1) aggressive tactics to attract new, often inexperienced investors; 2) failure to implement policies and procedures reasonably designed to prevent and respond to outages and disruptions on its trading platform; 3) use of strategies such as gamification to encourage and entice continuous and repetitive use of its trading application; 4) failure to follow its own written supervisory procedures regarding the approval of options trading; and 5) breach of the fiduciary conduct standard required by the Act and Regulations.
Good afternoon, Chairwoman Waters, Ranking Member McHenry, and members of the Committee. I'm honored to appear before you today for the first time as Chair of the Securities and Exchange Commission. Thank you for inviting me to testify on the market volatility we witnessed in January. I'd like to note that my views are my own, and I am not speaking on behalf of my fellow Commissioners or the staff.We've all come to hear the general story: a stock that went from $20 to $480 and back down to $40, all in a matter of weeks. It opened at $162 Wednesday of this week. GameStop, though, was just one of the many so-called meme stocks that exhibited significant price volatility, trading volume, and attention in the markets in January. As these events reached an apex in late January, a number of broker-dealers imposed trading restrictions on some of these stocks.While entities such as GameStop, Melvin Capital, Reddit, and Robinhood have garnered a significant amount of attention, the policy issues raised by this winter's volatility go beyond those companies. Instead, I think these events are part of a larger story about the intersection of finance and technology.These forces have had a symbiotic relationship since antiquity. One thing that I've come to believe is that technology can bring greater access to our capital markets.Our central question is this: When new technologies come along and change the face of finance, how do we continue to achieve our core public policy goals and ensure that markets work for everyday investors?As we work to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation, I'd like to highlight seven factors that were at play in these volatile events:
- Gamification and User Experience
- Payment for Order Flow
- Equity Market Structure
- Short Selling and Market Transparency
- Social Media
- Market "Plumbing": Clearance and Settlement
- System-Wide RisksWe expect to publish a staff report assessing the market events over the summer. While I cannot comment on ongoing examination and enforcement matters, SEC staff is vigorously reviewing these events for any violations. I also have directed staff to consider whether expanded enforcement mechanisms are necessary.Gamification and User ExperienceMobile apps have done a lot to expand access to capital markets, making it easy for investors to sign up, start trading, get wealth management advice, and learn about investing. These apps use a host of features that have come to be familiar in our increasingly online world - features such as gamification, behavioral prompts, predictive analytics, and differential marketing.There isn't a settled definition of gamification, but broadly, it refers to the use of game-like features - such as points, rewards, leaderboards, bonuses, and competitions - to increase customer engagement.Beyond gamification, there are also behavioral prompts that encourage users to engage more with an app, much like push notifications we receive on breaking news stories. Other features, such as social trading or copy trading, allow customers to see what others are buying and selling and make trades influenced by that information.Underpinning many of these features is predictive data analytics, which has allowed apps to analyze the success of individual gamification and behavioral prompts to increase activity. Based on such data analytics, users might see an ever-changing set of features that are differentially communicated to different customer segments.These types of features are implemented across many different technologies, from streaming platforms to fitness trackers.If we watch a movie that a streaming app recommends and don't like it, we might lose a couple of hours of our evening. If a fitness app nudges us to exercise, that's probably a good thing.Following the wrong prompt on a trading app, however, could have a substantial effect on a saver's financial position. A big loss could have immediate implications for the app user's ability to afford their rent or pay other important bills. A small loss now could compound into a significant loss at retirement.Many of these features encourage investors to trade more. Some academic studies suggest more active trading or even day trading results in lower returns for the average trader.It's in this context that I've asked staff to prepare a request for public input for consideration on these issues. We need to ensure investors using apps with these types of features continue to be appropriately protected and consider how all of our rules apply in these situations, including Regulation Best Interest. In addition, many of our regulations were largely written before these recent technologies and communication practices became prevalent. I think we need to evaluate our rules, and we may find that we need to freshen up our rule set. If we don't address this now, the investing public - those saving for their futures, retirements, and education - may shoulder a burden later. . . .
SEC Investor Education and Advocacy Director Schock's Shocking Analogy[T]his brings us to another major development since 2019-that is, the so-called "gamification" of retail stock trading. This is not a precise term, but it refers generally to the use of technological tools to make trading easier and more exciting. Broker-dealers, as well as some investment advisers, now utilize a variety of digital engagement practices, or DEPs, to connect with a broader array of retail investors, particularly younger investors who grew up with similar design features in other online apps and games on their devices.Although they have been used in other contexts, "DEPs" in the securities industry sprung into the national consciousness at the beginning of this year, when unexpected and unprecedented retail trading in a number of public companies attracted media and Congressional attention. The Commission continues to study the market events of January 2021 and is appropriately considering the implications for rulemaking in a number of areas.On the bright side, the events in January confirmed a positive trend our office has been tracking during the pandemic-a growing interest by retail investors in investing in the stock market. In part, this may be a reflection of historic stimulus payments coupled with pandemic-inspired lockdowns, but broker-dealers have encouraged this trend by reducing or eliminating commissions, selling lower-cost fractional shares, reducing or eliminating account minimums, and yes, by making it more fun to trade.These developments have lowered the barriers to entry for investors, particularly those of limited means. In response to a survey conducted by the FINRA Investor Education Foundation in the fall of last year, younger and less experienced investors reported that two developments -- market dips that made stocks cheaper to buy and the ability to invest with small amounts - were among the top reasons they entered the stock market during the year. These lower barriers to entry, in turn, create greater access to the financial markets for all investors, including those from disadvantaged communities. I note that the SEC's Investor Advisory Committee, on which I sit, recently recommended that we at the Commission devote greater resources to helping financial services firms expand and improve their ability to encourage investment by under-represented communities in a variety of ways, from investor education and direct outreach to strategic marketing of financial services to these communities.Technological tools have also given broker-dealers the opportunity to think more creatively about ways to educate and serve their customers. Using DEPs, well-meaning brokers can require customers to engage with important educational content before making important decisions, and they can imbed warnings to help investors avoid making foolish decisions such as incurring unnecessary taxes. So, as we turn now to some of the downsides of gamification, I hope we can enhance investor protections without undermining investor participation in the markets or constraining the positive uses of DEPs.With that said, my primary concern with gamification is its potential to induce trading that is more frequent or higher-risk than an investor would choose for herself in the absence of DEPs. In my view, to regulate this new generation of online brokers effectively, we need to fully understand the scope of DEPs in the industry and how they influence investor behavior and decision making. And, to its credit, the Commission has begun this process by issuing a recent Request for Information and Comment on the use of DEPs. In the Request, the Commission sought information on a number of topics related to DEPs, including behavioral prompts, differential marketing, game-like features, and other elements or features designed to engage with retail investors on digital platforms. As the Commission and public begin to digest the numerous responses to the Request, I want to highlight a significant issue that the Commission must consider as part of this - how does the use of DEPs intersect with Reg BI?As most of you know, Reg BI generally requires that, when broker-dealers make recommendations of securities transactions or strategies involving securities to retail customers, they must act in the customer's best interest and not place the broker-dealer's interests ahead of the customer's. Under Reg BI, any broker making a recommendation to its customer needs to comply with four component obligations: a disclosure obligation; a care obligation; a conflict of interest obligation; and a compliance obligation. Combined, these obligations enhance the broker-dealer standard of conduct and attempt to align with retail customers' reasonable expectations of how their brokers should act in the customers' interest. However, these important investor protections are not triggered by just any interaction between the broker and its customer-there must be a recommendation. As the Commission noted in the adopting release, Reg BI was not intended to "apply to self-directed or otherwise unsolicited transactions by a retail customer" (emphasis added). So, when a retail customer independently directs their broker to make a trade without any related recommendation, the broker does not have to consider any of the component obligations in carrying out the trade.The concern I have is that some DEPs, using artificial intelligence, sophisticated algorithms, and game-like features, may blur the line between solicited and unsolicited transactions. 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. In my view, it appears that the use of certain DEPs, by gamifying securities trading for retail customers, could significantly influence these retail customers' investment decisions in ways that were not fully contemplated when the Commission adopted Reg BI with its important distinction between solicited and unsolicited trading. This leaves open the possibility that investors would not receive the benefit of Reg BI protections even though they are being influenced to engage in securities transactions.When Reg BI was adopted in the pre-gamification era, I observed that the utility of Reg BI would ultimately depend upon how it is enforced by the Commission and FINRA. In my view, for Reg BI to remain a relevant and useful regulation in this era of gamification, the Commission should make clear that "recommendations" include instances where a broker-dealer utilizes DEPs to nudge investors in a way that reasonably could be viewed as encouraging trading, and the Commission should use its enforcement authority to back up its position.This is easier said than done, of course. With such a vast array of DEPs that continue to evolve, applying the facts and circumstances to determine whether any particular DEP or combination of DEPs arise to the level of a "recommendation" will be challenging and could consume a lot of Commission resources. And litigation in a gray area like this is always risky.But, investors need the protection of Reg BI in this new world in which they are being pushed or pulled by the platforms they utilize to access the markets. To me, it appears the DEPs are being used in ways that make the distinction between solicited and unsolicited trades almost meaningless, and brokers' obligations under Reg BI should not turn on whether the customer technically initiates the trades after the broker has used subtle techniques to influence the customer to engage in active trading, trade on margin, trade options, and engage in other risky practices. In the end, then, if Reg BI proves to be inadequate to protect investors, I believe the Commission should go back to the drawing board so that its critical investor protections no longer rise and fall on whether the broker-dealer made a specific recommendation.Before wrapping up, let me briefly open up one more can of worms related to this issue. And that is, what is the difference between an investment adviser and broker-dealer as we approach the end of 2021? For years now, I have struggled to explain the difference between a full-service broker and an investment adviser because in my view the Commission has allowed brokers to do virtually everything that an adviser does, notwithstanding the fact that brokers are excluded from the definition of an investment adviser only if their advice is "solely incidental" to their brokerage business. But now 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. At some point, if the Commission fails to brighten the distinction between advisers and brokers, it will make little sense to regulate the two with such distinct regulatory models. . . .
With the Big Game just around the corner, it's a good time to talk about how investing is a lot like football. Both need a strong playbook to be successful. To invest wisely, you should put together a special team of professionals so there is safety for your holdings and you can hand off assets to your family without stressing whether your investment is a coin toss.Bill Singer's Comment
And if that's not enough football references for you, read on.
It's important to huddle with those involved in your future financial plans to identify goals. Every investment plan should have a strong offense. For your first down play, go to Investor.gov. Investor.gov provides a game winning playbook on how to invest wisely and avoid fraud. You will be able to check to see if your investment professional is registered and see if they have been involved in any kind of illegal procedure, as well as find a variety of investment tools and resources.
As you kick off your financial plan, it is vital you keep in mind your level of risk tolerance. All investments have some degree of risk. You can help yourself avoid a sack by understanding the different risks and returns of every saving and investment product you're considering.
You need to have an equally tough defense in order to protect yourself against investment fraud. Fraudsters often engage in high-pressure sales tactics, pitch too good to be true opportunities, promise guaranteed returns and rush you into making quick decisions. Never make snap decisions on investments. Call an audible and take a time out to research every investment opportunity before you invest. Getting into the red zone is the place to be, so is checking out our red flags of fraud guidance.
Watch out for the blitz. Celebrities are endorsing investments on social media, radio and TV. Never make an investment decision based solely on celebrity endorsements. Just because your favorite celebrity says a product or service is a good investment doesn't mean it is. You don't want to get hit on your blind side so always conduct thorough, independent research of the product.
You may fumble or be offside here and there but you have a better chance of protecting yourself against financial devastation if you diversify your investments. That way, if one of your investments loses money, the other investments can make up for it. It's just like spreading the risk by using a variety of plays in a playbook rather than using the same play over and over again.
Understand how fees and expenses affect your portfolio. Some fees may seem small at first, but over time they can have a major impact on your investment game plan--just like throwing a pick six. It's also important to ask your investment professional about any penalties that could be incurred for selling an investment product before its maturity date.
All of these tips may seem hard to tackle. However, you'll score the game winning touchdown and be celebrating in the end zone (thank goodness you can do that again!) if you put together a strong investment playbook that includes setting financial goals, doing research and going to Investor.gov before you invest.
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The Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This article expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.