Five Issues Wealthtech Firms Should Consider Under U.S. Securities Laws | Wilson Sonsini Goodrich & Rosati

Firms in the emerging “wealthtech” space often face new regulatory and legal challenges under federal securities laws. Wealthtech firms combine traditional asset management and brokerage services with new technologies: algorithmic modeling, including but not limited to artificial intelligence (AI); social media tools that allow investors to interact with each other; sophisticated communication protocols that facilitate more efficient transactions; and data scraping to generate new sources of information about the economy, investments, and specific investors. Some wealthtech firms are registered broker-dealers or investment advisers; some provide services to these registered entities but are themselves unregistered.

Financial technology companies, an increasingly important part of the financial technology sector, have attracted the attention of the U.S. Securities and Exchange Commission (SEC), which has prioritized new technologies in its analysis, issued guidance on their use, and announced proposed regulations applicable to the industry.¹

Particularly in light of the SEC’s scrutiny, wealth technology companies should consider several key issues:

Investment advisors, broker-dealers and their lawyers need to be tech savvy. Complex technologies (such as AI) can be difficult to understand, predict, and monitor, even for engineers. The challenges are even greater for employees of advisors and brokers to whom investors entrust their money, who are not engineers.
Regulators generally do not like the idea that investment professionals (or their general counsels) do not understand technology. Instead, regulators insist that anyone tasked with making investment recommendations or trading for clients understands how the technology works and its risks. They also demand ongoing oversight of what the technology is allowed to do.

Accordingly, legal and compliance staff of wealthtech firms using advanced technology should ensure that they fully understand the technology and its drawbacks, and carefully consider whether and how its use is consistent with the wealthtech firm’s regulatory obligations to its clients, including its fiduciary obligations as an investment adviser or its duty as a broker-dealer to act in the best interests of its clients.
Advanced asset management technology may require developers to register, even if users typically operate the technology themselves. Complex and innovative technology products that help investors allocate investments, provide trading signals, connect investors to facilitate transactions (including through defi protocols), or otherwise assist users in engaging in investment activities may be subject to regulation, even if their products are marketed as a type of software, “calculator,” or similar tool. Wealthtech firms should therefore consider whether their innovative offerings are subject to regulation as an investment advisor, broker, exchange, or other intermediary.
For example, for decades the SEC and its staff have held that technologies used to provide information about potential investment decisions may be subject to regulation under the Investment Advisers Act of 1940, depending on factors such as the degree of sophistication and proprietary nature of the algorithms used, the public availability of the data used, the degree of control users have over customizing the service with custom inputs, the sophistication of the users, and others.² Generally, the newer and more complex a service is, and the less sophisticated its users are, the more likely it is to constitute advice that the SEC will deem subject to regulation.

Based on these guidelines, recent advances in AI and other advanced technologies raise the very real possibility that providing access to these tools for investment purposes will result in developers becoming subject to Advisers Act regulations due to the sophisticated nature of the technology. Developers should not assume that structuring their investment products as subscription software services or using similar product models will eliminate the need for regulatory compliance—it is highly likely that the strategy will not be successful.
Marketing using social media is still marketing. Many wealthtech companies use social media and influencers to promote their products. These arrangements don’t always allow a company to dictate its message as much as it would like: YouTubers and others in this space can insist on creative control. The company placing the ad or buying airtime will ultimately be responsible for what is said in the marketing campaign it pays for, according to applicable laws.
To the extent an advisor or broker uses these channels, they should negotiate content guardrails and as many reviews and approvals as possible. If a marketing channel doesn’t allow for these types of restrictions, the firm may have to walk away—a situation where not all advertising is good advertising.
Social media tools may also increase regulatory risk for wealthtech firms based on investor activity. The use of social media technology in investment platforms can be appealing to investors who are able to identify trends, track economic developments, and vet ideas using these tools. However, these interactions can raise concerns about insider trading or other fraud if a user discloses nonpublic information or attempts to manipulate market prices through posts. Additionally, when investors interact, they can cross the line into providing regulated investment advice—especially when they know something about the investment goals of the people they are interacting with and have the opportunity to benefit from providing that advice, and thus be “compensated.”³ And if a wealthtech firm allows investors to interact via social media, it could be held liable for aiding, abetting or causing any investor to act as an illegal unregistered investment advisor.
Wealthtech firms that provide social media tools to investors should ensure that they have policies in place to regulate the use of these tools to ensure that investors do not provide regulated investment advice to each other or engage in fraud – for example, by prohibiting payments from one investor to another, prohibiting investment professionals from using the platform to solicit clients, and restricting postings where an investor has confidential information or could otherwise personally benefit from trading based on the content they post.
Working with regulated service providers can be helpful but is not necessarily free from securities law regulations. In some cases, wealthtech firms partner with registered investment advisors or broker-dealers to provide their services to investors so that the regulated entity is held accountable for compliance. This often happens in “brokerage-as-a-service,” “advice-as-a-service,” or similar models of providing wealth management tools to investors. However, these models only protect the unregistered wealthtech firm for now.
If an unregistered wealthtech provides regulated services, it can still be held liable for failure to register and independently comply. In addition, wealthtech can be contractually liable for the compliance obligations of the regulated entity. Finally, the SEC has proposed rules that would impose certain due diligence and monitoring requirements on investment advisers when they use third-party service providers, which will inevitably mean that fintech service providers will have additional obligations in their partnerships with advisers. These rules could be adopted in the fall of 2024.⁴

Unregistered financial technology firms that work with registered advisers and brokers should be careful about the things they are committing to and consider whether the scope of their activities would make them subject to direct regulation, taking into account factors such as the services they provide, to whom they provide those services, directly or indirectly, and how they are remunerated.

(1) See e.g.Office of Information and Regulatory Affairs, Agency Rulebook—Spring 2024—Securities and Exchange Commission (agenda including rules related to the use of predictive data analytics, such as artificial intelligence (AI); asset protection, including digital assets; outsourcing by investment advisers to third parties, including financial technology firms; and others); SEC Examination Division, Examination Priorities for 2023, p. 14 (noting the division’s focus on the examination of investment advisers and broker-dealers offering new products or services or incorporating new technologies); SEC, Further Defining “As Part of the Regular Business” in the Definition of Dealer and Government Securities Dealer in Connection with Certain Liquidity Providers (Adoption of Notice) (February 6, 2024) (stating that emerging technologies, such as defi platforms that provide liquidity and market-making services, may be regulated as dealers); SEC, Conflicts of Interest Related to the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers (Issue Proposal) (July 26, 2023) (proposed rulemaking regulating the use of artificial intelligence and other data analytics by broker-dealers and investment advisers); SEC, Outsourcing by Investment Advisers (Issue Proposal) (October 26, 2022) (proposed rulemaking regulating relationships with service providers, including financial technology firms).

(2) See e.g.Datastream International, Inc., SEC Staff No Action Letter (March 15, 1993); EJV Partners, L.P., SEC Staff No Action Letter (December 7, 1992).

(3) See e.g., Lowe vs SEC472 U.S. 181 (1985) at pp. 207–08 (enacting the Investment Advisers Act of 1940 (Advisers Act)) was designed to regulate the provision of personalized advice); See also Advisers Act, Section 202(a)(11) (defining an investment adviser as a person who provides investment advice for compensation). Historically, the SEC has taken a broad view of what constitutes compensation. See e.g.SEC v. Ahmed, 308 F. Supp. 3d 628, 653 (D. Conn.) (“There is no requirement that an investment adviser be compensated in any particular way”), 343 F. Supp. 3d 16 (D. Conn. 2018); Family Life Ins. Co., SEC staff no-action letter (Apr. 2, 1974) (potential new business in the form of insurance contracts sufficient as “compensation”).

(4) See Outsourcing by Investment Advisors; Agency Policy List.