregulatorsincaseswheresuchcoordinationwouldhelpmarketparticipants.Forexample,legislaturesmayconsider:

(a) Rationalizingtheregulatorystructuretocreatefewerregulatorswithclearanddistinctjurisdictions.

(b) Designatingaprimaryregulatorforparticularindustriesoractivities,withclearlydelineatedpowers,whoseregulationssupersedethoseofotherregulators.Thiscanpreventconflictorpreventthemostconservativeregulatorhavingadefactoveto.54

Whileaprimaryregulatorcouldprovideconsistencyandclarity,itwouldalsohavetobemonitoredtoavoidregulatorycapturethatresultsinsuboptimalregulation.

(c) Creatingformalmechanismstoforceregulatorstocoordinateinthecreationandapplicationofregulationstopreventinconsistencyoruncertainty.

54.TheDodd-FrankActtransfersconsumerfinancialprotectionfunctionsfrommany,butnotall,financialregulatorstotheCFPB(12USC§5581).However,therearestilloverlapsbetweentheCFPBwithitsfocusonconsumerprotection,andotherregulatorsresponsibleforoverseeingmarketsthatmayresultinconfusionorinconsistentgovernmentaction.

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i. Forexample,theDodd-FrankActrequirestheCFPBandFTCtocoordinateonrulemaking55andenterintoanagreementregardingenforcementefforts.56

ii. Ano-actionletterclearinghouse—wheremarketparticipantsrequestno-actionrelieffromtheirprimaryregulatorandtherequestiscirculatedforcoordinationwithotherregulatorswhocanengagewiththemarketparticipantandsignoffontheletter—couldhelpprovideregulatorycertainty.

RegulatoryAgencies

(1) Whilelegislatureshavemorepowertocreateormodifystructuresdenovo,regulatoryagenciesmayhavesomeabilitytocreatearegulatorystructurethataddressesthepotentialpitfallsofwhoregulates.Insomecases,thismaybeformalandderivedfromregulator’senablinglegislation;inothersitmaybeinformalandconsensusdriven.Regulatorsshouldconsiderthefollowingoptionswhenassessingregulation:

(a) Ifthefederalregulatorhastheappropriateauthority,considerpreemptingstateregulationswhereitisnecessaryandappropriatetodosotoremoveunduebarriers,inconsistencies,anddistortions.

(b) Seekregulatoryharmonyamongdifferentregulatorstothegreatestextentpossible,includingcompromisingincaseswherecompromisebothprovidessufficientprotectionandisnecessaryforgreaterconsistencyandclarity.

(c) Resistcreatingaregulatorysplitwithinamarketunlesssuchasplitisunavoidabletofurtheranessentialpolicygoal.

(2) Regulatorsinamultiple-regulatorenvironmentshouldacttoavoidcreatingunnecessaryconfusionordelay,including:

(a) Workingwithfellowregulatorstocoordinaterulemakings,guidance,andenforcementactionstoprovideasmuchconsistencyandtransparencyaspossible.

(b) Developingadequateprocessestoaddresstheneedsofmarketparticipantsgiventheeconomicrealitytheyoperatein,eveniftheyarenottheprimaryregulatorforamarket.

(3) Regulatorsshouldalsobemindfuloftheirrelationshipswiththeentitiestheyregulate,includingbothSROsandmarketparticipants,including:

(a) LeveragingSROsandmarketparticipantswherepossibleandappropriatetoprovideappropriateregulationofmarketactors,butmonitoringtheSROstopreventcapturebyincumbents.

55.12USC§5514(a)(2).56.12USC§5514(c)(3).

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(b) Clearlycommunicatingthescopeandlimitationsoftheregulator’sauthoritytomarketparticipantssotheycanavoidbeingblindsidedbyunexpectedregulators.

(c) Engagingwithstakeholdersonanongoingbasistobetterunderstandtheimpactoftheregulatorystructureonthem,evenifthereisn’tarelevantrulemakingongoing.

PrivateRegulatorsPrivateregulators(SROsandmarketparticipants)mayhavethemostlimitedabilitytochangetheregulatorystructuredirectly,butthatdoesnotmeanthattheiractionsdonotimpactwhoregulatestheirindustries.First,theythemselvesregulatetheirindustriesthroughformalandinformalmeans.Second,therealandperceivedconsequencesoftheirregulation(orlackthereof)canimpactlegislatures,regulators,andthevoterswhoinfluencegovernmentregulatorsviaelections.Finally,theycandirectlyinfluencegovernmentregulatorsbyeducatingthemontheeffectsofregulatorystructure.Assuch,privateregulatorsshouldconsiderthefollowingtohelpcreateadurableregulatoryenvironmentthatencouragesinnovationandcompetitionwhilealsoprovidingcertainty.

(1) Marketparticipantsshouldeffectivelyself-police.Internalpolicing,whetherviaSROs,contractualrelationships,orcompetition,isvitaltothecontinuedviabilityofprivateregulation.Ifgovernmentregulators,customers,orvotersperceivethatthemarkethasbecomepredatory,orthatitsparticipantsareunableorunwillingtoappropriatelyprotectcustomers,therewillbeincreasedpressureforformalgovernmentalregulation.Thiscouldresultinregulationsbasedonalimitedunderstandingofmarketrealityorovercorrectiontoreflectthepoliticsofthemoment.

(2) Marketparticipantsshouldalsoavoidregulatinginawaythatpreventscompetitionandinnovation,unlesssuchregulationisabsolutelynecessarytoaccomplishanessentialandlegitimateregulatoryfunction.Whileitmaybetemptingtotrytoerectregulatorymoatsaroundanindustry,sucheffortsmayultimatelyproveself-defeating:

(a) Theseeffortsmayantagonizecustomers,creatingpoliticalpressurethatcouldresultinadverseregulationanddepletecustomergoodwillthatmaybenecessarywhenchangedoesfinallycome.

(b) Regulatoryprotectionismmaydullacompanyorindustry’scompetitiveedgeandencourageoverinvestmentinthestatusquo,leavingcompanieslessabletocompetewhentechnologyorpoliticalpressurefinallydisruptthemarketenvironment.

Inconclusion,itisimportanttoengageandeducatelegislators,regulators,andthepubliconthecostsandbenefitsof“who”theregulatoris,inadditionto“how”regulationworks.Theimpactsofregulatorystructurearelikelybestunderstoodbymarketparticipantsandmaybelessobviousorintuitivetootherstakeholders.

Educationaboutwhysomearrangementsmaybebetterorworsethanothersisvitaltohelpinformthedebateandcounterargumentsthatmarketparticipantsaresimplyseekingaregulatoryracetothebottomor,inthecaseofSROs,protectingtheirprerogativesandfundingsources.

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About the Author BrianKnightisaseniorresearchfellowattheMercatusCenteratGeorgeMasonUniversity.PriortojoiningtheMercatusCenter,hewastheassociatedirectorforfinancialpolicyattheMilkenInstituteCenterforFinancialMarkets.Hisresearchfocusesonfinancialtechnologyandsmallbusinesscapitalaccess.ThisreportwaswrittenwhileattheMilkenInstitute.

Acknowledgments TheMilkenInstitutewouldagainliketothankthosewhoparticipatedinthefollowingprivateroundtablesessions:“FinTech:APaymentsRevolution,”heldinSanFranciscoonFeb.19,2015;“FinTech:21stCenturyFinance,”heldinNewYorkonMarch5,2015;“FinTech:InnovationandRegulation,”heldinWashington,DC,onJune25,2015;andaprivateroundtablesessionheldduringtheMilkenInstituteLondonSummitonOct.28,2015,“21stCenturyFinTechRegulatoryApproachesandParadigms.”Theviewsexpressedbyparticipantsintheseprivatesessionswereinstrumentalintheshapingofthisreport.

TheauthorwouldliketothankDanielGorfine,ChrisBrummer,JacksonMueller,HeatherFields,andThayaKnight.Withoutthem,thispaperwouldnothavebeenpossible.

About the Center for Financial MarketsBasedinWashington,D.C.,theMilkenInstituteCenterforFinancialMarketspromotesfinancialmarketunderstandingandworkstoexpandaccesstocapital,strengthen—anddeepen—financialmarkets,anddevelopinnovativefinancialsolutionstothemostpressingglobalchallenges.

About the Milken InstituteTheMilkenInstituteisanonprofit,nonpartisanthinktankdeterminedtoincreaseglobalprosperitybyadvancingcollaborativesolutionsthatwidenaccesstocapital,createjobs,andimprovehealth.Wedothisthroughindependent,data-drivenresearch,action-orientedmeetings,andmeaningfulpolicyinitiatives.©2016MilkenInstituteThisworkismadeavailableunderthetermsoftheCreativeCommonsAttribution-NonCommercial-NoDerivs3.0UnportedLicense,availableatcreativecommons.org/licenses/by-nc-nd/3.0/