Retail investors, particularly novices, are being misled — intentionally or otherwise — by robo-advisors such as Robinhood Financial and steps need to be taken to protect users, according to multiple members of the Securities and Exchange Commission’s Investor Advisory Committee.
The IAC advises the SEC on regulatory priorities, investor protection and investor confidence, among other things.
In a committee meeting Thursday, invited speaker Punam Anand Keller, a marketing specialist and senior associate dean of innovation and growth at Dartmouth College’s Tuck Business School, laid out a series of ways she believes that Robinhood has misled investors.
First, Keller touched on the issue of prompts, such as a notification that a given stock has gained big on a given day or the display of a confetti image after a trade is made. Instant prompts create what Keller called an implemental mindset, in which users are focused on overcoming hesitation and achieving short-term goals, rather than a deliberative mindset that promotes reflection.
Last month, the SEC issued a request for information and public comment on the use of digital engagement practices by broker-dealers and investment advisors, including behavioral prompts, differential marketing, gamification and more. Meanwhile in June, the Financial Industry Regulatory Authority hit Robinhood with $70 million in penalties for alleged false and misleading information in communications with its customers.
Other problems include the easy access to the apps at all hours of the day, which Keller said creates a false sense of urgency. She also noted that many trades are made during “periods of depletion,” or times of the day when consumers have less self-control.
“We don't buy a Jeep because it has an open frame, we buy a Jeep because it makes us feel free,” Keller said.
To illustrate her point about the time element, Keller said she tells consumers to wait until noon the following day after putting something in an Amazon cart before going ahead with a purchase. The same principle could be applied to trades and withdrawals from investment accounts, she said.
Stephen Hall, legal director and securities specialist at the non-profit organization Better Markets, also an invited speaker at the meeting, underscored the need for regulations.
“If the SEC cannot regulate these practices simply because they are not formally couched in terms of recommendations, then digital platforms will have a de facto digital exemption from the primary regulation designed to protect investors from broker-dealers pushing investment products onto their clients exclusively for their own gain," Hall said. “In that case, the SEC must consider adopting a new set of rules, specifically addressing the threat to investors that online trading platforms can pose.”
What Keller, Hall and others agreed upon at the meeting is that investors, particularly novices, would be much better served if they were prompted in ways that encouraged responsible financial decision making.
For example, apps could create so-called “decision points” that prompt them to think about their long-term goals and what future decisions they might make rather than short-term trades, Keller said.
Daniel Egan, the director of behavioral finance and investing at robo-advisor Betterment, said that survey data from his platform showed that between 15% and 25% of users were not aware that long-term capital gains were taxed at a lower rate than short-term capital gains. When informed of this fact, Egan said capital allocation dropped by about 90%, without divulging the timeframe of that drop. Robos could be required to provide that information if they were subjected to the SEC’s Regulation Best Interest.
Reg BI requires broker-dealers to comply with the best interest standard when making a recommendation of any securities transaction or investment strategy involving securities to a retail customer.
“In a case like Robinhood, I don't think it's a close call,” Better Markets' Hall said. “If you add up the various tactics and communications they use, I think you don't have too much difficulty saying these constitute, in effect, recommendations that should trigger the protections in Reg BI.”
‘Very important questions’ to address
In prepared remarks for the meeting, SEC chair Gary Gensler said new technology has features that may end up encouraging investors to trade more often, invest in different products or change their investment strategy.
“Predictive analytics and other digital engagement practices often are designed, in part, to increase platform revenues, data collection, and customer engagement, leading to potential conflicts between the platform and investors,” he said in the remarks.
Gensler also identified three “very important questions” that he believes must be addressed:
- How are investors protected from the potential conflicts of interest that may exist when DEPs optimize for platform revenues, data collection or investor behavior?
- Are DEPs making a recommendation or providing investment advice?
- How do these new business models ensure for fairness of access and pricing?
Regulators have set their sights on the impact of game-like and social media-driven trading, especially following the GameStop frenzy in January. GameStop’s stock price soared in January after day traders on Reddit’s Wall Street Bets community encouraged others to wipe out the short sellers in the stocks.
In May, Gensler told legislators the SEC is considering new rules for trading apps and plans to review whether they have features that could violate its Regulation Best Interest.
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