October 13, 2021

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The Securities and Exchange Commission must refine the distinction it makes between investment advisors and broker-dealers, as well as broaden how it applies Regulation Best Interest, to effectively counter gamification’s corrosive influence on investor protections, the federal agency’s Investor Advocate told an online audience Wednesday.

Acknowledging his proposals were akin to opening “a can of worms,” the growth of artificial intelligence, sophisticated algorithms, and game-like features on online trading platforms had precipitated the need for additional reforms, Rick Fleming, who started as the SEC’s first Investor Advocate in 2014, said while speaking at an online conference with presentations by other SEC officials at the Practicing Law Institute’s The SEC Speaks in 2021.

“[N]ow it seems that most if not all of the on-line discount brokers are influencing investor behavior with digital engagement practices, which further blurs the line between providing investment advice and traditional brokerage service,” Fleming said. “At some point, if the Commission fails to brighten the distinction between advisors and brokers, it will make little sense to regulate the two with such distinct regulatory models.”

Broker-dealers register with and are regulated by the Financial Investment Regulatory Authority; investment advisors register with and regulated by the SEC. Reg BI bars brokers from putting their own interests above their clients and mandates that they identify conflicts of interests, but investment advisors also must follow additional and stricter fiduciary standards.

To address inadequacies of Reg BI, the SEC may need to “go back to the drawing board,” Fleming argued.

When the SEC adopted Reg BI in June 2019, the federal agency noted specifically that the rule “was not intended to ‘apply to self-directed or otherwise unsolicited transactions by a retail customer,’” Fleming noted. But times have changed rapidly as online platforms “blur the line between solicited and unsolicited transactions,” he noted. 

“DEPs may subtly nudge investors to trade specific securities or, perhaps more likely, be designed to increase a retail investor’s trading activity generally, even when not appearing to recommend a specific security,” he added. “[T]he rapid evolution of the broker-dealer business model now leaves me wondering whether Reg BI was worth the effort after all. 

Another former securities industry enforcement official welcomed Fleming’s proposal to better apply Reg BI. Similar ideas have been under “active discussion in the SEC building for the past year,” Brad Bennett, a former chief of enforcement for the Financial Industry Regulatory Authority, said. Finding ways to apply Reg BI to online platforms is “the easiest way to deal with it because you don’t need new rules,” Bennett added.

Fleming made his remarks in the wake of SEC Chairman Gary Gensler continuing in recent weeks to turn up the heat on trading apps and robo-advising platforms, doubling down in September on skepticism he previously voiced about gamification and DEP tactics.

At the same time, Gensler and Gurbir Grewal, the SEC’s director of the Division of Enforcement, who both spoke at the PLI event, have stressed in recent weeks that the agency will ratchet up regulations, fines and penalties as a more effective deterrent against misconduct.

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