SEC Proposes Rules for IAs/BDs Regarding Digital Engagement Practices (Gamification) and Proposes Amendments Regarding 'Robo-Adviser' Registration

On July 26, the Securities and Exchange Commission (SEC) voted 3-2 in favor of proposing new rules and amendments designed to address certain conflicts of interest associated with the use of predictive data analytics (so-called "Gamification") by investment advisers (IAs) and broker-dealers (BDs) (IAs and BDs, collectively "Firms"). The SEC also unanimously voted 5-0 to approve proposed amendments to modernize the internet adviser (Robo-Adviser) exemption from the prohibition on SEC registration for smaller investment advisers. These rulemaking proposals continue to make good on the Spring 2023 regulatory agenda, which sets out the SEC Chairman's rulemaking priorities over the next year. 

IA/BD Gamification

In August 2021, the SEC published a request for public comment on Firms' digital engagement practices. Citing Firms' increased use of new and complex technologies, the SEC has now proposed new rules and amendments to address certain conflicts of interest associated with Firms' use of predictive analytics and other artificial intelligence as it relates to investing. Certain Commissioners expressed concern with newer technologies, such as predictive data analytics, artificial intelligence, and machine learning -- particularly when (i) such technologies are, for example, used to optimize a Firm's revenue or generate behavioral prompts or social engineering to change investor behavior in a way that benefits the Firm to the detriment of the investor; and (ii) the scalability of such technologies fuels the potential for rapid and widespread impact to investors.

The proposed rules would apply when a Firm uses or reasonably foreseeably may use "covered technology" in an investor interaction. "Covered technology" would include a Firm's use of analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor. The proposed rules would apply to the use of covered technology in connection with a Firm's engagement or communication with an investor, including the exercise of investment discretion, providing information to an investor, or soliciting an investor.

The proposed rules would, in general, have three required elements. First, the Firm must eliminate or neutralize the effect of conflicts of interest associated with the use of covered technologies in investor interactions, where the Firm's or its associated persons' interests are placed ahead of investors' interests. Second, such Firms would be required to have written policies and procedures reasonably designed to prevent violations of or achieve compliance with the proposed rules. And finally, the proposed rules would include certain related recordkeeping requirements.

In dissent, Commissioner Peirce noted, in part, that the proposed IA/BD Gamification proposal reflects:

* the Commission's attitude toward technology, which is not neutral, but hostile[;]

* this Commission’s loss of faith in one of the pillars of our regulatory infrastructure: the power of disclosure and the corresponding belief that informed investors are able to think for themselves[;] [and]

* the Commission's continued degradation of a principles-based regulatory regime, replacing it once again with overly prescriptive rules[.]

The comment period will end 60 days following publication in the Federal Register.

Robo-Adviser Registration

The proposed rule would amend rule 203A-2(e) of the Investment Advisers Act of 1940, which, practically speaking, allows IAs to register with the SEC, rather than state securities regulators, where the IA meets certain enumerated conditions. Reliance on the rule requires, among other things, that the IA use an interactive website to advise clients. The Commissioners generally agreed that the current rule should be modernized to continue to reflect the intent of a narrowly crafted exemption, citing: (i) an expanding universe of Robo-Advisers relying on the rule (stretching further an already resource-constrained Examinations staff); and (ii) findings from the Division of Examinations suggesting inappropriate use of the exemptive rule by such advisers.

The proposed rule would amend the Robo-Adviser exemption to require an IA relying on the rule to at all times have an operational interactive website (except during temporary technological outages of a de minimis duration) through which the IA provides investment advisory services on an ongoing basis to more than one client. The proposed rule would also eliminate the de minimis exception in the current rule which permits IAs relying on the rule to have fewer than 15 non-internet clients in a 12-month period. As a result, Robo-Advisers would be required to provide advice to all of its clients exclusively through an operational interactive website. Form ADV would also be amended to reflect conforming changes.

The comment period will end 60 days following publication in the Federal Register.