December 8, 2022

Former chairman of the Commodity Futures Trading Commission, Gary Gensler, testifies at a US Senate Banking Committee hearing on systemic risk and market oversight on Capitol Hill in Washington on May 22, 2012.

Jonathan Ernst | Reuters

The Securities and Exchange Commission announced on Friday that it is intensifying its investigation into gamification and behavioral prompts used by online brokers and investment advisors to encourage people to trade more stocks and other securities.

Wall Street’s top regulator said that rosy earnings forecasts can mislead investors from technology that in reality underestimates the risk of a particular investment or the chances of staggering returns.

“While new technologies allow us greater access and product choice, they also raise the question of whether we as investors are adequately protected when we trade and seek financial advice,” said SEC chairman Gary Gensler in a press release. “In many cases, these characteristics can encourage investors to trade more often, to invest in other products or to change their investment strategy.”

The SEC often seeks public comments before drafting new rules and regulations for Wall Street, which means Friday’s announcement, while procedural, could be a headache for industry leaders.

Robinhood Markets, the operator of a popular digital trading platform that has been under scrutiny for its client trading requests, fell as much as 1% to the day’s lows, according to the SEC report.

The commission said that online investment firms and brokers often use “predictive” analytics tools designed to show clients what they would make under optimal – but not necessarily likely – outcomes.

While brokers may disclose that their predictive models are no guarantees of future returns, Gensler would like to gather investors’ thoughts on game-like features on financial platforms, behavioral prompts, more frequent trading, and “other digital elements or features designed to interact with” retail investors on digital platforms. “

As part of the announcement, the SEC announced that it would collect public submissions for 30 days after the application and comment forms are made available online.

Gensler said he was particularly keen to hear from the public on two key issues.

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First, the SEC chairman would like to know how financial regulators should protect investors from a potential conflict of interest.

Online brokers make profits when their customers trade more often. Robinhood Markets, for example, makes part of its money by sending its customers’ orders to high-frequency traders for cash. This process is itself controversial and known on Wall Street as paying for the flow of orders.

But if game-like prompts or congratulatory messages from online brokers encourage customers to make more trades – and especially if more trades result in poor portfolio performance at slightly lower prices – should the SEC intervene?

Gensler’s second key question is a little more cerebral.

In essence, the SEC wants to answer: If the game-like or predictive prompts from brokers are producing optimal results and affecting how often clients trade, should the regulator treat those prompts in the app as formal investment recommendations or advice?

The SEC often seeks public comments before drafting new rules and regulations for Wall Street, which means Friday’s announcement, while procedural, could be a headache for industry leaders.

Despite the stellar growth of the millennials favorite stock trading app, Robinhood has faced regulatory headwinds when it comes to its digital engagement with its millions of clients.

The Financial Industry Regulatory Authority imposed Robinhood in June with the highest fine ever of around $ 70 million. FINRA said its punishment was in response to Robinhood’s technical failures in March during a spike in trading frenzy, their lack of diligence in authorizing clients to place option trades, and providing misleading information to clients on aspects such as margin trading.

CEO Vlad Tenev testified to the U.S. House of Representatives Financial Services Committee in February about the GameStop trading mania in early 2021.

Robinhood also paid the SEC $ 65 million after being charged with misleading clients about how the app makes money and fails to deliver the promised best execution of trades.

In response to the public backlash, Robinhood has since taken steps to address some of the controls, such as:

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