Blog FinReg + Policy Watch October 01, 2021

SEC Seeks Input on BD and RIA Digital Engagement Practices

The SEC recently solicited public comment on digital engagement practices (DEPs) used by some broker-dealers and investment advisers, including predictive data analytics, differential marketing, and behavioral prompts (such as gamification).  The public comment window closes October 1, 2021.  Comments letters submitted already are available here—viewpoints run the gamut and are quite interesting to read.

The SEC’s request comes amid heightened scrutiny of these practices and also builds on SEC Chairman Gary Gensler’s May 2021 remarks to the House Financial Services Committee, which Gensler bolstered in subsequent testimony to the Senate Banking Committee on September 14, 2021.  Gensler’s remarks highlighted the rise of firms’ use of DEPs and, at least as Gensler seems to view it, the associated risks to investors.  Through the public comment process, the SEC hopes to gain a better understanding of DEPs in order to facilitate an assessment of their use in light of existing regulations and to further consider what regulatory action may be needed to protect investors.

While the SEC did not define DEPs, it did provide examples: social networking tools; games, streaks and other contests with prizes; points, badges, and leaderboards; notifications; celebrations for trading; visual cues; ideas presented at order placement and other curated lists or features; subscriptions and membership tiers; and chatbots.  The SEC also notes that firms are employing artificial intelligence and machine learning to “transform user interfaces and the interactions that retail investors have on digital platforms by developing an understanding of the investor’s preferences and adapting the interface and related prompts to appeal to those preferences.”  The SEC’s request includes a number of specific questions related to DEPs in addition to an 11-question retail investor survey.

The SEC notes certain benefits that can result from DEPs, such as increased investor engagement.  At the heart of the SEC’s request, however, seems to be the notion that technology is enabling investor engagement in ways that may cause investors to act in a manner that is detrimental and that may conflict with the interests of the brokers and advisers delivering the cues.  For instance, the SEC notes that DEPs can encourage frequent trading, using strategies that carry additional risk, and even use what the SEC calls “dark patterns”—interface and design choices that are knowingly designed to confuse users or manipulate preferences or actions.  And in his recent remarks to Senate Banking, Gensler suggested that “models also could inadvertently reflect historical biases embedded in data sets that may be proxies for protected characteristics, like race and gender.”  His remarks also juxtaposed benefits such as increased access and choice in the markets against “questions about potential conflicts within the brokerage, wealth management, and robo-advising spaces, particularly if and when brokerage or investment advisor models are optimized for the platform’s revenue and data collection.”  The ever-ominous “systemic risk” concern also seems front-of-mind.

At a minimum, we expect the SEC to double down on Gensler’s recent remarks by issuing staff guidance to the industry.  The staff is likely to focus its attention on conflicts of interest, firms’ disclosures to customers (including surrounding how they generate revenue, even in a zero trading fee environment), and whether firms’ actions rise to the level of actionable advice or recommendations.  But outright bans on particular DEPs seem unlikely, as does formal rulemaking, at least any time soon.  Much of the attention paid to these issues hangs on the investor protection prong of the SEC’s tripartite mission.  But the plaintiffs’ bar could be the chief beneficiary of all the negative inferences cast toward DEPs.

 

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