Finra tackles critical issue in assessing impact of innovation

The financial advice industry is evolving, and much of the recent change involves new technology. Advisory firms have adapted to advances ranging from account aggregation to robo-advisers; now they’re starting to grapple with cutting-edge technologies like machine learning and artificial intelligence.

The brokerage industry regulator, the Financial Industry Regulatory Authority Inc., responded to the industry’s evolution last month by launching a new unit, the Office of Financial Innovation, that Finra says will examine “issues related to significant financial innovations by Finra member firms, particularly new uses of financial technology.”

The new office succeeds the Innovation Outreach Initiative, which Finra launched back in 2017, and the agency’s existing Office of Emerging Regulatory Issues will be folded into the new unit.

The Office of Financial Innovation’s responsibilities include not only innovative technology, but digital investments such as cryptocurrencies. It will work with other departments at Finra and with the regulator’s stakeholders on these areas.

Technology can provide valuable efficiencies for advice firms and help them serve their clients more effectively. But advances in technology also can leave firms and their clients vulnerable to new risks.

Finra’s own reports on financial technology make this point.

For example, data aggregation can help investors and the financial professionals they work with by providing an overview of investors’ holdings across various accounts. But a 2018 alert from Finra notes that such arrangements often require investors to provide the aggregator with their passwords to the various accounts so that the data can be pulled together, which can entail privacy and security risks, and leave investors open to identity theft and cyberfraud.

Adopting regulatory technology can improve firms’ compliance programs and help them get a better handle on managing their risks. But Finra warned in a September 2018 report that such technology can create new challenges. Do the firm’s compliance staffers have the know-how to assess the algorithms used in some types of software so they can audit the system? What about risks to customer data privacy as a compliance tool pulls data from other systems? Even if a firm outsources reporting or compliance chores to a third party, the firm remains responsible for ensuring that it is complying with all of Finra’s rules and regulations.

‘Misleading’ information

On the digital investing side, Finra recently looked at social investment tools that weigh in on the outlook for markets, the economy or particular investments based on data from social media sites such as Twitter and Facebook. It warned that the information from such tools could be “inaccurate, incomplete or misleading” based on dated tweets and chatter, or even social media postings that aim to mislead investors.

And Finra has issued a number of reports and investor alerts on initial coin offerings and cryptocurrencies like bitcoin, warning of their complexity and the lack of investor protections in these investments.

The extent of the in-house technology expertise at advisory firms varies, as does the level of outside expertise brokerages can access. At a time when new tech products aimed at the financial advice industry are launching all the time, it’s a plus that Finra is increasing its efforts to assess innovative technology products and sort through their implications for brokers and the advice industry as a whole.

The regulator’s efforts don’t excuse firms from doing their own due diligence. But Finra’s assessments and guidance can smooth the way for its member firms to make better-informed decisions about technology.