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Regulators want firms to ramp up fintech accountability

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Officials at the SEC and FINRA have been talking a lot lately about how they have been ramping up their use of sophisticated technologies to root out questionable conduct among the firms they regulate.

It turns out that they're expecting advisors and brokers to do the same.

"It's not just for the SEC, but for all of your organizations," Scott Bauguess, deputy director of the SEC's Division of Economic and Risk Analysis, said this week at a conference hosted by the Practising Law Institute and broadcast online. "If you're not using your data or the data you're buying, you're probably behind the curve in terms of your strategic plans."

Carlo di Florio, chief risk officer and head of strategy at FINRA, described an elaborate risk assessment process at his organization, involving a multi-factor analysis that every year produces a ranking of all the firms in the regulator's jurisdiction and effectively determines which firms will receive the most scrutiny.

"That exercise helps us identify the firms, branches and reps that we're going to focus on in that particular year," di Florio said . "So data analytics is critical to that exercise becoming better, smarter, more focused every year."


Regulators are increasingly expecting firms to undertake similar processes in-house. For a brokerage shop, that might mean taking a hard look at various branches, reps and trading desks to identify risky or aberrant activity.

"To the extent you're doing those [reviews], that's exactly the right thing," di Florio said . "To the extent you're not, or not applying the latest tools and technologies, that's an area where you can really help your firm hone in on the right issues."
The regulators' comments come at a moment of substantial technological upheaval within the wealth management sector. The SEC and FINRA both continue to warn about cybersecurity threats, and both regulators are keenly watching how firms deploy digital advice platforms and other novel technologies.

But while fintech commands the headlines, there is a major push underway to develop smarter systems to help firms with regulatory compliance, too. Di Florio is working with an industry advisory board to develop a white paper on the subject of regtech, "looking at how technology tools help achieve regulatory objectives," which he hopes will provide some insight for firms trying to tune up their compliance and risk management operations.

"We want to publish that so the industry benefits from that research and analysis and they can decide whether or not it's appropriate for them to bring that kind of tool in-house," he said .

All of the enthusiasm for firms to embrace new technologies comes with a significant caveat, however.

Bauguess explained that SEC examiners are expecting a certain level of accountability among advisors for how their systems operate under the hood, and whether they are providing service and recommendations that align with clients' risk profiles and investment objectives.

"If you're using technology to help make decisions at your entity, in particular using machine-learning type technology that can be more of a black box, you really need to understand how that algorithm or those analytics are working to meet the objectives," he said. "If you're advising clients in a way that's using a program or an analytic tool, you need to be sure that it's meeting the requirements with whatever you have agreed to with that client."

Those considerations track with the broader shift in how the SEC's Office of Compliance Inspections and Examinations conducts its oversight work. Exams used to be about site visits and requests for reams of paper. But amid the digitization of the advisor shop, those reviews increasingly focus on how firms are keeping track of their data.

"The discussions that happen between OCIE examination staff and registrants changed significantly, and it's about accessing information and data," Bauguess said. "So one of their initial questions is going to be, often times, who manages your data? Do you have a chief data officer? How do you transport information? How is it organized?"

Within the SEC, which perennially bemoans its infrequent advisor exam schedule, smarter technology can have the practical benefit of enabling examiners to touch more firms at far less cost than site visits entail.

"At the end, all of this is really intended to help allocate scarce resources,” Bauguess said. “There's a big issue in terms of boots on the ground, being able to go out and do on-site examinations or inspections.”

”In today's computing [and] data environment, you can do an examination sitting in a home office at your computer if you do so cleverly," he added. "And that saves a lot of resources on everybody's part — whether you're the one being examined or you're the one doing the examination, it makes the process a lot more efficient."

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