On June 22, 2023, the Investor Advisory Committee (“IAC”) of the US Securities and Exchange Commission (“SEC” or “Commission”) held a panel discussion regarding current challenges and potential improvements to the use of digital engagement practices (“DEPs”) by broker-dealers and investment firms.  The discussion was mostly focused on the DEPs used by digital trading platforms and apps (the “Platforms”).  Paul Roye moderated the discussion, and four panelists from universities and research firms shared their observations and research findings, followed by their recommendations for the Commission.

While the panelists acknowledged certain benefits of the Platforms, such as democratization of investing by increasing access and reducing costs, they shared concerns regarding the conflicts of interest between the Platforms and retail investors, particularly unsophisticated investors with limited financial means, including young and senior investors.  The panelists took the view that because Platforms are incentivized to promote trading, they use DEPs to encourage investors to trade more frequently, invest in different products and change investment strategies, even when such activity may not in the investor’s best interest.  Sivananth Ramachandran, Director at CFA Institute, shared findings from a survey conducted by CFA Institute on investor trust.  According to this survey, the majority of the 3,500 retail investor respondents answered that:  (1) they trust information provided by digital nudges; (2) trading tools/apps enhance their understanding of investing; and (3) retail trading tools/apps increased frequency of their trading.  Over 90% of the respondents ages 25-34 agreed that they trust the information from digital nudges, which indicates that they are less likely to be skeptical of the goals of the Platforms according to Mr. Ramachandran.  Melanie Cherdack, Acting Associate Director of University of Miami School of Law Investor Rights Clinic, shared similar observations and highlighted that unsophisticated investors often rely on the information they receive from the Platforms.  Her clinic has observed investors facing negative consequences after using complex and risky strategies, such as options or margin trading for the first time after opening an account on the Platform.  Jasmin Sethi, Associated Director at Morningstar, Inc., discussed issues with the defaults set by the Platforms as these settings align with the interest of the Platforms.  Examples include push notifications or placement into a risky account as default when an account is created.

To ensure that broker-dealers and investment firms use DEPs responsibly and to protect retail investors, the panelists made the following recommendations:

  • Expand the Commission’s interpretation on what constitutes a “recommendation” under the SEC’s Regulation Best Interest (“Reg BI”) in the Platforms’ use of DEPs to ensure the definition encompasses the types of intentional stimuli used by Platforms to induce investors to engage in frequent trading or certain types of investment strategies.
  • Provide guidelines that advise Platforms on the types of DEPs that would be considered “recommendations” under Reg BI and pronounce that boilerplate language in Platforms’ customer agreements or Form CRS filings will not be determinative as to whether the Platforms made a “recommendation.”
  • Provide clear guidance articulating that Platforms should consider whether their default settings are in the interest of the investors and whether such settings present conflicts.
  • Provide clear guidance regarding which disclosures are required on Platforms, especially regarding conflicts and costs.
  • Encourage Platforms to have features that allow for review and reflection by users to address the issue of automatic intuitive thinking.  One example is using a third party authenticators for validating transactions in penny stocks and meme stocks.  Such a speed bump creates a little friction without taking away investor choices.
  • Use existing regulations and tools, such as fiduciary duty, brokerage sales practices regulation, antifraud provisions, and compliance framework to regulate DEPs.