Analysis: Will the games stop? SEC mulls crackdown on trading apps

WASHINGTON, Jan. 26 (Reuters) – A year after the “share meme” rally that humbled hedge funds and rattled Wall Street, U.S. regulators are studying ways to crack down on psychic routers used by Robinhood Inc (HOOD.O) and others. From companies without commissions. Brokers to promote stock trading frequently on smartphone applications.

The Securities and Exchange Commission (SEC) began examining commission-free brokers such as Robinhood, Webull Financial LLC and SoFi Inc (SOFI.O) last year after retail investors drove GameStop (GME.N) and other “meme stocks” to record highs in the Jan. 2021.

The furious recovery sent GameStop shares up more than 1,500% at one point and created a “short squeeze” that burned hedge funds that had bet against the video game retailer’s shares. Shares of movie theater chain AMC Entertainment (AMCN) and other companies also rose.

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At the height of the frenzy, many brokers restricted trading in meme shares, which infuriated investors. Robinhood CEO Vlad Tenev and other executives have been brought before the US Congress to testify.

The SEC has found that many brokers, in addition to roboadvisors, are increasingly using artificial intelligence-led analytics, video game-like features and other behavioral triggers to encourage stock trading or the sale of certain products.

Trading contests, points and bonuses are just some of these techniques. There are also vibrant sounds, bright colors, notifications, social networking tools, and curated lists of trading and investment ideas, among other practices.

“The Securities and Exchange Commission was very concerned that many young investors, many of whom were too young to legally drink alcohol, were instead getting drunk due to digital participation in the market,” said Howard Fisher, partner at law firm Moses & Singer. . Likely to pay hard.

It could possibly wage war on its own.”

Commission-free brokers say they democratize investing, making it easy and fun to trade for anyone. In a blog post Tuesday night, Robinhood said it has added resources to help clients learn the basics of investing.

Critics say commission-free brokers try to maximize retail trading volumes because they earn lucrative fees for directing orders to wholesale market makers. This could be a conflict of interest; Studies show that retail investors generally lose money when they change their portfolios.

“Americans are bombarded every day with behavioral claims…brokering apps and robotic browsers are doing it too,” Securities and Exchange Commission Chairman Gary Gensler told CNBC last week. “Their motive is to make more revenue.”

On Wednesday, Gensler said in a statement that he looks forward to employee recommendations on digital sharing practices, without going into details.

In an advisory in August, the Securities and Exchange Commission (SEC) suggested that digital claims may sometimes constitute an investment recommendation that falls under better regulation. This 2019 rule requires a broker-dealer to make a recommendation to act in the best interest of the retail client and to identify a conflict of interest.

If the SEC goes down this path, it is likely that companies using digital sharing tools will have to file new, large-scale disclosures. This compliance burden will complicate their business and could make them more vulnerable to lawsuits.

“It is conceivable to change the game,” Fisher said.

The land of the novel?

At the time of the meme stock rally, there were more than 100 million retail users/accounts open at six of the top online brokerages, Reuters reported last year.

A survey conducted by the Financial Industry Regulatory Authority (FINRA), which has also stepped up its scrutiny of game-like trading features, found that 66% of investors who opened an investment account in 2020 were new to investing.

Industry groups, including the Securities Industry and Financial Markets Association (SIFMA), say digital sharing practices can be beneficial to investors, for example when they are used to guide them to save more money or invest in the long term.

In response to an SEC advisory in October, SIFMA also said it believed that in the vast majority of interactions, the use of digital engagement practices would not constitute a recommendation, based on “well-established” guidelines.

Some experts who support regulation acknowledge that the Securities and Exchange Commission (SEC) is veering into new territory, noting that there has been limited research on how digital sharing practices directly affect investor decision-making.

Edwin Ho, a research fellow at New York University and a former SEC official, said financial institutions have the best data on the issue, but little incentive to publish it widely.

“One of the key questions is whether user interface design can be considered investment advice and to what extent interface design affects investment decisions at all,” Hu said. “This is a very difficult empirical and legal question that the SEC faces.”

James Felder, a professor at Colorado State University, said studies of the gaming and gambling industries indicate that noise, bright colors and other sensory details intended to replicate real-world stimulation “direct users to act.”

“If… you build these trading experiences as if it were a game, but with real money at stake, that’s a big deal.”

Some experts worry that digital sharing practices are getting so complex that they may increase circulation in general without clear individual claims. That could mean a best interest approach to regulation may be insufficient, warned Rick Fleming, an advocate for insider investors at the Securities and Exchange Commission.

“If the Reg BI proves insufficient to protect investors, I think the Commission should go back to the drawing board so that important investor protection measures don’t go up and down to whether the broker-dealer makes a specific recommendation.” he added.

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(Reporting by Katanga Johnson in Washington; Editing by Michael Price and David Gregorio)

Our Standards: Thomson Reuters Trust Principles.

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