Securities Litigation

On August 27, the Securities and Exchange Commission (“SEC”) issued a broad request for information and comments on “gamification” in financial-market user interfaces, including artificial intelligence and machine learning, among others.

As the Release explains:  The SEC requests input on

broker-dealer and investment adviser use of “digital engagement practices” or “DEPs”, including behavioral prompts, differential marketing, game-like features (commonly referred to as “gamification”), and other design elements or features designed to engage with retail investors on digital platforms (e.g., websites, portals, and applications or “apps”), as well as the analytical and technological tools and methods used in connection with these digital engagement practices; and, investment adviser use of technology to develop and provide investment advice.

Release at 1.

Examples of digital engagement practices include: 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. Various analytical and technological tools and methods can underpin the creation and use of these practices, such as predictive data analytics and artificial intelligence/machine learning 4 (“AI/ML”) models.

The Commission notes that firms may use these technologies to influence investor behavior or target information or services to investors based on known behavioral profiles.  Release at 2-3.

The SEC notes that DEPs may influence investors’ frequency of trading, encourage additional risk (for example trading on margin, or options), and exposure to more complex products.  The SEC also expressed concern that some market participants may be engaged in “dark patterns,” using interface design to knowingly confuse or manipulate investors.

DEPs implicate a variety of regulatory obligations, among them:

• Account opening requirements;
• Disclosures on a variety of topics;
• Regulations BI & CRS – brokers’ “best interest” obligation and the accompanying requirement to distribute disclosures about the nature of the account relationship;
• Supervision of complex products, e.g. margin and options
• Supervision and compliance generally, including of algorithmic or other automated processes.

Although largely directed to broker-dealer practices, the Release includes investment advisors and so-called “robo-advisors.”

The Release is the latest in continuing fallout from this winter’s Robinhood / GameStop short squeeze that roiled markets and kicked off regulatory and Congressional concern.

I wrote about

• The initial GameStop fiasco and initial regulatory response, here: blogs/securities-litigation/2021/02/05/robinhoods-long-way-out-of-sherwood-forest/
• The “gamification” of investing and wrongful death suits, here: blogs/securities-litigation/2021/02/09/stonk-trading-is-not-a-game/
• And Robinhood’s impending regulatory settlement, here: blogs/securities-litigation/2021/03/01/robinhood-to-settle-options-related-investigations/
• FINRA caution and exam sweep on options-account practices, her blogs/securities-litigation/2021/08/18/finra-targeted-exam-letter-on-options-accounts/

Over the longer term, we should expect additional regulatory responses in the form of rulemaking directed to these practices.

“Request for Information and Comments on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comments on Investment Adviser Use of Technology to Develop and Provide Investment Advice,”  Release Nos. 34-92766; IA-5833; File No. S7-10-21 (SEC Aug. 27, 2021) is here:  https://www.sec.gov/rules/other/2021/34-92766.pdf

The Comment period runs thirty days from publication and includes a short-form “flyer” seeking comments from retail investors.

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. See attorney profile.