SEC requests public comment on digital brokers and robo advisors

The SEC wants to take a closer look at how broker-dealers and RIAs use digital tools to engage investors.

The agency issued a request for information and public comment on so-called “digital engagement practices” used by the financial services industry. These include behavioral prompts, marketing techniques, gamification features and the design elements of retail-facing websites, portals and apps, according to an SEC statement.

Retail stock trading app Robinhood in particular has faced criticism from the SEC, FINRA and legislators for deploying gamification techniques to encourage investors to make trades. In June, the company paid $70 million for allegedly providing false information to customers. And the SEC has been increasing scrutiny on digital advice, with SoFi’s robo getting hit with a $300,000 fine in August and Charles Schwab announcing in July it set aside $200 million for a probe into its Intelligent Portfolios product. 

"While new technologies can bring us greater access and product choice, they also raise questions as to whether we as investors are appropriately protected when we trade and get financial advice," said SEC chairman Gary Genlser in a statement. "In many cases, these features may encourage investors to trade more often, invest in different products or change their investment strategy.”

In addition to gamification, which Gensler pledged to target following the GameStop and AMC trading frenzy earlier this year, the SEC is also concerned with potential conflicts that arise from predictive analytics and optimization practices employed to increase revenues, data collection and time spent on digital investment platforms, Gensler said.

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The request for comment also mentions tools used by financial advisors to develop and provide advice through online platforms or as part of a traditional client relationship.

While the SEC could review how traditional advisors use financial planning and data aggregation tools with clients, the primary focus will likely be on the fast-growing, retail-facing fintech startups, said Max Schatzow, a partner with law firm Stark & Stark who concentrates on financial services firms. The regulator made its first enforcement actions against robo advisors in 2018; now it wants to expand the focus to the growing presence of DIY trading tools.

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“I think this is a clear counterpunch to the GameStop and AMC trading issues, and Robinhood being in the news a lot recently,” Schatzow said. “Gensler is mindful about what technology has been doing to the [financial] advice landscape over the years.”

Ben Marzouk, a financial services attorney with Eversheds Sutherland, agrees, adding that the digital client engagement tools traditional advisors use are already subject to existing regulatory oversight. However, new hybrid business models that combine digital self-service tools with human advice could be impacted by a future SEC rule, Marzouk said.

Firms also need to think about how the technology they use collects, stores and shares client data, as the SEC could be looking to hold advisors accountable for how that data is used to inform product recommendations and financial advice, he said.

There is a need to update some SEC rules that don’t adequately cover new technology, Schatzow added. For example, chatbots don’t fit neatly within existing advertising rules and are mostly used for customer service, but they can be used to recommend products and potentially generate business.

“It’s certainly long overdue to review all these rules with an eye to the change in technology over the years,” he said.

This emphasis on digital customer engagement could impact the SEC’s interpretation of Reg BI rule, particularly when it comes to how technology pushes customers toward opening accounts, Marzouk said. Fintechs are increasingly pushing the envelope with incentives and behavioral nudges, blurring the line between advertising and financial advice that would fall under a best-interest standard.

“When it comes to account opening, there’s quite a bit of gamification. I see offers all the time about getting free stocks for a new account or for recommending a friend to join [a trading app],” he said. “I think they want to see whether it’s practical to expand the scope of a financial recommendation to include these types of behavioral prompts.”

Even if the SEC’s request for comment doesn’t directly impact traditional financial services firms, Schatzow said it’s a chance for advisors to weigh in on what the future of the industry looks like and level the playing field with “move-fast-and-break-things” startups.

“[Advisors] can put their foot down and say we need some additional rules and guardrails, otherwise these [fintech startups] are going to keep pushing the limits,” Schatzow said. “They all want to grow, but some of these tech-focused companies have shown they’re willing to grow at almost any cost.”

The public comment period will be open for 30 days following the publication of the request in the federal register. The SEC also has a questionnaire for retail investors to share their experiences with digital investing services.