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What Broker-Dealers Should Know About Gamification and Marketing Compliance

by InnReg

Fintech Gamification has lately become a financial buzzword, but the concept is not novel. As a strategy for influencing and motivating behavior, many industries have used it for years across activities from frequent-flier awards to educational training sessions.

However, in the world of online broker-dealers, the gamification business has begun to raise regulatory scrutiny and marketing compliance questions.

Digital brokerages have recently begun using game-like elements and predictive analytics to encourage customers to trade financial securities more actively. They have been incorporating features to promote increased trading, such as adding vivid colors, celebration balloons, and other digital effects that stimulate user behaviors. Other freebies and enticements to lure customers include gifts of free stock for opening accounts, awarding bonuses and hosting contests for referrals, or making funds instantly available for trading.

Regulators are eyeing these promotions warily. Since the phenomenon is still relatively new, there is little consensus on which behaviors create marketing compliance issues. Over the past year, the SEC and FINRA have stepped up their focus on the risks of gamification to induce inappropriate participation or speculation.

Subject-matter experts with decades of experience wrote this analysis, not freelance copywriters, third party agencies, or AI-based tools. We are global regulatory compliance experts.

Fintech Gamification

Sales Gamification May Cross Regulatory Lines

GameStop Corp and other “meme” stocks experienced a rollercoaster of volatility in January 2021. According to an SEC October 2021 Staff Report, the share prices of these securities soared “as bullish sentiments of individual investors filled social media.”

During his confirmation hearing before the Senate Banking Committee on March 2, 2021, Gary Gensler promised to investigate trading apps that might be creating behavioral prompts. Two months later, after having been confirmed as SEC Chair, Gensler said, “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…Following the wrong prompt on a trading app, however, could have a substantial effect on a saver’s financial position.”

Meanwhile, FINRA has been even more direct, warning broker-dealers to be wary of digital platforms with interactive gamification features in its 2021 Examinations and Priorities report, released in February. By May 19, 2021, Amy Sochard, FINRA’s Vice President of Advertising Regulation, announced that her organization would be seeking public feedback on gamification in conjunction with the SEC.

The announcement indicated that FINRA might be issuing “sweep” letters to selected firms to collect more information. In this case, a FINRA sweep could focus on whether broker-dealers are making actual recommendations to customers by prompting or nudging them or whether rewards are tempting recipients to make emotional rather than rational decisions. Including gamification audits in marketing compliance workflows could help broker-dealers prepare for FINRA queries.

Robinhood, a Notable Gamification Platform

Massachusetts securities regulators began to take an interest in April 2021, seeking to bar the trading app Robinhood in their state. Regulators are seeking to have the app’s brokerage registration revoked, banning Robinhood from operating in Massachusetts. Other state securities regulators have said they may also investigate.

In August 2021, the SEC solicited public comments on whether online brokers’ disclosures to retail investors sufficiently explained the efforts they were making to influence trading, as well as potential conflicts of interest. Game-like elements might create such conflicts if they intentionally increase revenue, collect data, or keep users engaged. The agency circulated a document including a raft of questions examining investors’ experiences with digital trading celebrations, contests, badges, and prize points.

At the SEC Speaks conference (October 13, 2021), participants discussed the risks and benefits of digital engagement practices (DEPs). Rick Fleming, an investor advocate, described both downsides and advantages of gamification. Fleming said, “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 as incurring unnecessary taxes.”

At that same conference, Gensler expressed how digital platforms “have enhanced the user experience and brought greater participation into our markets.” Yet, he cautioned that digital nudges might require future regulation. He observed that DEPs might “use nudges opportunistically to encourage more trading because (brokers) would receive more payment from those trades.”

On October 18, 2021, the SEC released a report noting that stock trading apps with gamification features may risk leading investors to trade more than they would have done in a more traditional format. As a result, the SEC concluded that the apps call for further investigation.

What Constitutes a Recommendation?

The dilemma of gamification brings to the fore the thorny issue of recommendations, which directly bears upon Regulation Best Interest (Reg BI). This SEC regulation establishes a standard of conduct for broker-dealers. Under Reg BI, a broker who makes a recommendation to a customer must comply with several disclosure obligations to discharge the duty of placing the customer’s interests ahead of their own.

That core requirement, however, begs the question for gamification: what is a recommendation? Do flashing lights and game-like confetti bursts add up to a real suggestion or advice? As Fleming pointed out at the October 13 SEC Speaks conference, “Reg BI was not intended to apply to self-directed or otherwise unsolicited transactions by a retail customer.”

The Robinhood case had already explored what qualifies as a recommendation. Attorneys noted that it would usually consist of a call to action; the more customized and specific the call, the more likely it would count as a recommendation.

Fleming voiced concern that DEP transactions may “blur the line” between solicited and unsolicited transactions. As a result, investors who are psychologically influenced to trade may lose the core protections of Reg BI. That consideration serves to remind that the regulation of gamification is still evolving, with ample room for further definition and even litigation. With a hint that the Commission may need to “go back to the drawing board,” Fleming summarized: “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.”

Broker-Dealer Marketing Compliance Impacts

At this stage, app design may well fall beyond the scope of existing broker-deal regulations. There are pitfalls if securities regulators enter this territory. In their article, On ‘Confetti Regulation’: The wrong way to Regulate Gamified Investing, Kyle Langvardt and James Fallows Tierney, both at the University of Nebraska Lincoln – College of Law, warn the SEC against pursuing regulatory strategies that would precipitate more deregulatory constitutional challenges.” The authors remind that securities regulation has largely sidestepped First Amendment scrutiny, while the SEC has also lost many Supreme Court appeals.

Language in the SEC’s DEP information release of last August may also suggest that existing law already requires broker-dealers to maintain procedures in place to supervise gamification and DEPs. Question 3.2 of that Information Request Release asks the following: 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? Pending further clarification, broker-dealers may need to examine and tighten broker-dealer compliance workflows for using DEPs.

Nevertheless, regulators watch rapid evolutions in trading practices very closely. Drivers such as zero-commission trading and accessible mobile apps have helped draw a new generation of investors into the market. On February 22, 2021, at a George Washington University Law School conference, SEC Commissioner Hester Peirce said, “For technology to have its maximum benefit, we will need to change our attitude. Specifically, we tend to look at technological innovation in the markets with deep suspicion, and that mindset has to change.”

If you have concerns about whether your user experience or use of gamification raises compliance risks, we will be happy to discuss. Please be in touch at info@innreg.com.

The Author

InnReg is a team of over 30 Regulatory Compliance and Innovation Consulting experts helping fintechs succeed in highly regulated markets since 2013. InnReg specializes on mitigating regulatory risk while helping clients launch and grow innovative fintech products and services.

Topics: Marketing Compliance, Broker-Dealer Compliance

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