Just over a year removed from its compliance date, Regulation Best Interest (Reg BI) might already be unable to keep pace with the current state of the broker-dealer business model.
Rick Fleming, the longtime director of the Office of the Investor Advocate at the Securities and Exchange Commission (SEC), said in a speech Wednesday that so-called “gamification” platforms—ones like Robinhood designed to make stock trading more easily accessible and exciting—“expose what may be a significant flaw in Reg BI.”
Fleming advised the SEC should “go back to the drawing board” on the investor protection rule to keep pace with modern digital engagement practices (DEPs), which have received additional scrutiny since this year’s “meme stocks” craze.
“In my view, 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,” he said at the SEC Speaks virtual forum.
The compliance deadline for Reg BI was June 30, 2020. The rule requires broker-dealers to “to act in the best interest of a retail customer” when making a recommendation of any securities transaction or investment strategy involving securities. It is not intended to apply to self-directed or otherwise unsolicited transactions by a retail customer, the SEC has explained.
So, what happens when a retail customer independently directs their broker to make a trade without any related recommendation? The broker does not have to consider any of four key component obligations of Reg BI—disclosure, care, conflict of interest, and compliance—to carry out the trade, Fleming noted.
“The concern I have is that some DEPs, using artificial intelligence, sophisticated algorithms, and game-like features, may blur the line between solicited and unsolicited transactions,” he said. “… 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.”
The SEC in August launched a request for information about how DEPs affect the investment strategies of retail investors. Fleming said the request must consider how the use of DEPs intersect with Reg BI or risk the rule proving inadequate to protect investors and not worth the effort.
Fleming closed his speech by noting the SEC might also want to enhance the distinction between advisers and brokers in looking ahead to 2022. “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,” he said.