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Recent US SEC briefing on gamification

United States Publication October 2021

Recently, the SEC published a report titled "Staff Report on Equity and Options Market Structure Conditions in Early 2021" (the report). The report focuses on what SEC chair Gensler, in his public statement on the report's issuance, referred to as the "meme stock" events of winter 2021.

The report mainly serves to educate the public on the facts related to trading during the covered period in GameStop while also providing an overview of the relevant market structure and securities regulatory framework. The report does not offer policy recommendations or identify regulatory violations or possible wrong-doings. Instead, it identifies four areas where further consideration may be necessary. These areas are summarized in Gensler's public statement as follows:

  • events that may cause a brokerage to restrict trading, as well as matters related to clearing and settling
  • the use of digital engagement practices (DEPs), including predictive data analytics, differential marketing, and behavioral prompts
  • equity market structure and incentives, as well as the role of dark pools and wholesalers
  • the transparency and related market dynamics of short selling

The report is one more step in the SEC's efforts to understand and determine whether the meme stock events of last winter may indicate the need for additional regulation or guidance. Most notably, these steps include the SEC's publication in August of a Request for Information and Comment on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comment on Investment Adviser Use of Technology to Develop and Provide Investment Advice (the DEP Information Request Release). Notably, the comment period on the DEP Information Request Release expired on October 1.

Broadly, Digital Engagement Practices (DEPs) are customer prompts designed to engage retail investors' use of a brokerage firm's digital platform. While DEPs can serve various purposes, many of which are benign, there is also a concern that DEPs can create a conflict of interest between brokerage firms and customers by, for example, encouraging customers to trade more, or could constitute a recommendation as to a trading strategy or to a particular security. Any such recommendation would trigger Regulation Best Interest compliance obligations for brokerage firms and similar concerns for registered investment advisers under their fiduciary duty to clients.

While this issue figures prominently in the DEP Information Request Release, Gensler, in his remarks at the NYU's October 19 program on Corporate Compliance and Enforcement (PCCE) and Institute for Corporate Governance and Finance (ICGF), voiced his concern that existing rules, including Regulation Best Interest, marketing rules and investment advisor rules, may not adequately deal with the issue of customer prompts as potential recommendations. Rick Fleming, the SEC's investor advocate, recently made similar statements in his remarks at SEC's Speaks. These statements suggest that the SEC is likely to update its rules for brokers and investment advisors to cover DEPs better.

While it seems likely that the SEC will move to update its rules to further regulate the making of DEPs by broker-dealers and investment advisors, of perhaps more immediate concern is language in the DEP Information Request Release that seems to suggest a view that existing law already requires both brokerage firms and registered investment advisers to have extensive procedures in place to supervise the use by firms of DEPs. Specifically, the DEP Information Request Release, at Question 3.2 thereof, poses this obligation as follows (emphasis added):

What types of policies and procedures and controls do firms establish and maintain to ensure the design, development, and use of DEPs and related tools and methods comply with existing obligations? How do firms supervise the design, development, and use of these features, tools and methods after implementation and adoption for continued compliance? How do firms' policies and procedures, controls and supervision differ concerning their use of DEPs and related tools and methods from other policies and procedures, controls and supervision that the firms employ?

Accordingly, brokerage firms and investment advisers that use DEPs should consider whether they need to examine and improve their existing procedures regarding their use of DEPs.

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