SEC's New Rules Target Algorithms and Gamification Tools That Encourage Trading

The U.S. Securities and Exchange Commission (SEC) enhanced rules applicable to trading platforms such as Robinhood (HOOD) that use predictive analytics to encourage trading, nearly two and a half years after 'gamification of trading' helped fuel the meme stock frenzy.

What's Predictive Analytics And How Does It Impact Investors?

According to the SEC, brokers' use of predictive analytics—technology that helps guide, forecast or direct customers' investment behaviors—has gone up. And while that may encourage investors to trade, brokers get paid when clients trade more. So does that raise the question of a conflict of interest?

"Today’s predictive data analytics models provide an increasing ability to make predictions about each of us as individuals," said SEC Chair Gary Gensler. "This raises possibilities that conflicts may arise to the extent that advisers or brokers are optimizing to place their interests ahead of their investors’ interests."

In a 3-2 vote, the SEC decided Wednesday to subject broker-dealers and trading apps to the same regulatory standard to which investment advice they give to their clients is held.

Under Regulation Best Interest (BI), brokers are required to put the interest of their clients ahead of their own, disclose any conflicts of interest (such as commissions earned through the sale of financial products) and mitigate those conflicts where possible.

Similarly, the new rules unveiled Wednesday are meant to eliminate potential conflicts of interest between algorithms and investors, and prevent new technologies from undermining companies' legal obligations to clients.

There were two dissenting voices—those of Republican Commissioners Hester Peirce and Mark Uyeda—who argued that the rules were too broad, encompassing even everyday technological functions, while undermining investors' decision-making capabilities.

The vote is a culmination of a two-year SEC investigation launched in the aftermath of 2021's meme stock-fueled trading frenzy. Regulators have questioned whether brokerage apps like Robinhood, which engage investors with stimulating features like push notifications, colorful graphics, and a game-like interface, may encourage excessive trading that harms investors, but tends to be profitable for market intermediaries.

Vote on Cybersecurity Risk Disclosure

Earlier in the hearing, the commission also voted on whether to pass a rule requiring companies to disclose material cybersecurity risks. The resolution also passed in a 3-2 vote, with Chair Gary Gensler tipping the scale in favor of passage.

"Increasingly, cybersecurity incidents and risks are just a fact of life," Gensler said, emphasizing that the new rules would benefit investors. He mentioned that the new guidelines would focus only on material risks, or those that pose a significant threat to a company's operations. Companies would only be required to disclose material risks in an 8-K filing.

Commissioners Peirce and Uyeda dissented, stating that the new rules fall outside of the SEC's authority, and would unduly burden smaller companies with excessive regulatory requirements.