RegFi Episode 44: Principles Over Prescriptions: Rethinking Fintech Regulation
33 min listen
RegFi hosts Jerry Buckley and Sasha Leonhardt welcome Tom Brown, Partner and General Counsel at Nyca Partners, a venture capital firm specializing in fintechs. Tom provides a critical analysis of the current financial services regulatory environment and offers an insider’s perspective on other pressing issues and opportunities in the fintech marketplace.
The discussion explores the regulatory challenges fintech companies face today, particularly the fragmented state-by-state regulatory framework in the U.S. Tom advocates for a more unified, passporting regime similar to Europe, which could streamline operations and foster innovation. The conversation also touches on the complexities of navigating banking partnerships, the potential for a more principle-based regulatory approach, and policy considerations surrounding the adoption of a U.S. digital currency.
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Jerry Buckley:
Hello, this is Jerry Buckley, and I am here with RegFi co-host Sasha Leonhardt. Our guest today is Tom Brown, who is a partner and general counsel of Nyca, a venture capital firm focused solely on investing in financial services companies where technology is a critical competitive advantage. Nyca seeks to bridge the gap between financial institutions and startup founders.
Tom, let’s begin by talking about what you and your colleagues at Nyca are doing. Before joining Nyca, you had a robust private law firm practice representing fintech companies. What was your thinking in deciding to move to the venture capital business? As chief legal officer at Nyca, you have legal and compliance functions, but you have always had an entrepreneurial instinct, so I can imagine that the chance to bring your varied skills to the business side of Nyca as a partner in the business must have been an attraction.
Would you be willing to share your personal journey from antitrust lawyer to lawyer for fintech players to your current role in connecting startups with financial institutions?Tom Brown: Absolutely. And thanks, Jerry, Sasha, and the team at Orrick for inviting me. This is going to be, this will be fun.
So, there’s a lot in there. And let me start with how we at Nyca —so people often sort of think that it’s each of the letters as opposed to the idea. The brand itself, I think, actually captures what we’re attempting to do, which is to serve as a bridge between New York, the “NY”, and then, which is, of course, you know, the world financial center, and then “CA,” California, and specifically San Francisco, which is actually captured in the iconography of the logo itself. It’s the color of the Golden Gate Bridge — so the bridge between the world’s financial center and the world’s technology and innovation center.
And so, as you outlined, like looking for companies that are seeking to make an impact in the financial services industry principally through some technical as opposed to financial innovation and invest broadly speaking around what, what people think of and define as fintech.
And as for as how I got there, well, to quote another famous Northern Californian, it’s been sort of a long, strange trip in some ways, Jerry, from the South Side of Chicago to San Francisco in a role as both an investor and as the general counsel of a venture fund. And the real sort of focal point in the transition from antitrust law and principally litigation to identifying places where there was opportunity to apply technology and, frankly, other innovations, principally sort of identifying white space in the regulatory environment was really my time at Visa.
This is my second in-house stint. And the role at Visa that I found myself thrust into was helping to lead the reorganization of Visa from a co-op, which had been its corporate form since the early ‘70s, to the traditionally organized, i.e., shareholder owned, independent director-governed entity that we see today. And that experience forced me both to learn a lot of law that I had not otherwise been familiar with but also helped to put me at the center of what we now think of as the fintech ecosystem.
So that’s how we got there.Jerry: Turning to the type of things that are attracting you and engaging you on the business side, any observations you’d like to share on that? Tom: Sure. I mean, as you know, from having worked with me in a co-counsel or opposing counsel way for a number of years, I tend to be attracted to white space and zero-to-one opportunities and where that frontier is sort of shifts over time. You know, if we rewind the tape to 2008, several things happened at once: obviously, the financial crisis, but also the introduction of Android, iPhone, blockchain, and those things together sort of cracked open opportunities in bringing technology to financial services.
And some of that was sort of upgrading the technology stack of legacy financial services. But other entrepreneurs saw opportunities to take the unique combination of technologies embodied in mobile devices and to address sort of long-standing problems that consumers and merchants had in connecting to the existing financial infrastructure.
The sort of iconic example for me at this point in that era was Square. Lots of bankers looked at these devices as a threat to the branch network, not wrongly, but what Jack and team saw was the opportunity to bring payment acceptance to anyone, anywhere who could connect to a wireless network.
I think today that frontier has shifted. I don’t know that even a Jack Dorsey would see tremendous appetite in the venture community to bring mobile payment acceptance to an Android or iPhone device, in part because with what Apple announced this morning, that functionality is embedded in, in the device. I think to find today’s opportunities, you have to sort of look and think, again to quote another iconic Northern Californian, differently.
And, and for me, those differences are often sort of identifying legacy payment types that don’t connect well to the digital world or are not served well. Examples include EBT, other restricted spend, so transit vouchers, meal voucher programs around the world have only sort of fitfully made the transition to the native digital world. So that’s sort of one set of categories.
I’d say another category are sort of foundational technologies for what could be the next generation of financial services. So, you know, deep cryptography, quantum computing and AI, of course. I think these are other places where there are some interesting opportunities that are not necessarily on everybody else’s road map.Sasha Leonhardt:
Tom, thank you for joining us today and thank you for that background. I think that’s really insightful. You’re well known as a critical thinker in these areas, and you certainly haven’t been afraid to call out areas where you see regulations impeding progress. Just given kind of what you do and what you’re seeing in your perch, what do you view as the biggest regulatory hurdles for fintech players today? Do you have some concrete examples you can point to?
At the risk of piling on, perhaps, when we’re talking about regulation, I’d love to hear your thoughts about the Supreme Court’s Loper Bright decision and how that might change the regulatory dynamics.
So, kind of respond to that morass, as you will.Tom: That’s a great question, Sasha. And no, I have not been afraid to call out areas of the regulatory framework that I think poorly serve the American community. And this is something I have said for, I mean, at this point, almost 20 years. The crazy quilt nature of the regulatory framework for the delivery of financial services to merchants and consumers, I think, poorly serves Americans.
We have models in other parts of the world where a single license in a single jurisdiction can be passported over a common market to enable people to offer financial services on a level playing field. I had hoped that with the introduction of the CFPB creating a level playing field for the enforcement of federal consumer protection law, that the United States might follow up with further steps to allow sort of that kind of passporting regime that we see principally in Europe. I mean, I can use my driver’s license issued by the state of California to drive a car in any state in the United States. There’s no particular reason why a financial institution licensed and chartered in the state of California can’t do the same. And there are obviously a set of entrenched interests that prevent that, but I don’t think that those are in the broad interest of the people of the U.S.
And that is, from my perspective, the single biggest obstacle and it’s a particular obstacle in a world that is made flatter by technology because one of the benefits of what we think of as the internet or the combination of technologies that connect us, that are enabling us to do this podcast across five different geographies, is that they’re accessible anywhere to anybody who has both electricity and access to broadband wireless. In that world, we should move towards uniformity with respect to the regulatory framework, not pull ourselves apart towards idiosyncratic requirements that depend on the precise geographic locations of the counterparties to the transaction. And the U.S. is just stuck in a 19th century mindset about how best to serve the interests of local communities.Sasha: Tom, I think that’s helpful. And I think it’s unique that financial services is so balkanized among different regions where you have state financial regulators in every state. We don’t often see that in other industries. Tom: We see it in insurance. I mean, we see it in financial services, right? So, insurance famously, banking is sort of a hybrid, right? Because, certainly post the National Bank Act of 1863, we are allowed to have institutions that operate across the Commonwealth. But with respect to non-banks in particular, they’re left to sort of crib together permission on a state-by-state basis and then have to accommodate each state’s idiosyncratic interest. And there’s just no empirical evidence that that serves folks particularly well.
I didn’t get to the second part of your question, which has to do with Loper Bright. As to which I have many, many, many thoughts. I think, though, that the focus on — and there are certainly ways to improve the siloed nature of regulation of financial services at the federal level, like the alphabet soup of regulators. I tend to think, though, that those are, at least from the standpoint of unleashing the benefits associated with our existing technology for the broad set of consumers and firms, households, state and local governments, I think they pale relative to the benefits that would accrue if we had something like the passporting regime that we see in Europe, and that has been successful in Europe.Jerry: You know, to that point and to your discussion about our complexities, both in terms of multiple state regulators and the federal regulation, you know, we really, these things have accreted over time. You know, as you referenced, you know, first we had state regulation, then we had the National Bank Act, you know, to finance the Civil War. Then the Federal Reserve came along to deal with the crisis. Tom: The currency crisis. Jerry: The currency crisis, the panic of 1907. And then there was the Great Depression, and we set up the FDIC and the Federal Home Loan Bank System, which has come and gone. And then in 2008, we had the financial crisis, which led to the creation of the CFPB.
And Tom, going back to the point you’ve made, but if you were to really rebuild the federal level and the state and the relationship between the federal and state, how would you do it?Tom: It’s such a — there’s sort of two ways to approach that question, right? There’s the, “What is possible and achievable on an incremental basis?” And then, if you are operating against a blank canvas, how would you design it? I think, and the instinct is always to approach things from the perspective of the blank canvas. And I’m happy to start there, but it’s not, and maybe it helps aspirationally — Jerry: I think so. I think it does. I think to have the vision, you know, when you’re, when you’re shooting a basket, imagining it going in is a good idea because you are usually more likely going to get the ball — Tom: It’s better to imagine it going in than, than, than not. Jerry: Yeah. So, you envision that the, the, the way in which it happened. Now, if you envision the end game as you’re, suggesting the black canvas. We can talk later about how we get there, which may be a long and circuitous route, but we may have a crisis that will get us there. But what is your vision for how it should be? Tom: I think one of the core challenges with the existing regulatory framework, particularly at the federal level, is that it is prescriptive as opposed to principled. And so, you can take any number of the various silos, so CFTC, SEC. The one that I’m most familiar with are the rules and regulations that relate to the interaction between consumers and financial institutions with respect to certain products. So, let’s just talk Reg E and Reg Z. These are technical and dense rules that exposit technical and dense statutory frameworks. And they’re of the, “Say this, don’t say that” variety. And thus, the behaviors that you then see that those regulatory frameworks are specifically designed and implemented to produce are the output of certain information.
Now, that information may or may not be useful, but it is several steps removed from what should be the core driver of regulation, which is what is the social welfare associated with the interaction between suppliers and customers with respect to this particular product?
As somebody who came to bank regulation after having been a research assistant for Cass Sunstein at the University of Chicago and then an antitrust lawyer working for a former partner at Orrick, but I met him in his pre-Orrick incarnation, Steve Bomse and Larry Popofsky, it’s just odd to confront a regulatory regime that seems disconnected from the core objective, which is, what does the interaction between these private market participants produce? And is there some reason to believe that there’s a market failure that is leading to some outcome that is inconsistent with what we would expect through more regularized private ordering? Right?
And what are the things that interrupt the efficiency of private markets? So, fraud, of course. Force. But where you don’t see either of them you should be somewhat hesitant as a regulator to intervene and restructure in private ordering. The financial regulation, both on the prudential side, the safety and soundness side, and on what we call consumer protection is sort of disconnected completely from that philosophy for regulatory engagement.
And it doesn’t — there’s no evidence that that the costs associated with maintaining that regime are worth the —produce some kind of corresponding benefit. And again, other parts of the world have approached these problems from a principled basis, which is, we’re looking to get to a set of outcomes. Let’s examine in a sophisticated way the supply and demand conditions associated with providing that thing: It could be payments; it could be deposit products; it could be credit. And let’s try to understand why we’re not getting the market outcomes that we want.
That approach is foreign to how U.S. regulators, for the most part, approach the problem. And that failure is a bipartisan failure. This isn’t as though any one party is particularly good at taking a principled approach to regulation. There are obviously sort of different flavors of intervention, but they approach it from a prescriptive approach as opposed to a principled approach.
And if I could change one thing, just one thing, it would be to reorient financial regulators to a welfare-based approach from the prescriptive, industrial-policy type framework that we use today.Jerry: Very interesting, Tom, and very insightful. In some ways, it reflects the conservativeness of our society, which once something is in place, it’s almost impossible to change it. And so, you know, once these 50-year-old statutes are enacted, and then the incrustation of regulation around them develops, it’s very hard to rethink. But what you’re calling for is a rethink.
Tom: And we have done it, right? We tend to do it when something new happens, right? So the existing regulatory framework at the consumer protection level for financial services, right, was born of a moment in the late ‘60s that began with the Johnson administration and continued through the Nixon administration and the creation of a sort of national commission to sort of reimagine what kind of consumer protection framework should govern a set of financial services that went from being offered in a very balkanized, very local way to being offered on a national level.
That’s how you got, as you know, that’s where we got the Truth in Lending Act, the Electronic Funds Transfer Act, the Fair Credit Reporting Act. They were all born of that, that sort of in systematic interest and study of an industry that hadn’t really existed in the form that it took in, you know, through the late ‘60s and early ‘70s. And we have lost the capacity for sort of re-examination.Sasha: Tom, I want to come back to something else you said earlier about the quilt of regulatory enforcement and the idea of a passporting regime. A lot of fintechs will try to navigate one of those in the States by doing a bank partnership or banking as a service. But as you know, obviously, that’s facing a lot of headwinds now. I mean, it does have the benefit of allowing you to export under the National Bank Act or FDI Act and avoid the headache of buying a bank charter or the effort of setting up a de novo bank.
But I’m curious about your thoughts about how to do this, how to actually, in the absence of a 50-state passport, how fintechs can best offer financial products across the internet, which knows no borders, and in kind of the balkanized, state-focused regulatory regime we face in 2024.Tom: So, there’s the business piece of that, and then the sort of, like, what is the core regulatory playbook?
We’ll start with what I think of as the right order of operations in trying to build a business in that space. The most successful businesses in that space, and you can see this with Square, to some extent with PayPal, though oddly people seem to overlook this with respect to PayPal, prior generations like Green Dot, Lending Club, go build a business. And then to the extent that that business depends on some regulatory charter, obtain the charter. In all of those instances, it’s a bank of some kind or another. So, Square has an ILC, PayPal is a bank in Europe, Lending Club acquired Radius, Green Dot acquired a bank. That story has played out over and over again.
In terms of how you sort of crib together the regulatory permission to offer your service, that sort of depends on the precise moment in time and where the white space is. So, to give sort of a concrete example, and as Jerry knows, I spent a lot of time, gosh, probably as long ago as 2010, but certainly like 2010 to 2014, trying to create white space for what we now think of as earned wage access services. But the principal potential obstacle at that point was the CFPB’s payday rule and the extent to which the payday rule would read on EWA services. And we succeeded in persuading then-Director Cordray to create a sort of picket fence in which EWA could operate and that would be outside the scope of the payday rule.
If you now fast forward 10 years, a lot of the white space associated with EWA has been filled in. We’ve seen what I will describe as several pirouettes on the part of the Bureau with respect to their tolerance and embrace of — that is the polite way I think of pointing out.Jerry: You try to be very polite on this podcast, yes. Tom: But when you watch someone spinning, the polite way seems to describe it as a pirouette.
But obviously, lots of state interest. We now have, I think, eight states have adopted statutes that define or embrace EWA in a particular way. So, if you were trying to bring that product today to market, the strategy and approach that you bring is just very different than the one that you followed a decade ago.
So, I think it requires attention to the specific nature of the user experience that you want to provide. And then an identification of the paths. In many instances, the easiest path is going to be, even in today’s environment, is going to be to structure some relationship with a financial institution in which you, as the non-bank, effectively help a bank offer that service to consumers or small businesses. Now, that’s not always the way, but that is often the way.
But, you know, I can think of other examples too. So, I mean, for example, when Afterpay came to the United States, it operated — so Afterpay, of course, then later acquired by Square, a buy now, pay later service that had started in Australia — it launched on a vendor finance model as opposed to a bank sponsor model. Now, it changed, but that path provided an opportunity for them to get to market in a way that perhaps other paths would not have.Jerry: You know, our time is running out, but we haven’t touched on the regulation of digital currencies yet, and we could take a long time on that, or the creation of a central bank digital currency for that matter. But if you could decide, how should digital currencies be regulated in the United States? Tom: How should they be regulated? Well, I’m going to start with what I think of as a practical political constraint. I think it is unlikely in the current political environment that the Federal Reserve will receive permission to introduce a native digital alternative to the dollar. It’s possible that that constraint will lift, but I’m skeptical of that given that there are commercial versions now of native digital dollars. And that, absent some crisis or collapse with respect to those commercial entities, I think a public version of that service is unlikely.
It’s sort of another part of the political culture of the U.S. that we look to the private sector to create things and absent some problem with the version that the private sector provides we tend not to look to the public sector to support.
I think given that constraint the question becomes, “What’s the right regulatory framework?” Here, consistent with the passporting regime that I mentioned earlier, I think something like — and this is another thing that I’ve spoken quite a bit about. I’ve written about many of the others or even testified in front of Congress about them. What I’m about to talk about is something that I have written about. I don’t know that I’ve published it widely, but certainly circulated among friends.
The U.S. made a very deliberate choice in the 1930s to embrace deposit insurance relative to other ways of creating confidence with respect to access to day-to-day payments. This is the so called Chicago Plan, right? So, recognizing that credit intermediation does not necessarily have to be provided on the back of daily deposits. So, a group of scholars associated with the University of Chicago had suggested that instead of creating deposit insurance for fractionally reserved financial institutions, we limit the ability to provide daily deposits to fully reserved institutions. That was, in essence, the Chicago Plan. The United States rejected that. It’s embraced deposit insurance.
But I think as you look at the commercialization of things like a digital alternative to the dollar, those are offered on a fully reserved basis. We have things like fully reserved financial institutions chartered at the state level in the form of money transmitters and stored value providers. There are versions of those charters offered, so these are non-insured trusts now over how many different administrations? So, Obama, Trump, Biden. We’re now three jurisdictions into the digital dollar age, and we’re 0 for 3 in allowing a fully reserved, federally chartered trust to offer a digital equivalent to the dollar. That feels like a failure.
And interestingly, we’ve now had three different, I think, all acting — no, Comptroller Curry was confirmed — but both acting Comptroller Brooks and acting Comptroller Shu, like we’ve had three Comptrollers of the Currency, obviously appointed by very, very different presidents in different political environments, all say the same thing: that we should have a charter for fully reserved institutions and provide access to the payment system. And yet, we don’t.Jerry: You know, we could explore that a lot further as to why. But unfortunately, our time has run out. Tom, we could go on with you, and maybe we should have you back if you’d be willing to do it, to have further conversation. This has been a fascinating insight by somebody who’s been very close to and a strong commentator on our financial regulatory system.
You’ve been very restrained today and polite in your description of the phenomena that we’ve been discussing. I’ve heard you on other occasions be more direct, but you’re very polite on this podcast, and we thank you for doing that. We’ll look forward to a further discussion. And Sasha and I both want to thank you so much for being with us.Tom: Thank you so much. And I’ll come back anytime, anytime you want. So again, thanks to both of you and to the team at Orrick generally for hosting these and look forward to future discussions and really appreciate the opportunity to spend time with you, Jerry and Sasha. Sasha: No, thank you, Tom. This has been a great chat. Take care.