The Securities and Exchange Commission (“SEC”) has just posted a “request for information and comments” seeking  information  concerning the  “digital engagement practices” that are used by online and app based brokers. The SEC reports that it is looking into the methods by which  brokerage firms are using digital tools designed to  appeal to their investors’ behavioral tendencies. In particular, the regulator is looking into game-like engagement (commonly referred to as “gamification”) which online firms use to encourage investor activities on their websites, portals and mobile apps. The SEC is focusing on  behavioral prompts, differential marketing, and other elements or features which are specifically designed to engage with retail investors on digital platforms as well as the analytics and technology behind them.  These are called digital engagement practices or “DEPs” 

In his remarks regarding this request for comment, the new SEC Chairman, Gary Gensler, states “In the last few years we’ve seen a proliferation of trading apps, wealth management apps, and robo-advisers that use these practices to develop and provide investment advice to retail investors.” Chairman Gensler  notes that “In many cases, these features may encourage investors to trade more often, invest in different products, or change their investment strategy. Predictive analytics and other DEPs often are designed with an optimization function to increase revenues, data collection, or customer time spent on the platform. This may lead to conflicts between the platform and investors. I’m interested in the varied questions included in the Request for Comment, and I’m particularly focused on how we protect investors engaging with technologies that use DEPs.”

The SEC Asks for Investor’s Real Life Trading Experiences 

The SEC’s request for comments specifically asks for input from investors  in a “feedback flyer” regarding their experiences with these trading platforms. Some of the more interesting questions include the following:

1. What would you like us to know about your experience with the features of your online trading or investment platform? (Examples of features are: social networking tools; games, streaks, or contests with prizes; points, badges, and leaderboards; notifications; celebrations for trading; visual cues, like changing colors; ideas presented at order placement or other curated lists or features; subscription and membership tiers; or chatbots.)

2. If you were trading or investing prior to using an online account, how have your investing and trading behaviors changed since you started using your online account? (For example, the amount of money you have invested, your interest in learning about investing and saving for retirement, the amount of time you have spent trading, your knowledge of financial products, the number of trades you have made, the amount of money you have made in trading, your knowledge of the markets, the number of different types of financial products you have traded, or your use of margin.)

The deadline to complete the SEC’s Feedback Flyer is October 1, 2021. 

After the deadline for comments, the SEC might create new regulations governing these trading apps. Interestingly , the question looms as to whether, by encouraging users to buy and sell securities, platforms such as Robinhood might actually be making “recommendations” to their customers.  

No Such Thing as “Free”  Trading

Another major issue facing the regulation of new trading apps is that their use of  technology in securities trading is  moving faster than the regulations that govern the space.  This appears in a number of ways as securities  trading becomes quicker  and trading platforms such as Robinhood create newer and faster ways for retail investors to enter the market.  

Many securities firms have hopped on the bandwagon to provide their customers with what they call  “commission-less ”trading.   While it appears to the average investor that such trades are “free,” in truth the costs are passed on another way.  This is known in the industry as payment for order flow, and is a major source of income for firms such as Robinhood which route their customer’s trades through third party firms in exchange for payment. As The Wall Street Journal has explained, brokerage firms profit by reaping the benefit of the small difference between the spread on the trade, or the price at which shares of securities are bought and sold. Under the SEC’s best execution rules, securities firms can’t fill buy or sell orders at prices that are worse for the customer than the best price available on a stock exchange.

Chairman Gensler has announced that the SEC is looking into this common practice. In fact, even prior to Gensler’s arrival at the SEC, in December 2020 it fined Robinhood for failing to reveal that payments for order flow represented the firm’s  largest revenue source.  According to that SEC order,  because Robinhood had  unusually high payment for order flow rates as compared to its peers, its customers’ orders were executed at inferior prices than their peers. While it is true that access to markets has been made  seemingly cheaper and seamless through the advent of  app based trading, this has come at a cost to customers.   So much so that the SEC found these inferior trade prices to have collectively cost Robinhood customers $34.1 million —even after taking into consideration that their customers had savings from not paying customary commissions.

Firms which support the practice of payment for order flow say that this allows for commission-free trading and fractional share investing. Critics say that it incentivizes brokers to send their orders to whichever market-maker is paying them the highest fees, rather than the place that might get the best deal for their customers. 

Under the securities regulations, brokerage firms are required to get their customers the “best execution” of orders to buy and sell.   The Best Execution rule requires firms to use reasonable diligence to find the best market for the security being traded and to buy or sell in that market so that the ultimate price to its customer is as favorable as possible under the prevailing market conditions. 

The SEC found that in March 2019 Robinhood was aware that its execution prices were worse than its competitors and ordered that it hire an Independent Consultant to ensure the best execution of customer trades

Chairman Gensler told Barron’s that the practice of  payment for order flow is “on the table” for the SEC. He also noted that there are too many conflicts of interest caused by such practices. 

Whatever the outcome, it appears that there’s a new sheriff in town who wants to protect the investing public. While payment for order flow is not investment fraud, Robinhood’s FAQ page touted that its execution quality matched or beat that of its competitors. The SEC found that  Robinhood’s conduct was a violation of the securities laws.

Have You Lost Money Trading on an App?

Securities fraud can take many forms. It can even occur in self directed trading apps. While not everyone who suffers investment losses has the right to sue for damages, victims of investment fraud, negligence or misrepresentation may have legally actionable claims. 

CONTACT US TODAY FOR A FREE CONSULTATION

If you or a loved one have suffered investment losses as a result of your online account or app, or any other type of investment fraud or broker negligence, contact the offices of Investment Fraud lawyer Melanie Cherdack for a free consultation. Because she has been in the trenches as a former Wall Street attorney, Melanie Cherdack and her team of experienced attorneys have seen just about every type of investment fraud or investment scam. While almost every investment carries a degree of uncertainty and risk, you may have been unnecessarily exposed to such risk. Former Wall Street securities attorney Melanie S. Cherdack and her team of lawyers represent individual and institutional investors who are unwitting victims of investment fraud and broker negligence. She heads up a group of attorneys who represent investors across the United States. Contact us by filling out our online contact form, or calling 844-635-1609 or 305-349-2336.