Recent guidance on “game-like” features from FINRA should concern every online broker.
Like many media stories, the GameStop saga loomed large and made people feel that everything was about to change. But the moment has passed, and the media has moved onto the next novelty. But for online brokers, this story may end up having a lasting impact.
One interesting aspect of the GameStop saga was that many online brokers, most notably Robinhood, restricted their customer’s ability to buy certain volatile stocks, like GameStop. This exercise of direct control over the customers’ accounts was unusual and created an absolute uproar.
There was a great deal of anger, some people even called for the brokers to be sent to prison. If you want to get into the weeds on why Robinhood halted trading, you should read Francine Mckenna’s article on the topic.
In their recent guidance FINRA focused on online brokers who are attracting a great deal of interest from retail investors. They are primarily concerned by online apps that “include interactive and “game-like” features, as well as related forms of advertising and marketing.”
FINRA has expressed concern that these features, which may improve the customer’s experience, will increase risk for retail investors. In their guidance, FINRA tells brokers that they must evaluate these “game-like” features to see if they “constitute a ‘recommendation’ that requires a broker-dealer to act in a retail customer’s ‘best interest.’”
This guidance directly undermines a key position held by online brokers. For years, these brokers have required customers to sign agreements stating that they do not rely on their brokers for advice or recommendations; these agreements create paper shields that protect the brokers from liability and leaves the customers bereft of the suitability protections traditionally granted by the law.
According to a case decided in 2006, online platforms are not required to provide suitable recommendations because they do not have “discretionary authority” over their customers accounts. That legal assessment was obliterated when Robinhood and other online brokers took control over their users accounts in the name of protecting their customers from volatility.
On a somewhat related note, it is curious that the SEC allows ETF managers complete discretion to set an index and pick stocks without any consideration of whether the strategies or underlying are suitable for the ETF purchasers.
FINRA’s focus on game-like features punches another hole in the online brokers’ paper shield. FINRA’s guidance explicitly expresses concern about the features that come with the mobile investing app that Robinhood pioneered and most online brokers shamelessly copied. But FINRA’s concerns are not isolated to mobile investing, they are worried about how online brokers are influencing their customer’s behavior with their features:
“Such features affect … how firms interact and communicate with customers, from initial advertisements through the opening of accounts, recommendations and the presentation of different investment choices.”
With this guidance FINRA is opening the door to examining the relationships formed between online brokers and their customers, regardless of what the registration agreement says. And the scope of that potential examination is exceptionally broad, covering advertisements, marketing materials, and the website interface.
FINRA may be contemplating some changes that will affect how every online broker does business. But instead of running from the legal obligation that brokers act in the best interests of their customers and provide suitable recommendations, they should find creative ways to meet these obligations.
They could provide a suite of tools that allow investors to easily understand and evaluate the risks that come with investing in any investment vehicle, from single stocks to ETFs. If those risk profiles were the product of unbiased and independent research, then it would be easier to convince FINRA that their features were not unduly influential.
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