Gary Gensler, former chairman of the Commodity Futures Trading Commission, testifies during a U.S. Senate Banking Committee hearing on systemic risk and market oversight on Capitol Hill in Washington May 22, 2012.
Jonathan Ernest | Reuters
The Securities and Exchange Commission said Friday it was stepping up its investigation into so-called gamification and behavioral prompts used by online brokers and investment advisers to trick people into trading more stocks and other securities. .
Wall Street’s top regulator said investors can be misled by optimistic earnings projections by technologies that, in reality, underestimate the risk of a particular investment or the chances of eye-popping returns.
“While new technologies can bring us greater access and choice of products, they also raise questions about whether we as investors are adequately protected when trading and obtaining financial advice,” SEC Chairman Gary Gensler said in a statement. “In many cases, these characteristics may encourage investors to trade more often, invest in different products, or change their investment strategy.”
The SEC often seeks public comment before drafting new rules and regulations for Wall Street, which means Friday’s announcement, while procedural, could pose a headache for industry executives.
Shares of Robinhood Markets, operator of a popular digital trading platform that has come under scrutiny for its client trading prompts, fell as much as 1% to hit day lows after the SEC report.
The commission said investment firms and online brokers will often use “predictive” analytics tools designed to show customers what they would earn under optimal – but not necessarily probable – conditions.
While brokers may disclose that their predictive models are not guarantees of future returns, Gensler said he wanted to gather investor thoughts on gambling-like features on financial platforms, behavioral incentives to trade more often and “other digital elements or features designed to engage with retail investors on digital platforms.”
As part of the announcement, the SEC said it would collect public comments for 30 days after the request and comment submission forms go live.
Gensler said he was particularly interested in hearing from the public on two key issues.
First, the SEC Chairman wants to know how the financial regulator should protect investors from a potential conflict of interest.
Online brokers generate profits when their clients trade more often. Robinhood Markets, for example, makes money in part by sending its clients’ orders to high-frequency traders in exchange for cash. This process is itself controversial and known on Wall Street as payment order flow.
But if game-like prompts or congratulatory messages from online brokers entice customers to make more trades — and especially if more trades lead to weaker portfolio performance at slightly lower prices — should the SEC intervene? ?
Gensler’s second key question is a little more cerebral.
Essentially, the SEC wants to answer: If brokerage game-like or predictive prompts assume optimal outcomes and impact customer trading frequency, should the regulator consider these in-app prompts as formal investment recommendations or investment advice?
The SEC often seeks public comment before drafting new rules and regulations on Wall Street, which means Friday’s announcement, while procedural, could pose a headache for industry executives.
Despite exceptional growth for millennials’ favorite stock trading app, Robinhood has faced regulatory headwinds regarding its digital engagement with its millions of customers.
In June, the Financial Industry Regulatory Authority imposed its heaviest penalty on Robinhood, totaling approximately $70 million. FINRA said its sanction came in response to Robinhood’s technical failures in March during a flurry of trading mania, its lack of due diligence before allowing clients to trade options and peddle information misleading customers on aspects such as margin trading.
CEO Vlad Tenev testified before the US House Financial Services Committee in February regarding GameStop’s early 2021 business mania.
Robinhood also paid $65 million to the SEC after being accused of misleading customers about how the app makes money and failing to deliver promised best trade execution.
In response to public backlash, Robinhood has since taken steps to address some of the scrutiny, such as providing more educational services to its customers and removing the confetti feature when investors transact.
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