The Securities and Exchange Commission’s investor advocate is calling into question whether the agency’s Regulation Best Interest went far enough, given the proliferation of digital investing platforms use of “gamification” and other practices.
“As the Commission noted in the adopting release, Reg BI was not intended to ‘apply to self-directed or otherwise unsolicited transactions by a retail customer,’” Rick Fleming wrote in prepared remarks for the Practicing Law Institute's SEC Speaks conference.
Since then, changes in the brokerage industry, including commission-free trading platforms, the introduction of fractional shares, and lower account minimums have quickly drawn a new swath of investors into the market, he said.
"Broker-dealers, as well as some investment advisers, now utilize a variety of digital engagement practices, or DEPs, to connect with a broader array of retail investors, particularly younger investors who grew up with similar design features in other online apps and games on their devices," he said.
Online brokers and apps have used behavioral economics "in ways that were not fully contemplated when the Commission adopted Reg BI with its important distinction between solicited and unsolicited trading,” he wrote.
And apps and online platforms that "nudge" investors to take certain actions can also "induce" frequent trading, or the selection of risky products, he said.
"The rapid evolution of the broker-dealer business model now leaves me wondering whether Reg BI was worth the effort after all," said Fleming.
He pointed to "recent events" that point to potential "flaws" in Reg BI, alluding to Robinhood Financial and its role in the trading frenzy in so-called “meme” stocks such as GameStop.
And although he acknowledged that some "well-meaning" brokers can use these tools to deliver educational materials and "embed warnings" to avoid "foolish decisions such as incurring unnecessary taxes," Fleming said the line between "nudges" and advice is blurry.
As a result, Reg BI, as written, would not provide the investors on many investment platforms the type of protection the SEC may have intended, according to Fleming.
The investor advocate also says that the rise of discount brokers only further blurs the SEC’s already unclear distinction between broker-dealers and investment advisors, as “most if not all of the online discount brokers are influencing investor behavior with digital engagement practices.
“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,” Fleming wrote.
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