By Katanga Johnson

WASHINGTON, (Reuters) – A year ago, the rally of “meme stocks” sank hedge funds and roiled Wall Street. Now U.S regulators study ways to curb psychological prompts Robinhood (NASDAQ;) Inc and other commission free brokers that promote stock trading via smartphone apps.

Following retail investors driving GameStop (NYSE) and other “meme stock” to record heights in Jan. 20,21, the Securities and Exchange Commission started looking into commission-free brokers such as Robinhood and Webull Financial LLC.

GameStop stock rose more than 1,500% during the furious rally. It also created a short squeeze that robbed hedge funds that bet against GameStop stock. AMC Entertainment (NYSE 🙂 shares and those of other companies rose as well.

Several brokers stopped trading the meme stocks during the frenzy. This angered investors. Robinhood CEO Vlad Tenev and other executives were hauled https://www.reuters.com/article/us-retail-trading-usa-congress/long-tense-with-cat-photo-for-relief-how-the-gamestop-hearing-unfolded-idUSKBN2AI1C4 before U.S. Congress to testify.

SEC discovered that many brokers as well as robotadvisors use increasingly artificial intelligence and video-game-like features to stimulate stock trading, or even sell products.

There are many other techniques that can be used to trade, such as points or rewards. There are many other options, including bright sounds and vibrant colors, notifications and social networking tools.

“The SEC has been very concerned that many younger investors, many of them too young to legally drink alcohol, are instead getting intoxicated by digital engagement in the market,” said Howard Fischer, a partner at law firm Moses & Singer, adding the industry is likely to push back hard.

“It’s likely to be in a war.”

Brokers that do not charge commissions claim they have made investing more accessible and enjoyable for everyone. Robinhood announced Tuesday evening that they have added resources to assist customers in learning investment basics.

Some critics claim commission-free brokers are trying to maximise retail trading volumes by charging lucrative fees to route orders to wholesale market-makers. It could lead to conflicts of interest. Studies show that retail investors lose money when their portfolio is churned.

CNBC’s Gary Gensler, chair of the SEC said that Americans are constantly bombarded with behavioral prompts. He also mentioned that the brokerage apps as well as the roboadvisors do the same. Their motivation is to increase revenues.

Gensler stated Wednesday that he looked forward to receiving recommendations from the staff on digital engagement practices. He did not elaborate.

In an August consultation https://www.reuters.com/legal/transactional/us-markets-regulator-wants-public-feedback-firms-digital-engagement-practices-2021-08-27, the SEC suggested that digital prompts may sometimes constitute an investment recommendation that falls under Regulation Best Interest. The 2019 rule obliges broker-dealers to make a recommendation that acts in the customer’s best interests and disclose conflicts of interest.

The SEC could require firms using digital engagement tools to disclose additional information if they go that route. The compliance burden they would have to make could cause them to be more susceptible and costly.

Fischer said, “It could be a game-changer.”

NO UNEXPECTED TERRITORY

According to Reuters, more than 100,000,000 retail accounts were open at six top online brokerages during the rally.

The Financial Industry Regulatory Authority, which also has increased scrutiny of trading games, conducted a survey and found that 66% of those who opened investment accounts in 2020 were brand-new to investing.

According to industry groups like the Securities Industry and Financial Markets Association, digital engagement can benefit investors. For example, they can help them save money and invest longer term.

SIFMA, in an October reply to the SEC consultation, stated that the SIFMA believes the widespread use of digital engagement techniques would not be considered a recommendation, and was guided by “well-established” guidelines.

Experts who back regulation acknowledge that the SEC has entered new territory. There is not enough research to determine how investor decisions are affected by digital engagement.

Edwin Hu, who is a New York University researcher and an ex-SEC official, stated that financial institutions hold the best information on the topic but are not motivated to share it.

“One of the key questions is whether or not user interface design can count as investment advice. If so, how does it affect investment decisions?” Hu said that this is an extremely difficult legal and empirical question for the SEC.

James Fielder of Colorado State University, said studies into the casino and gambling industries show that stimulations such as bright colors and noises that mimic real-world stimuli “steer” users to take action.

These experiences can be turned into trades, with real money at stake.

Experts worry that digital engagement techniques are becoming so complex they could increase trading without any obvious prompts. Rick Fleming (internal investor advocate at the SEC), has warned that this could make the Regulation Best Interest approach less effective.

If Reg BI fails to protect investors then I think the Commission should return to the drawing board to ensure that critical investor protections do not rise or fall on the recommendation of a broker-dealer. He concluded.