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SEC Investor Advocate: Does Gamification Mean Game Over for Reg BI?

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What You Need to Know

  • A significant issue that the SEC must consider: How does the use of digital nudges intersect with Reg BI?
  • SEC should make clear that recommendations can include when digital platforms nudge investors in a way that could be viewed as encouraging trading.
  • Most if not all online discount brokers are influencing investor behavior with digital engagement practices, Fleming said.

Securities and Exchange Commission Investor Advocate Rick Fleming said Wednesday that as the agency digests the comments it received on the use of digital engagement practices, or DEPs, by broker-dealers and advisors, there is “a significant issue that the commission must consider as part of this: How does the use of DEPs intersect” with Regulation Best Interest?

“In my view, it appears that the use of certain DEPs, by gamifying securities trading for retail customers, could significantly influence these retail customers’ investment decisions in ways that were not fully contemplated when the commission adopted Reg BI with its important distinction between solicited and unsolicited trading,” Fleming said in comments at the Practising Law Institute’s SEC Speaks event.

“This leaves open the possibility that investors would not receive the benefit of Reg BI protections even though they are being influenced to engage in securities transactions,” Fleming warned in his speech, Investor Protection in the Age of Gamification: Game Over for Regulation Best Interest?

When Reg BI was adopted “in the pre-gamification era, I observed that the utility of Reg BI would ultimately depend upon how it is enforced” by the SEC and the Financial Industry Regulatory Authority, Fleming said.

For Reg BI “to remain a relevant and useful regulation in this era of gamification, the commission should make clear that ‘recommendations’ include instances where a broker-dealer utilizes DEPs to nudge investors in a way that reasonably could be viewed as encouraging trading, and the commission should use its enforcement authority to back up its position,” Fleming advised.

While this is easier said than done, as a vast array of DEPs continue to evolve, Fleming continued, “applying the facts and circumstances to determine whether any particular DEP or combination of DEPs arise to the level of a ‘recommendation’ will be challenging and could consume a lot of commission resources. And litigation in a gray area like this is always risky.”

Investors, however, “need the protection of Reg BI in this new world in which they are being pushed or pulled by the platforms they utilize to access the markets,” Fleming said.

DEPs “are being used in ways that make the distinction between solicited and unsolicited trades almost meaningless, and brokers’ obligations under Reg BI should not turn on whether the customer technically initiates the trades after the broker has used subtle techniques to influence the customer to engage in active trading, trade on margin, trade options, and engage in other risky practices,” Fleming said.

If Reg BI “proves to be inadequate to protect investors, I believe the commission should go back to the drawing board so that its critical investor protections no longer rise and fall on whether the broker-dealer made a specific recommendation,” Fleming added.

Broker, Advisor Can of Worms

Another can of worms related to Reg BI: “What is the difference between an investment adviser and broker-dealer as we approach the end of 2021?” Fleming asked.

“For years now, I have struggled to explain the difference between a full-service broker and an investment adviser because in my view the commission has allowed brokers to do virtually everything that an adviser does, notwithstanding the fact that brokers are excluded from the definition of an investment adviser only if their advice is ‘solely incidental’ to their brokerage business.”

Now, “it seems that most if not all of the online discount brokers are influencing investor behavior with digital engagement practices, which further blurs the line between providing investment advice and traditional brokerage service,” Fleming said.

“At some point, if the commission fails to brighten the distinction between advisers and brokers, it will make little sense to regulate the two with such distinct regulatory models.”

Pictured: SEC Investor Advocate Rick Fleming