The Securities and Exchange Commission (SEC) launched its first foray against risks posed by stock trading platforms like Robinhood with a request for information about how digital engagement practices (DEPs) affect the investment strategies of retail investors.

These DEPs, like the so-called “gamification” of stock trading offered by FinTech disruptors, caught the SEC’s attention during the “meme stocks” craze earlier this year that saw the value of previously moribund stocks like GameStop and AMC Entertainment Holdings skyrocket, then plunge.

Gamification describes a series of tools used by platforms to engage and encourage retail investors to invest in stocks, including social media, prizes, games, badges, contests, leaderboards, subscriptions, membership tiers, and more.

Some DEPs involve artificial intelligence and machine learning that spits out investment advice based on real-time movements in the markets. They can also be used to respond to an investor’s previous investments and stock purchases to make recommendations for new investments based on those patterns. More darkly, DEPs can play on known addictive behaviors, the SEC said, either by default or by design.

These DEPs are concerning to the SEC because they encourage retail investors to buy more stock and consider riskier investments than they might have if they worked with a traditional financial advisor. There is also an apparent conflict of interest with the business model of companies like Robinhood that earn their profits not from fees on individual stock sales but instead on the volume of stock purchase requests they deliver to other brokers, a system called “payment for order flow.”

This system incentivizes some FinTechs to encourage more trading by customers, the SEC said, and might not be fully disclosed to users. (Robinhood was fined $65 million in December 2020 by the SEC over this issue).

“While these new technologies can bring us greater access and product choice, they also raise questions as to whether we as investors are appropriately protected when we trade and get financial advice,” SEC Chair Gary Gensler said in a public statement Friday.

“Many of these features encourage users to engage more with a digital platform. In the last few years, we’ve seen a proliferation of trading apps, wealth management apps, and robo-advisers that use these practices to develop and provide investment advice to retail investors,” Gensker wrote. “In many cases, these features may encourage investors to trade more often, invest in different products, or change their investment strategy.”

Gensler told financial news outlet Barron’s in an interview Monday that banning payment for order flow is “on the table.”

Areas of interest

The SEC’s request for information asks market participants to provide the agency with testimony on three areas in the business models of FinTechs using DEPs: optimization functions to increase platform revenues, data collection, and customer engagement.

Questions asked include:

  • What types of DEPs do firms use (or in the future expect to use) on digital platforms, and what are the intended purposes of each type of DEP used?
  • What market forces are driving the adoption of DEPs on digital platforms and how?
  • Are DEPs used to promote or otherwise direct retail investors to specific securities or certain types of securities, investment strategies, or services?
  • What trading or investment activities are retail investors engaging in through digital platforms that use DEPs?
  • What customer and client trends have been observed in connection with or as a result of the adoption and implementation of DEPs?
  • What are the risks and benefits to firms using DEPs?
  • Have researchers studied the use of DEPs by broker-dealers and investment advisers?
  • To what extent, and how, do firms test or otherwise assess how their DEPs affect investor behavior and investing outcomes?
  • How are firms approaching compliance relating to their use of DEPs and the related tools and methods?
  • Are there particular types of DEPs that broker-dealers avoid using because they would be recommendations?
  • Are there regulations that currently prevent firms from using DEPs and related tools and methods in ways that might be beneficial to retail investors?
  • How do investment advisers currently use technology in developing and providing investment advice?
  • Should the Commission consider amending Form ADV to collect information about the types of technology that advisers use to develop and provide investment advice?

Comments will be accepted for 30 days after the request is published in the Federal Register.

Aaron Nicodemus covers regulatory policy and compliance trends for Compliance Week. He previously worked as a reporter for Bloomberg Law and as business editor at the Telegram & Gazette in Worcester, Mass.

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