Securities Litigation

In remarks this week at SEC Speaks, SEC Investor Advocate Rick Fleming mused that the “gamification” of securities trading might pose an undue risk that exploits a potential loophole in Regulation Best Interest (“Reg. BI”).

Recall that Reg. BI, adopted in 2019, imposes a “best interest” standard of conduct for broker-dealers when they make a recommendation to a retail customer of any securities transaction or investment strategy. (The Adopting Release). Reg. BI came about after many years of struggle to try to harmonize the fiduciary-duty standard for investment advisers with the “suitability” standard for broker-dealers. Its adoption was hastened by the Department of Labor’s efforts to pre-empt SEC action with its own “fiduciary rule.”

Then the GameStop short-squeeze imbroglio in early January 2021 and the rise of app-based brokerage services brought the notion of “gamification” to the party. This past August, the SEC sought information and comment on “gamification.” I discussed that Release here.

In the Release, the SEC sought comment on nine categories of digital engagement practices (“DEPs”) in connection with securities trading: (i) social networking tools, (ii) games, streaks and other contests with prizes, (iii) points, badges and leaderboards, (iv) notifications, (v) celebrations for trading, (vi) visual cues, (vii) ideas presented at order placement and other curated lists or features, (viii) subscriptions and membership tiers, and (ix) chatbots.

Investor Advocate Fleming said his “primary concern with gamification is its potential to induce trading that is more frequent or higher-risk than an investor would choose for herself in the absence of DEPs.” Fleming said he is particularly concerned that gamification might open a loophole in Reg. BI:

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. DEPs may subtly nudge investors to trade specific securities or, perhaps more likely, be designed to increase a retail investor’s trading activity generally, even when not appearing to recommend a specific security. 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. This leaves open the possibility that investors would not receive the benefit of Reg BI protections even though they are being influenced to engage in securities transactions.

Fleming’s Remarks are here.

On the other hand, the Securities and Financial Markets Association (“SIFMA”) said in its October 1 comment letter to the SEC that DEPs are just another evolution within the markets, already are subject to well-established rules, and that new rules, guidance or interpretations are not necessary:

Used responsibly, DEPs provide significant benefits to retail investors, including enhanced access to customized products and services, lower costs, access to a broader range of products, better customer service, and improved compliance efforts leading to safer markets. Certain DEPs also raise potential risks, highlighting the need to ensure investor protection in connection with their use. The existing, robust regulatory regime, however, amply addresses firms’ use of DEPs today, preserving their well-documented benefits, while appropriately managing potential risks and conflicts. Specifically, the primary intersection between DEPs and our current regulatory regime are in two discrete areas:

• communications to retail investors (educational, informational, advertising, and marketing); and
• potential recommendations (i.e., personalized investment advice) to retail investors.

SIFMA Comment Letter, at 2, is here.

Stay tuned. Although the Comment period has closed, the game’s not over.

Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman LLP. Tom is licensed in Tennessee, Texas, and Louisiana. He has over 35 years of experience representing financial institutions in litigation, regulatory, and compliance matters.