Financial Compliance for Tech Startups in the US: How to Maintain it?

As of 2023, the financial technology sector's valuation is 179 billion USD and is anticipated to soar to 376 billion USD by 2026. Adhering to regulatory requirements is an essential foundation for success.

The leading cause of startup failure, at 18%, is regulatory or legal challenges. Legal issues must be solved in the very beginning to minimize the risk of failure. Let’s explore possible regulatory and legal challenges in this article.

What is FinTech regulatory compliance?

Fintech regulations refer to the laws and rules governing the financial technology industry that companies must abide by to be compliant. This includes anti-money laundering (AML) laws, know-your-customer (KYC) requirements, consumer protection laws and GDPR/CCPA rules.

US agencies that regulate FinTech companies 

The primary regulatory bodies governing fintech in the United States include:

• The Financial Crimes Enforcement Network (FinCEN) aggregates transaction data to identify and prevent financial crimes.
• The Office of the Comptroller of the Currency (OCC) supervises businesses to ensure compliance with pertinent banking laws and regulations.
• The Consumer Financial Protection Bureau (CFPB) mandates that banks, lenders, and other financial entities ensure the fair treatment of consumers.
• The Commodity Futures Trading Commission (CFTC) oversees digital assets that primarily meet the criteria of commodities or are utilized as derivatives.
• The Securities and Exchange Commission (SEC) provides comprehensive regulatory oversight for companies involved in securities sales and offers guidance on reporting and disciplinary obligations.

Moreover, fintech is subject to various significant regulations, including:

• The Gramm-Leach-Bliley Act (GLB), also known as the Financial Modernization Act, aims to uphold the confidentiality of personal data held by financial institutions, provide customers with privacy policies, and provide options for opting out of personal data disclosure.
• The Fair Credit Reporting Act (FCRA) protects information collected by consumer reporting agencies.
• The Bank Secrecy Act (BSA) is primarily designed to combat money laundering by necessitating vigilant monitoring of suspicious activities and reporting of potentially problematic transactions.
• The Patriot Act sets standards for customer identification and mandates know-your-customer (KYC) protocols.
• The Electronic Fund Transfer Act (EFTA) governs practices related to online monetary transaction authorizations.
• The Truth in Lending Act (TILA) encompasses regulations for credit cardholder protection aimed at enhancing credit card disclosures, managing rate increases and payment allocations, and establishing reasonable payment completion durations.

The regulations above represent only a portion of the legal framework impacting fintechs. Additional legislation such as the E-Sign Act, the TISA, and federal rules concerning Red Flags and Affiliate Marketing may also influence fintech operations and business models.

Who is covered by Fintech regulations?

Companies in the following areas are subject to the regulations: banking/open banking, lending, contracting, InsurTech, cryptocurrency, and blockchain. 

In 2019, FinCEN released guidance proposing the application of the Bank Secrecy Act (BSA) to business models involving the transfer of digital assets, often referred to as convertible virtual currencies (CVCs) by FinCEN. Consequently, certain business models may fall under regulation:

• Peer-to-peer (P2P) exchange platforms
• Providers of hosted wallets
• Providers of multiple-signature wallets 
• Operators of CVC kiosks that accept and transfer value
• Decentralized applications facilitating money transmission
• Providers of anonymizing services for CVCs 
• Payment processing services involving CVC money transmission
• CVC money transmission is conducted by internet casinos or individuals engaged in gambling businesses not covered by the traditional definitions of casinos, gambling casinos, or card clubs, but which accept and transmit value denominated in CVCs.

Moreover, in 2021, the Anti-Money Laundering Act (AMLA) amended the BSA, broadening the definition of "financial institutions" to encompass "value that substitutes for currency." Consequently, financial institutions now include, among others:

• Companies engaged in currency exchange, fund transfer, or providing alternative forms of currency or funds.
• Individuals operating as currency transmitters, facilitating domestic or international money transfers through informal networks or systems, outside the conventional financial sector.

Fintech compliance checklist

Fintech companies must establish robust compliance procedures and policies that address various operational aspects to achieve several objectives: preventing money laundering, safeguarding data integrity, and protecting customer privacy. In this regard, adhering to a key fintech compliance checklist is essential:

• Anti-Money Laundering (AML) is designed to detect, prevent, and report money laundering activities, terrorist financing, and fraud-related risks. 
• Know Your Customer (KYC), Know Your Business (KYB), and Customer Due Diligence (CDD) establish robust customer identification procedures. KYC or KYB is the essential procedure of confirming the identities of customers or businesses when they register for an account. It involves continuously monitoring transaction behaviors to assess risk. During the onboarding process, users must provide evidence of their identity and address to verify their authenticity.
• The Red Flag rules mandate that businesses establish and execute a documented identity fraud prevention program to identify warning signs, known as red flags, of identity theft. This program aids companies in promptly recognizing suspicious activities within their operations, enabling them to take necessary measures to prevent identity theft and minimize its impact.
• Data Security and Privacy. Fintechs engaged in international payment systems must adhere to the Payment Card Industry Data Security Standard (PCI DSS), which outlines 12 security requirements aimed at maintaining a secure data protection environment for companies handling credit card information. Additionally, it's crucial to recognize the increasing importance of data privacy laws and regulations such as the General Data Protection Regulation (GDPR) in Europe and the California Consumer Privacy Act (CCPA). 

The first step for privacy compliance with these regulations is to draft a Privacy Policy. We drafted a privacy policy for Kash, a product based on blockchain technologies and decentralized finance, aiming to provide hybrid banking solutions. More details about this case here.

An AML program should be tailored to suit the scale and characteristics of a company and must encompass at least the following elements:

• Policies, procedures, and internal controls that are adequately formulated to ensure compliance with the requirements outlined in the Bank Secrecy Act (BSA) and its associated regulations.
• Independent testing to assess and verify compliance with regulatory obligations.
• Appointment of an individual or a team responsible for overseeing and managing the implementation of operations and internal controls, as well as monitoring their effectiveness.
• Continuous training to ensure they remain well-informed and updated on AML protocols and procedures.

What are the consequences of non-compliance in the fintech industry? 

Over 60% of fintech startups paid at least $250K in compliance fines in 2023. The largest fine of $4.3 billion was imposed on Binance for an ineffective anti-money laundering program. The exchange failed to report more than 100,000 suspicious transactions involving designated terrorist groups including Hamas, al Qaeda and the Islamic State of Iraq and Syria, or ISIS.

Not only large Fintechs face fines, so compliance is a crucial task for every company in the Fintech area. By analyzing and meeting regulatory demands early on, FinTechs can secure their future, establish trust, and seize growth opportunities. Taking a proactive stance on compliance isn't just a legal necessity; it's also a strategic edge in the dynamic realm of financial technology.