Notice2021-18901
Request for Information and Comments on Broker-Dealer and Investment Adviser Digital Engagement Practices, Related Tools and Methods, and Regulatory Considerations and Potential Approaches; Information and Comments on Investment Adviser Use of Technology To Develop and Provide Investment Advice
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
September 1, 2021
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission (the "Commission" or the "SEC") is requesting information and public comment ("Request") on matters related to: Broker-dealer and investment adviser use of "digital engagement practices" or "DEPs", including behavioral prompts, differential marketing, game-like features (commonly referred to as "gamification"), and other design elements or features designed to engage with retail investors on digital platforms (e.g., websites, portals and applications or "apps"), as well as the analytical and technological tools and methods used in connection with these digital engagement practices; and, investment adviser use of technology to develop and provide investment advice. In addition to or in place of responses to questions in this release, retail investors seeking to comment on their experiences may want to submit a short Feedback Flyer.
Full Text
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[Federal Register Volume 86, Number 167 (Wednesday, September 1, 2021)]
[Notices]
[Pages 49067-49087]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2021-18901]
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SECURITIES AND EXCHANGE COMMISSION
[Release Nos. 34-92766; IA-5833; File No. S7-10-21]
RIN 3235-AN00
Request for Information and Comments on Broker-Dealer and
Investment Adviser Digital Engagement Practices, Related Tools and
Methods, and Regulatory Considerations and Potential Approaches;
Information and Comments on Investment Adviser Use of Technology To
Develop and Provide Investment Advice
AGENCY: Securities and Exchange Commission.
ACTION: Request for information and comment.
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SUMMARY: The Securities and Exchange Commission (the ``Commission'' or
the ``SEC'') is requesting information and public comment (``Request'')
on matters related to: Broker-dealer and investment adviser use of
``digital engagement practices'' or ``DEPs'', including behavioral
prompts, differential marketing, game-like features (commonly referred
to as ``gamification''), and other design elements or features designed
to engage with retail investors on digital platforms (e.g., websites,
portals and applications or ``apps''), as well as the analytical and
technological tools and methods used in connection with these digital
engagement practices; and, investment adviser use of technology to
develop and provide investment advice. In addition to or in place of
responses to questions in this release, retail investors seeking to
comment on their experiences may want to submit a short Feedback Flyer.
DATES: Comments should be received on or before October 1, 2021.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
<bullet> Use the Commission's internet comment form (<a href="https://www.sec.gov/rules/submitcomments.htm">https://www.sec.gov/rules/submitcomments.htm</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#8cfef9e0e9a1efe3e1e1e9e2f8ffccffe9efa2ebe3fa"><span class="__cf_email__" data-cfemail="7c0e091019511f1311111912080f3c0f191f521b130a">[email protected]</span></a>. Please include
File No. S7-10-21 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, Securities and Exchange
Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-10-21. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (<a href="http://www.sec.gov">http://www.sec.gov</a>). Comments are
also available for website viewing and printing in the Commission's
Public Reference Room, 100 F Street NE, Washington, DC 20549, on
official business days between the hours of 10 a.m. and 3 p.m.
Operating conditions may limit access to the Commission's public
reference room. All comments received will be posted without change.
Persons submitting comments are cautioned that we do not redact or edit
personal identifying information from comment submissions. You should
submit only information that you wish to make publicly available.
Retail investors seeking to comment on their experiences with online
trading and investing platforms may want to submit a short Feedback
Flyer, available at Appendix A.
Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this Request. A
notification of the inclusion in the comment file of any such materials
will be made available
[[Page 49068]]
on the Commission's website. To ensure direct electronic receipt of
such notifications, sign up through the ``Stay Connected'' option at
<a href="http://www.sec.gov">www.sec.gov</a> to receive notifications by email.
FOR FURTHER INFORMATION CONTACT: Division of Trading and Markets,
Office of Chief Counsel, at (202)-551-5550 or
<a href="/cdn-cgi/l/email-protection#87f3f5e6e3eee9e0e6e9e3eae6f5ece2f3f4c7f4e2e4a9e0e8f1"><span class="__cf_email__" data-cfemail="bdc9cfdcd9d4d3dadcd3d9d0dccfd6d8c9cefdced8de93dad2cb">[email protected]</span></a>; Division of Investment Management,
Investment Adviser Regulation Office at (202) 551-6787 or
<a href="/cdn-cgi/l/email-protection#0a434b787f666f794a796f69246d657c"><span class="__cf_email__" data-cfemail="94ddd5e6e1f8f1e7d4e7f1f7baf3fbe2">[email protected]</span></a>.
SUPPLEMENTARY INFORMATION: The Commission is requesting information and
public comment on matters related to (1) broker-dealer and investment
adviser use of digital engagement practices on digital platforms, as
well as the analytical and technological tools and methods used in
connection with such practices; and (2) investment adviser use of
technology to develop and provide investment advice.
I. Introduction
A. Background
With the advent and growth of digital platforms for investing, such
as online brokerages and robo-advisers, and more recently, mobile
investment apps and portals, broker-dealers and investment advisers
(referred to collectively as ``firms'') have multiplied the
opportunities for retail investors to invest and trade in securities.
This increased accessibility has been one of the many factors
associated with the increase of retail investor participation in U.S.
securities markets in recent years.
As discussed in Section II of this Request, firms employ a variety
of digital engagement practices when interacting with retail investors
through digital platforms. Examples of digital engagement practices
include: Social networking tools; games, streaks and other contests
with prizes; points, badges, and leaderboards; notifications;
celebrations for trading; visual cues; ideas presented at order
placement and other curated lists or features; subscriptions and
membership tiers; and chatbots.
Various analytical and technological tools and methods can underpin
the creation and use of these practices, such as predictive data
analytics and artificial intelligence/machine learning (``AI/ML'')
models. Firms may use these tools to analyze the success of specific
features and practices at influencing retail investor behavior (e.g.,
opening new accounts or obtaining additional services, making
referrals, increasing engagement with the app, or increasing trading).
Based on the results obtained from such AI/ML models and data
analytics, firms may tailor the features with which different retail
investor segments interact on the firms' digital platforms, or target
advertisements to specific investors based on their known behavioral
profiles.
As discussed in Section III of this Request, some investment
advisers also use these tools to develop and provide investment advice,
including through online platforms or as part of more traditional
investment advisory services. Investment advisers can use analytical
tools to learn more about their clients and develop and provide
investment advice based on that information. These developments may
provide potential benefits and risks for investment advisers and their
clients.
B. Purpose of Request
The Commission is issuing this Request related to the use and
development of digital engagement practices by firms on their digital
platforms, in order to:
1. Assist the Commission and its staff in better understanding and
assessing the market practices associated with the use of DEPs by
firms, including: (1) The extent to which firms use DEPs; (2) the types
of DEPs most frequently used; (3) the tools and methods used to develop
and implement DEPs; and (4) information pertaining to retail investor
engagement with DEPs, including any data related to investor
demographics, trading behaviors, and investment performance.
2. Provide a forum for market participants (including investors),
and other interested parties to share their perspectives on the use of
DEPs and the related tools and methods, including potential benefits
that DEPs provide to retail investors, as well as potential investor
protection concerns.\1\
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\1\ To further enable retail investors to share their
perspectives, the Commission is issuing a user-friendly ``Feedback
Flyer.'' The Commission has determined that this usage is in the
public interest and will protect investors, and therefore is not
subject to the requirements of the Paperwork Reduction Act of 1995.
See Sections 19(e) and (f) of the Securities Act of 1933
(``Securities Act''), 15 U.S.C. 77s(e) and (f). Additionally, for
the purpose of developing and considering any potential rules
relating to this rulemaking, the agency may gather from and
communicate with investors or other members from the public. See
Securities Act section 19(e)(1) and (f), 15 U.S.C. 77s(e)(1) and
(f).
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3. Facilitate an assessment by the Commission and its staff of
existing regulations and consideration of whether regulatory action may
be needed to further the Commission's mission including protecting
investors and maintaining fair, orderly, and efficient markets in
connection with firms' use of DEPs and related tools and methods.
In addition to addressing the questions below, the Commission
encourages commenters to provide or identify any data and other
information in furtherance of the purposes articulated in this Request.
II. Digital Engagement Practices, Related Tools and Methods, and
Regulatory Considerations and Potential Approaches
A. DEPS
The Commission is issuing this Request, in part, to develop a
better understanding of the market practices associated with firms' use
of DEPs, which broadly include behavioral prompts, differential
marketing, game-like features, and other design elements or features
designed to engage retail investors. The Commission is aware of a
variety of DEPs that may be used by firms, including the following: \2\
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\2\ Broker-dealers' and investment advisers' use of DEPs and the
related tools and methods must comply with existing rules and
regulations. By identifying observed practices and soliciting
comment on them, the Commission is not expressing a view as to the
legality or conformity of such practices with the federal securities
laws and the rules and regulations thereunder, nor with the rules of
self-regulatory organizations (``SROs'').
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<bullet> Social Networking Tools. Digital platforms may be linked
to internet content, enabling users to access social sentiment on the
platform. Some digital platforms may embed social networking tools into
their platforms, or enhance existing tools to allow an investor to
create an on-line persona or avatar. Certain digital platforms enable
investors to copy the trades of other investors (known as ``copy
trading'') in certain types of investments.\3\
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\3\ It is our understanding that copy trading is currently
offered in certain investments, such as cryptocurrencies, in the
U.S. and may be offered more broadly in other jurisdictions. Copy
trading in securities may raise regulatory concerns under the U.S.
federal securities laws, including potential broker-dealer and
investment adviser status issues.
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<bullet> Games, Streaks and Other Contests with Prizes. Some
digital platforms may employ games that use interactive graphics and
offer prizes (e.g., slot-machine style interactive graphics,
interactive wheels of fortune, or virtual ``scratch-off'' lottery
tickets), for example, in connection with account opening. Some digital
platforms may offer prizes to investors for completing certain ``to-do
lists'' or tasks frequently within a specified time period (known as
``streaks'') or for other types of contests (including performance-
based contests). Prizes may include free stock, cash, gaining access to
additional features on the platforms, or a free trial period for a
subscription to certain market data or levels of service. Tasks
[[Page 49069]]
that may generate awards include referring others to the platform,
engaging in community forums, linking a bank account, funding an
account, trading, or promoting the app on social media.
<bullet> Points, Badges, and Leaderboards. Some digital platforms
may use points or similar ``scorekeeping'' related to a specific area
of activity. For example, some platforms offer ``paper trading'' (i.e.,
simulated trading) competitions that enable investors to practice
trading without real money. Certain platforms also offer badges as
visual markers of achievement as well as leaderboards to rank
individuals based on performance-based criteria developed by the firm.
<bullet> Notifications. Some digital platforms may use
notifications via email, text, or other means (e.g., push notifications
on mobile devices). In some cases, investors can opt-in or opt-out of
notifications; in others, notifications may be set by default with no
ability to opt-out. Investors may receive notifications indicating a
certain stock is up or down, noting a list of stocks qualifying as top
``movers'' (i.e., largest percentage change in price), or reminding
them that it has been a certain number of days since they last engaged
in a trade. Notifications may also be used to attempt to reassure
investors during periods of market volatility.
<bullet> Celebrations for Trading. Some digital platforms may have
embedded animations and graphics, such as digital confetti or crowds
applauding, that ``celebrate'' when investors enter orders to purchase
stock or options.
<bullet> Visual Cues. Interface design elements may provide visual
cues, including by displaying certain information more prominently than
other information. In some cases, visual cues are targeted specifically
to the investor. For example, some digital platforms' user interfaces
shift the coloration of the entire screen between green and red based
on an investor's portfolio performance. Some digital platforms present
relevant news or other pieces of information to the user immediately
once the portfolio turns negative.
<bullet> Ideas Presented at Order Placement and Other Curated Lists
or Features. Some digital platforms may present ``ideas'' prior to
allowing the investor to place an order. These ideas may involve
curated lists or features, news headlines, etc.
<bullet> Subscriptions and Membership Tiers. Some firms may offer
subscriptions or tiered memberships. Examples of additional features
that may be provided include access to research reports, briefs,
webcasts, and newspaper subscriptions; invitations to sports and
industry events; credit line access; and an exemption or reduction of
fees. In some cases, investors may be upgraded automatically based on
balances and holdings reaching certain thresholds. Some firms may offer
free subscription trials.
<bullet> Chatbots. Some digital platforms may offer chatbots, or
computer programs that simulate live, human conversation. Chatbots may
be offered to respond to investor inquiries relating to stock prices,
account information, or customer service matters.
DEPs may be designed to encourage account opening, account funding,
and trading, or may be designed solely to increase investor engagement
with investing apps, as there may be value in the number of investors
interacting with the platform, how often they visit, and how long they
stay.
The use of DEPs carries both potential benefits and risks for
retail investors. Simplified user interfaces and game-like features
have been credited with making investment platforms more accessible to
retail investors (in particular, younger retail investors),\4\ and
assisting in the development and implementation of investor education
tools. Others have noted that DEPs can encourage retail investors to
increase their contributions to retirement accounts and to engage in
other activities that are traditionally viewed as wealth-building
exercises.\5\
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\4\ See, e.g., Evie Liu, The Stock Market is Attracting New
Investors. Here Are 3 Trends to Know., Barron's (Apr. 13, 2021),
<a href="https://www.barrons.com/articles/the-stock-market-is-attracting-new-investors-here-are-3-trends-to-know-51618273799">https://www.barrons.com/articles/the-stock-market-is-attracting-new-investors-here-are-3-trends-to-know-51618273799</a>; Broadridge,
Insights on the U.S. Investor (2020) (``Zero commission trades,
mobile trading applications and the ability to acquire fractional
shares are making it more attractive and easier for younger, lower
asset investors to trade securities. This is bolstering Millennials'
ability to participate more actively in equity investing.''); Maggie
Fitzgerald, Now Teenagers Can Trade Stocks With Fidelity's New Youth
Investing Accounts, CNBC (May 18, 2021), <a href="https://www.cnbc.com/2021/05/18/now-teenagers-can-trade-stocks-with-fidelitys-new-youth-investing-accounts.html?&qsearchterm=margin%20debits">https://www.cnbc.com/2021/05/18/now-teenagers-can-trade-stocks-with-fidelitys-new-youth-investing-accounts.html?&qsearchterm=margin%20debits</a> (``Of the 4.1
million new accounts that Fidelity added in the first quarter of
2021, 1.6 million were opened by retail investors 35 and younger, an
increase of more than 222% from a year prior.''); Jennifer Sor,
Young Investors Drive Increased Use of Investing Apps, Los Angeles
Business Journal (Aug. 3, 2020), <a href="https://labusinessjournal.com/news/2020/aug/03/young-investors-drive-increased-use-investing-apps/">https://labusinessjournal.com/news/2020/aug/03/young-investors-drive-increased-use-investing-apps/</a>.
\5\ See, e.g., Chris Carosa, Are You Ready to Play the 401(k)
Game? Hint: You Already Are, Forbes (Apr. 14, 2021), <a href="https://www.forbes.com/sites/chriscarosa/2021/04/14/are-you-ready-to-play-the-401k-game-hint-you-already-are/?sh=4d6e1b8674ab">https://www.forbes.com/sites/chriscarosa/2021/04/14/are-you-ready-to-play-the-401k-game-hint-you-already-are/?sh=4d6e1b8674ab</a>; Greg Iacurci,
MassMutual Turns to Video Games to Boost Retirement Savings,
Investment News (July 18, 2016), <a href="https://www.investmentnews.com/massmutual-turns-to-video-games-to-boost-retirement-savings-66476">https://www.investmentnews.com/massmutual-turns-to-video-games-to-boost-retirement-savings-66476</a>.
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On the other hand, DEPs can potentially harm retail investors if
they prompt them to engage in trading activities that may not be
consistent with their investment goals or risk tolerance. Some have
expressed concerns that DEPs encourage: (1) Frequent trading; \6\ (2)
using trading strategies that carry additional risk (e.g., options
trading and trading on margin); and (3) trading in complex securities
products.\7\ DEPs also may employ what some researchers have called
``dark patterns,'' described as user interface design choices that are
knowingly designed to ``confuse users, make it
[[Page 49070]]
difficult for users to express their actual preferences, or manipulate
users into taking certain actions.'' \8\
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\6\ Some have argued that certain compensation practices (such
as payment for order flow or ``PFOF,'' in combination with zero
commissions) create incentives for firms to use DEPs to encourage
frequent trading, and that these incentives may not be transparent
to retail investors. See, e.g., Game Stopped? Who Wins and Loses
When Short Sellers, Social Media, and Retail Investors Collide, Part
II: Hearing Before the H. Comm. on Fin. Servs., 113th Cong. (2021)
(statement of Vicki L. Bogan, Associate Professor, Cornell
University), <a href="https://docs.house.gov/meetings/BA/BA00/20210317/111355/HHRG-117-BA00-Wstate-BoganV-20210317.pdf">https://docs.house.gov/meetings/BA/BA00/20210317/111355/HHRG-117-BA00-Wstate-BoganV-20210317.pdf</a>. One form of PFOF is
a practice wherein wholesale broker-dealers (often referred to as
``principal trading firms'' or ``electronic market makers'') offer
payment to retail broker-dealers in exchange for the right to trade
principally with (or ``internalize'') their customer order flow. See
17 CFR 10b-10(d)(8). Although PFOF is not prohibited, a broker-
dealer must not allow PFOF to interfere with its efforts to obtain
best execution for its customers' transactions. See Payment for
Order Flow, Securities Exchange Act of 1934 (``Exchange Act'')
Release No. 34902 (Oct. 27, 1994) [59 FR 55006, at 55009 & n.28
(Nov. 2, 1994)]; see also Robinhood Financial, LLC, Exchange Act
Release No. 90694 (Dec. 17, 2020) (settled order) (the Commission
brought an enforcement action against a broker-dealer for willfully
violating Sections 17(a)(2) and 17(a)(3) of the Securities Act and
Section 17(a) of the Exchange Act and Rule 17a-4 thereunder, for,
among other things, failing to take appropriate steps to assess
whether its higher PFOF rates were adversely affecting customer
execution prices).
\7\ In congressional hearings related to market events in
January 2021, investor protection concerns were identified relating
to the use of certain types of DEPs, including advertisements
targeted towards specific groups of investors on digital platforms
and game-like features on mobile apps. See Game Stopped? Who Wins
and Loses When Short Sellers, Social Media, and Retail Investors
Collide: Hearing Before the H. Comm. on Fin. Servs., 113th Cong.
(2021), <a href="https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407107">https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407107</a>; Game Stopped? Who Wins and Loses
When Short Sellers, Social Media, and Retail Investors Collide, Part
II: Hearing Before the H. Comm. on Fin. Servs., 113th Cong. (2021),
<a href="https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=406268">https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=406268</a>; Game Stopped? Who Wins and Loses
When Short Sellers, Social Media, and Retail Investors Collide, Part
III: Hearing Before the H. Comm. on Fin. Servs., 113th Cong. (2021),
<a href="https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407748">https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407748</a>; Who Wins on Wall Street? GameStop,
Robinhood, and the State of Retail Investing: Hearing Before the S.
Comm. On Banking, Hous., & Urban Affairs, 113th Cong. (2021),
<a href="https://www.banking.senate.gov/hearings/who-wins-on-wall-street-gamestop-robinhood-and-the-state-of-retail-investing">https://www.banking.senate.gov/hearings/who-wins-on-wall-street-gamestop-robinhood-and-the-state-of-retail-investing</a>.
\8\ See Jamie Luguri and Lior Jacob Strahilevitz, Shining a
Light on Dark Patterns, 13 Journal of Legal Analysis 43 (2021),
<a href="https://academic.oup.com/jla/article/13/1/43/6180579">https://academic.oup.com/jla/article/13/1/43/6180579</a>.
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In the questions below, the Commission's request for comment
pertains to all DEPs on brokerage and advisory digital platforms,
including, but not limited to, those identified above.
Industry Practices
1.1 What types of DEPs do firms use (or in the future expect to
use) on digital platforms and what are the intended purposes of each
type of DEP used? For example, are particular DEPs designed to
encourage or discourage particular investor actions or behaviors, such
as opening of accounts, funding of accounts, trading, or increasing
engagement with the app or platform? To what extent and how are firms
using DEPs such as notifications (e.g., push notifications or text
messages) or other design elements and features (e.g., design
aesthetics in the user interface) as a means to alter (or nudge \9\)
retail investor behavior or otherwise to encourage or discourage
certain behaviors or activities? If so, what types of design elements
are used and how are they used? Please explain any such specific design
elements, how they intend to encourage specific retail investor
behaviors, and whether and to what extent they are achieving their
intended purposes.
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\9\ Richard Thaler and Cass Sunstein define ``nudge'' as ``any
aspect of the choice architecture that alters people's behavior in a
predictable way without forbidding any options or significantly
changing their economic incentives.'' See Richard H. Thaler and Cass
R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and
Happiness 6 (Penguin Books 2009).
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1.2 To what extent do firms that utilize DEPs provide retail
investors the ability to opt in or out of interacting with those DEPs
when using the firm's digital platform? To what extent, and how, are
firms tailoring or personalizing DEPs to a particular retail investor?
1.3 What types of firms use DEPs on their digital platforms, and on
what types of platforms? Are these practices more prevalent among
certain types of firms, or on certain types of platforms? How prevalent
is the use of DEPs by broker-dealers? How prevalent is the use of DEPs
by investment advisers? Which types of DEPs are most prevalent? For
firms that have chosen not to use DEPs or certain DEPs, what are their
reasons? Are firms that are not currently using DEPs considering
adopting such features in the future?
1.4 What market forces are driving the adoption of DEPs on digital
platforms and how? For example, to what extent and how is the use of
DEPs influenced or driven by market practices related to compensation
and revenue (e.g., ``zero commission'' and PFOF)? What types of
compensation and revenue arrangements influence or drive market
practices related to the use of DEPs? Do such arrangements vary across
product types and asset classes (e.g., options, other complex
products)? How does the competition for new customers or clients or the
retention of existing customers or clients drive firm adoption or use
of DEPs?
1.5 Are DEPs used to promote or otherwise direct retail investors
to specific securities or certain types of securities, investment
strategies, or services? If so, what types of securities, investment
strategies, and services, what types of DEPs are used, and how are the
DEPs used for these purposes? Do firms use DEPs to promote or otherwise
direct retail investors to securities, investment strategies, or
services that are more lucrative for the firm or that may be riskier to
the retail investor than others--such as: margin services, options
trading, proprietary products, products for which the firm receives
revenue sharing or other third-party payments, or other higher fee
products? Do firms use DEPs that are or can be tailored to the retail
investor's investment profile and risk tolerance? If so, how? If not,
why not?
1.6 To what extent and how do firms monitor the use and proper
functioning of DEPs? For example, to what extent and how do firms
monitor notifications that retail investors receive or see from or on
the firm's digital platforms?
1.7 To what extent and how do firms use DEPs or alter their use of
DEPs in response to changes in the market price volatility and trading
volumes in securities, both for specific assets and the market as a
whole? For example, to what extent and how do firms use DEPs to notify
retail investors of market events? To what extent and how do firms use
DEPs to notify retail investors of firm policies and procedures or
other actions that may be taken by the firm, such as in response to
market events (e.g., imposition of trading restrictions)? What type of
DEPs are used, what information is communicated through DEPs in such
circumstances, and what is the timing of such communications?
1.8 Are firms seeking to use DEPs specifically to increase investor
education? If so, how? What type of investor educational content is
provided, how is that content chosen, and what types of DEPs are used?
For example, are firms using DEPs to educate investors about the risks
of certain activities, such as trading on margin or options trading?
Are firms using DEPs to help investors understand how to make
investment choices that are consistent with their investment
objectives? If so, what types of DEPs are they using for these
purposes, and how are they used? Have firms tested or otherwise
observed the effectiveness of any such educational efforts at
increasing retail investor knowledge and understanding of investing
concepts including risks? Please explain and include any relevant data
or information.
1.9 Do firms use DEPs to encourage longer-term investment
activities, including, but not limited to, increased contributions to
or establishment of retirement accounts? If so, how?
1.10 Do firms that utilize DEPs offer live, phone-based customer
support or customer support through live, human-directed online support
(i.e., online conversations that are not through an automated chatbot)?
Does the availability of this type of support depend on the type of
account or investments held (e.g., investors holding riskier products)
or on account balances or asset thresholds? If firms offer live, phone-
based customer support or human-directed online support, what training
do firms offer their customer support personnel, and what monitoring
and quality assurance programs are used? How do firms interact with
investors when the platform is unavailable--for example, when the firm
has lost internet service or when the platform is undergoing
maintenance? What alternative means of communication are available to
investors during those times?
1.11 To what extent and how do firms target certain specific groups
of retail investors (including prospective customers or clients)
through DEPs? What types of DEPs are used, and how are they targeted to
specific retail investors or groups of retail investors? What factors
do firms look to when deciding which groups of retail investors to
target for each type of DEP?
1.12 What feedback, positive or negative, or complaints do firms
receive from retail investors relating to the use of DEPs?
Investor Characteristics and Practices
1.13 What types of retail investors are customers or clients of
firms that utilize DEPs? How does this customer or client base differ,
if at all, from those firms that do not use such features--including as
to age, prior investment experience, education, net worth, risk
[[Page 49071]]
tolerance, liquidity needs, investment time horizon, and investment
objectives? What types of retail investors engage most frequently with
DEPs on platforms that use them? Do firms utilize DEPs for only certain
types of customers or clients? If so, which ones and why? To what
extent and how have DEPs enabled firms to reach, educate, and provide
experience to first-time retail investors? To what extent and how have
DEPs enabled retail investors to access specific investments or
investment strategies more quickly and/or with less investing
experience than under traditional methods? Please provide or identify
any relevant data and other information.
1.14 What trading or investment activities are retail investors
engaging in through digital platforms that use DEPs? For retail
investors who were investing prior to using digital platforms that use
DEPs, how have their activities with respect to trading and investing
changed since they started using such platforms and/or were first
exposed to DEPs? For example, how often do retail investors engage in
trading or investing through such platforms, how often did they engage
in trading or investing prior to using such platforms, and how has such
frequency changed as a result of using such platforms and/or being
exposed to DEPs? How often do retail investors engage in other ways
with such platforms (e.g., education, social features, and games)? How
do retail investors learn of these platforms (e.g., news coverage,
social media, internet search, paid advertisements)? Do firms collect
data on how retail investors learn about or use the platforms, such as
by asking as part of account opening? Please provide or identify any
relevant data and other information.
1.15 What customer and client trends have been observed in
connection with or as a result of the adoption and implementation of
DEPs? Specifically, is data available regarding changes in customer or
client behavior, including in accounts opened, amount invested,
frequency of deposits, order frequency, order size (including
fractional shares), types of securities traded, the risk profiles of
securities that are traded, use of margin, volume of customer
complaints, and the adoption and use of new features on the firms'
digital platforms? Is there data showing how, for customers with a
similar investment profile, these changes compare with any changes in
the behavior of customers or clients of firms that do not utilize DEPs?
Is there data regarding numbers or percentages of new accounts opened
by retail investors that received targeted communications from the firm
as compared to new accounts opened by retail investors that had
received no prior communications from the firm? Please provide or
identify any relevant data and other information. What experience did
retail investors have in the market prior to interacting with DEPs?
What percentage of retail investors invested for the first time after
interacting with a DEP? What role did DEPs play in their decision to
begin investing?
Public Perspectives and Data
1.16 What are the benefits associated with the use of DEPs from the
perspective of firms, retail investors, and other interested parties?
How do these benefits differ depending upon the type of feature used?
Are there specific types of DEPs or specific uses of DEPs that have the
potential to be particularly beneficial to retail investors? Are there
significant investor protection benefits that arise from the use of
DEPs generally or particular DEPs? Which particular DEPs and why? Are
there ways in which DEPs are particularly successful at conveying
information to retail investors in a way that they can process and
implement effectively? Please provide or identify any relevant data and
other information.
1.17 What are the risks and costs associated with the use of DEPs
from the perspective of firms, retail investors, and other interested
parties? How do these risks or costs differ depending upon the type of
feature used? Are there significant investor protection concerns that
arise from the use of DEPs generally or particular DEPs? Are there
particular DEPs that may pose unique risks or elevated investor
protection concerns? Are there characteristics of particular DEPs that
may encourage retail investors to engage in more frequent trading or
invest in higher risk products or strategies? Please provide or
identify any relevant data and other information.
1.18 What experience do retail investors have with DEPs? Do retail
investors believe that DEPs have caused a change in their investing
behavior or type of investments? If so, how? Do retail investors feel
like DEPs help or hurt their overall investment performance? Do retail
investors believe DEPs have helped increase their understanding of
securities markets and investing? If so, how? Do retail investors
believe DEPs have made trading, investing, and monitoring their
investments more or less accessible to them? Do retail investors
believe DEPs have increased or decreased the benefits or risks of
trading or investing in securities products? Do retail investors
believe that they would have invested in the markets if only more
traditional methods were available? Do retail investors believe that
they would trade less frequently, invest in different products, or use
different investment strategies if only more traditional methods were
available?
1.19 Do retail investors believe they are receiving investment
advice or recommendations from DEPs or certain types of DEPs? If so,
please explain. What types of DEPs do retail investors believe are most
beneficial, and what types of features are most harmful, in meeting
their own trading or investment objectives?
1.20 For retail investors who have previously invested with the
assistance of a financial professional, how do they believe their
investing experience has changed as a result of interacting with a
digital platform as opposed to a financial professional?
1.21 How do commenters view the educational services currently
provided by digital platforms? How could firms adopt or modify DEPs to
facilitate and increase opportunities for investor education and
encourage longer-term investment activities, including, but not limited
to, through increased contributions to or establishment of retirement
accounts?
1.22 What similarities and differences exist between the
functionality, and overall user experience, including with respect to
DEPs, on a digital trading or investment platform versus similar
practices on digital platforms in other contexts (e.g., shopping,
fitness, entertainment)? Does a retail investor's experience with these
types of features in other contexts affect the retail investor's
trading or investment activity, and their engagement with the broker-
dealer or investment adviser's digital platform where DEPs are
employed? Do commenters believe that certain types of DEPs are more,
less, or as appropriate in the investing context than in other
contexts? What types of features and why?
1.23 Have researchers (including in the fields of behavioral
finance, economics, psychology, marketing, and other related fields)
studied the use of DEPs by broker-dealers and investment advisers? In
particular, how have these practices been studied or observed to
influence or reinforce the behavior of retail investors? To the extent
retail investors have shifted from investing through human interaction
(with a financial professional) to digital interaction (on a digital
platform), how has that shift affected the behavior of retail
investors? Please identify any relevant literature or data, including
[[Page 49072]]
research related to the use of similar practices in other fields that
could assist the Commission in its consideration of these issues.
1.24 Is there research in the fields of experimental psychology and
marketing that contains evidence regarding the ability of DEPs to
influence retail investors? Are there findings in those fields that
suggest retail investors may not be fully aware that they have been
influenced by a particular DEP?
1.25 Do studies of gambling or addiction offer evidence regarding
whether and to what extent the immediate positive feedback provided by
certain DEPs may influence retail investor decision-making?
1.26 How do commenters view the disclosures that firms are
providing in connection with or specifically addressing the use of DEPs
and the timing of such disclosures? In particular, how effective are
disclosures at informing retail investors of any associated conflicts
of interest presented by the use of DEPs and how DEPs could influence
them and their trading and investing behavior? How accessible are these
disclosures to retail investors engaging with DEPs? Please identify any
relevant data or other information.
B. DEP-Related Tools and Methods
In order to develop, test, and implement these practices, and
thereafter to assess their effectiveness, firms may use numerous
analytical and technological tools and methods.\10\ From a
technological perspective, these tools and methods can employ
predictive data analytics and AI/ML models--including deep learning,
supervised learning, unsupervised learning, and reinforcement learning
processes.\11\ These tools and methods can be designed to build and
adapt DEPs based on observable investor activities. Such adaptations
may be based on the AI/ML models' understanding of the neurological
rewards systems of retail investors (obtained in the interactions
between each retail investor and the firm's investment platform), and
may be utilized to develop investor-specific changes to each retail
investor's user experience.
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\10\ In some cases, firms may rely on in-house and proprietary
tools and methods to develop, test and implement DEPs, and in
others, firms may use third-party service providers to assist in the
DEP development process.
\11\ See, e.g., Department of the Treasury et al., Request for
Information and Comment on Financial Institutions' Use of Artificial
Intelligence, Including Machine Learning (Feb. 2021) [86 FR 16837,
16839-40 (Mar. 31, 2021)] (``Treasury RFI''); FINRA, Artificial
Intelligence (AI) in the Securities Industry 5 (June 2020) (``FINRA
AI Report''), <a href="https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf">https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf</a>; Financial Stability Board, Artificial
Intelligence and Machine Learning in Financial Services: Market
Developments and Financial Stability Implications (Nov. 1, 2017)
(``FSB AI Report''), <a href="https://www.fsb.org/wp-content/uploads/P011117.pdf">https://www.fsb.org/wp-content/uploads/P011117.pdf</a>.
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Relatedly, firms that utilize AI/ML models may utilize model risk
management to provide a governance framework for these models
throughout their life cycle in order to account for AI/ML-specific
risks. Technological tools and methods also include the use of natural
language processing (``NLP'') and natural language generation
(``NLG''). These specific uses of AI/ML may be employed to transform
user interfaces and the interactions that retail investors have on
digital platforms by developing an understanding of the investor's
preferences and adapting the interface and related prompts to appeal to
those preferences.\12\
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\12\ See, e.g., FSB AI Report, supra note 11, at 14-15 (finding
that chatbots are being introduced by a range of financial services
firms, often in mobile apps or social media, and that chatbots are
``increasingly moving toward giving advice and prompting customers
to act'').
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Beyond technological tools, firms may engage in various forms of
research in order to help shape the DEPs developed and implemented on
their platforms. This may include consultations with behavioral science
professionals, and cross-industry research intended to identify those
customer engagement practices used in other industries that have proven
most effective.
Industry Practices
2.1 To what extent, and how, do firms use (or in the future expect
to use) tools based on AI/ML (including deep learning, supervised
learning, unsupervised learning, and reinforcement learning) and NLP
and NLG, to develop and evolve DEPs? What are the objective functions
of AI/ML models (e.g. revenue generation)? What are the inputs relied
on by those AI/ML models (e.g., visual cues or feedback)? Does the
ability to collect individual-specific data impact the effectiveness of
the ML model in maximizing its objective functions?
2.2 To what extent, and how, do firms use (or in the future expect
to use) behavioral psychology to develop and evolve platforms or DEPs?
To what extent, and how, do firms use (or in the future expect to use)
predictive data analytics to develop and evolve DEPs? To what extent,
and how, do firms use ``dark patterns'' \13\ in connection with DEPs?
To what extent do firms utilize these types of tools, analytics, and
methods to modify DEPs over time, tailored to a specific retail
investor's history on the platform? Which types of tools and methods
are used for these and other purposes?
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\13\ See supra note 8.
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2.3 What types of research, information, data, and metrics are
firms collecting, acquiring, and using in connection with the tools and
methods identified above, or otherwise to design, implement, and modify
DEPs and to assess their effectiveness? What are the sources for such
information and data (e.g., proprietary research, user data, third-
party behavioral research, consultants, other service providers)? Does
this research, information, data, and metrics, indicate whether DEPs
affect trading frequency, volume, and results? If so, how?
2.4 How are firms using cross-industry research and sources to
design, implement, and modify DEPs? Specifically, how are firms using
techniques employed, and lessons learned, within industries like retail
shopping, video gaming, and video or music streaming services? What
features originally adopted in other industries have been utilized and
implemented by firms to increase user engagement? How has the use of
such features impacted investor activity on digital platforms?
2.5 To what extent, and how, do firms test or otherwise assess how
their DEPs affect investor behavior and investing outcomes? What
metrics are used for these assessments? What data and other results
have such tests and assessments yielded? Have firms found that DEPs can
be developed, evolved and implemented in order to affect retail
investors' trading or investment behavior, either individually or as a
group? Have firms found that those behaviors can be affected in a
statistically significant way? If so, how? What controls do firms have
in place to monitor the impact of DEPs on investor outcomes? How do
firms incorporate any testing and monitoring into their policies and
procedures?
2.6 How do firms develop, test, deploy, monitor, and oversee the
tools and methods they use, including any AI/ML models (including deep
learning, supervised learning, unsupervised learning, and reinforcement
learning), NLP, NLG, or other types of artificial intelligence? To what
extent are these tools and methods proprietary to firms or offered by
third parties? Do relationships with vendors result in conflicts of
interest, and if so, what types of conflicts of interest? For example,
are broker-dealers or investment advisers affiliated with these
providers, or does compensation of the provider vary based upon
investor activity? What formal governance
[[Page 49073]]
mechanisms do firms have in place for oversight of the vendors they use
for these purposes? What model risk management steps do firms
undertake? How do firms incorporate these practices and mechanisms into
their policies and procedures?
2.7 What type of data concerning retail investors is used to
develop, evolve, implement, test and run DEPs? How is this data used?
For example, are firms using data on how retail investors--individually
and/or when grouped together--have engaged with their digital platform
(including trading or investment activity) following exposure to DEPs?
If so, how? Are firms tailoring or personalizing DEPs to individual
retail investors or groups (or sub-groups) of retail investors? If so,
how? Are firms collecting information about specific identifiers
attributable to particular retail investors or groups (or sub-groups)
of retail investors? If so, what types of specific identifiers are
collected? Do firms use such identifiers (or others) in connection with
determining the location of retail investors? If so, how do firms use
location information? Do firms seek to cause any particular types of
engagement with DEPs? If so, how? Are there other ways firms are using
data concerning retail investors to develop, evolve, implement, test,
and run DEPs?
2.8 To what extent do firms purchase data from third-party vendors,
including data concerning retail investors, to develop, evolve,
implement, test, and run DEPs? How are firms utilizing data acquired
from third-party vendors to develop, evolve, implement, test, and run
DEPs? Are firms using data obtained from third-party vendors to tailor
or personalize DEPs to individual retail investors? If so, how? To what
extent do firms sell or otherwise share data about their own customers'
or clients' behavior on their digital platforms, and who are the
primary purchasers or recipients of that data?
2.9 To the extent that firms use AI/ML to develop, evolve,
implement, test, and run DEPs, are they ensuring that the AI/ML is
explainable and reproducible? \14\ If so, how?
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\14\ See, e.g., Treasury RFI, at 16839-40 (describing
explainability as ``how an AI approach uses inputs to produce
outputs'' and describing challenges associated with lack of
explainability); see also FSB AI Report, at 2 (stating that the
``lack of interpretability or `auditability' of AI and machine
learning models could become a macro-level risk''); Gregory Barber,
Artificial Intelligence Confronts a `Reproducibility' Crisis, Wired
(Sept. 16, 2019), <a href="https://www.wired.com/story/artificial-intelligence-confronts-reproducibility-crisis/">https://www.wired.com/story/artificial-intelligence-confronts-reproducibility-crisis/</a>.
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2.10 Are there any particular challenges or risks that firms face
in using AI/ML (including deep learning, supervised learning,
unsupervised learning, and reinforcement learning), including AI
developed or provided by third parties? If so, what are they and how do
firms address such challenges or impediments and any risks associated
with them? Have firms found that using AI/ML or retail investor data
gathered in connection with DEPs raises unique issues related to
financial privacy, information security, or identity theft prevention?
2.11 To what extent and how do firms employ controls to identify
and mitigate any biases or disparities that may be perpetuated by the
use of AI/ML models \15\ in connection with the use of DEPs? For
example, do firms evaluate the outputs of their AI/ML models to
identify and mitigate biases that would raise investor protection
concerns? Do firms utilize human oversight to identify biases that
would raise investor protection concerns, in both the initial coding of
AI/ML models and the resulting outputs of those models?
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\15\ See e.g., Joy Buolamwini and Timnit Gebru, Gender Shades:
Intersectional Accuracy Disparities in Commercial Gender
Classification, 81 Proceedings of Machine Learning Research 77
(2018), <a href="https://dam-prod.media.mit.edu/x/2018/02/06/Gender%20Shades%20Intersectional%20Accuracy%20Disparities.pdf">https://dam-prod.media.mit.edu/x/2018/02/06/Gender%20Shades%20Intersectional%20Accuracy%20Disparities.pdf</a>; Ziad
Obermeyer et al., Dissecting Racial Bias in an Algorithm Used to
Manage the Health of Populations, 366 Science 6464, 447-453 (Oct.
25, 2019), <a href="https://science.sciencemag.org/content/366/6464/447">https://science.sciencemag.org/content/366/6464/447</a>;
Executive Office of the President of the United States, Big Data: A
Report on Algorithmic Systems, Opportunity, and Civil Rights pp. 6-
10 (May 2016), <a href="https://obamawhitehouse.archives.gov/sites/default/files/microsites/ostp/2016_0504_data_discrimination.pdf">https://obamawhitehouse.archives.gov/sites/default/files/microsites/ostp/2016_0504_data_discrimination.pdf</a>.
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Public Perspectives and Data
2.12 What are the benefits associated with the use of the tools and
methods identified above (e.g., AI/ML, predictive data analytics,
cross-industry research, behavioral science) in connection with the
design, implementation, and modification of DEPs from the perspective
of firms, retail investors, and other interested parties? How do these
benefits differ depending upon the type of tools or methods? Do the
tools and methods mitigate, or have the potential to mitigate, biases
in the market that may have prevented participation by some retail
investors (e.g., by lowering barriers to entry)? Please provide or
identify any relevant data and other information.
2.13 What are the risks and costs associated with the use of the
tools and methods identified above (e.g., AI/ML, predictive data
analytics, cross-industry research, behavioral science) in connection
with the design, implementation, and modification of DEPs from the
perspective of firms, retail investors, and other interested parties?
How do these risks differ depending upon the type of tools or methods
used? What are the most significant investor protection concerns
arising from or associated with the use of such tools and methods by
broker-dealers and investment advisers in the context of DEPs? Please
provide or identify any relevant data and other information.
2.14 What are the similarities and differences between the use of
the types of tools and methods identified above in the context of DEPs
versus other contexts? Do commenters believe that certain types of
tools or methods are more, less, or as appropriate in the investing
context than in other contexts? Please provide or identify any relevant
data and other information.
2.15 Are there any particular challenges or risks associated with
the use of AI/ML (including deep learning, supervised learning,
unsupervised learning, and reinforcement learning), including AI
developed or provided by third parties? If so, what are they and how
should firms address such challenges or impediments and any risks
associated with them? What model risk management steps should firms
undertake? Does the use of AI/ML or retail investor data gathered in
connection with DEPs raise unique issues related to financial privacy,
information security, or identity theft prevention?
2.16 Have researchers (including in the fields of behavioral
finance, economics, psychology, marketing, and other related fields)
studied the use of such tools and methods in the context of the use of
DEPs by firms, or in related contexts of individual decision-making?
Please identify any relevant literature or data, including research
related to the use of similar practices in other fields, that could
assist the Commission in its consideration of these issues.
2.17 To what extent can the use of the tools and methods identified
above (e.g., AI/ML models) in connection with the use of DEPs
perpetuate social biases and disparities? How, if at all, have
commenters seen this in practice with regard to the development and use
of DEPs on digital platforms (e.g., through marketing, asset
allocation, fees)? Are there AI/ML models that are more or less likely
to perpetuate such biases and disparities?
C. Regulatory Issues Associated With DEPS and the Related Tools and
Methods and Potential Approaches
Broker-dealers and investment advisers are currently subject to
[[Page 49074]]
extensive obligations under federal securities laws and regulations,
and in the case of broker-dealers, rules of SROs (in particular, the
Financial Industry Regulatory Authority, Inc. (``FINRA'') \16\) that
are designed to promote conduct that, among other things, protects
investors from abusive practices. Following is an overview of some of
the existing statutory provisions, regulations, and rules that are
particularly relevant to the use of DEPs and related tools and methods
by broker-dealers and investment advisers.\17\
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\16\ Any person operating as a ``broker'' or ``dealer'' in the
U.S. securities markets must register with the Commission, absent an
exception or exemption. See Exchange Act section 15(a), 15 U.S.C.
78o(a); see also Exchange Act sections 3(a)(4) and 3(a)(5), 15
U.S.C. 78c(a)(4) and 78c(a)(5) (providing the definitions of
``broker'' and ``dealer,'' respectively). Generally, all registered
broker-dealers that deal with the public must become members of
FINRA, a registered national securities association, and may choose
to become exchange members. See Exchange Act section 15(b)(8), 15
U.S.C. 78o(b)(8); 17 CFR 240.15b9-1. FINRA is the sole national
securities association registered with the SEC under Section 15A of
the Exchange Act. Because this Request is focused on broker-dealers
that deal with the public and are FINRA member firms, we refer to
FINRA rules as broadly applying to ``broker-dealers,'' rather than
to ``FINRA member firms.''
\17\ Broker-dealers and investment advisers are subject to a
host of other obligations that are not summarized in this overview,
and that may also be relevant to the use of DEPs and related tools
and methods. For example, additional regulatory obligations on
broker-dealers include those relating to: Registration; certain
prohibited or restricted conflicts of interest; fair prices,
commissions and charges; and best execution. As another example,
additional regulatory obligations on investment advisers include
those relating to registration; certain prohibited transactions; and
written codes of ethics.
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In addition to these specific obligations, federal securities laws
and regulations broadly prohibit fraud by broker-dealers and investment
advisers as well as fraud by any person in the offer, purchase, or sale
of securities, or in connection with the purchase or sale of
securities. Generally, these anti-fraud provisions cover manipulative
or deceptive conduct, including an affirmative misstatement or the
omission of a material fact that a reasonable investor would view as
significantly altering the total mix of information made available.\18\
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\18\ See Securities Act section 17(a), 15 U.S.C. 77q(a);
Exchange Act section 10(b), 15 U.S.C. 78j(b); Exchange Act section
15(c), 15 U.S.C. 78o(c); Investment Advisers Act of 1940 (``Advisers
Act'') section 206, 15 U.S.C. 80b-6; see also Exchange Act section
9(a), 15 U.S.C. 78i(a); see also Basic v. Levinson, 485 U.S. 224,
239 n.17 (1988).
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1. Existing Broker-Dealer Obligations \19\
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\19\ These obligations cannot be waived or contracted away by
customers. See Exchange Act section 29(a), 15 U.S.C. 78cc(a) (``Any
condition, stipulation, or provision binding any person to waive
compliance with any provision of [the Exchange Act] or any rule or
regulation thereunder, or any rule of a [SRO], shall be void.'').
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Under the anti-fraud provisions of the federal securities laws and
SRO rules, broker-dealers are required to deal fairly with their
customers and observe high standards of commercial honor and just and
equitable principles of trade.\20\ A number of more specific
obligations are summarized below:
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\20\ See, e.g., Duker & Duker, Exchange Act Release No. 2350, 6
SEC. 386, 388 (Dec. 19, 1939) (Commission opinion) (``Inherent in
the relationship between a dealer and his customer is the vital
representation that the customer be dealt with fairly, and in
accordance with the standards of the profession.''); see also U.S.
Securities and Exchange Commission, Report of the Special Study of
Securities Markets of the Securities and Exchange Commission, H.R.
Doc. No. 95, at 238 (1st Sess. 1963) (``An obligation of fair
dealing, based upon the general antifraud provisions of the Federal
securities laws, rests upon the theory that even a dealer at arm's
length impliedly represents when he hangs out his shingle that he
will deal fairly with the public.''); FINRA Rule 2010 (Standards of
Commercial Honor and Principles of Trade); NASD Interpretive
Material 2310-2 (Fair Dealing with Customers) (``Implicit in all
member and registered representative relationships with customers
and others is the fundamental responsibility for fair dealing. Sales
efforts must therefore be undertaken only on a basis that can be
judged as being within the ethical standards of [FINRA's] Rules,
with particular emphasis on the requirement to deal fairly with the
public.'').
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<bullet> Account Opening and Other Approval Obligations. Broker-
dealers must obtain certain information about their customers at
account opening, under anti-money laundering (``AML'') and know your
customer requirements,\21\ and are required to maintain customer
account information, including whether a customer is of legal age.\22\
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\21\ Financial institutions, including broker-dealers, are
required to establish written customer identification programs
(CIP), which must include, at a minimum, procedures for: Obtaining
customer identifying information from each customer prior to account
opening; verifying the identity of each customer, to the extent
reasonable and practicable, within a reasonable time before or after
account opening; making and maintaining a record of information
obtained relating to identity verification; determining within a
reasonable time after account opening or earlier whether a customer
appears on any list of known or suspected terrorist organizations
designated by Treasury; and providing each customer with adequate
notice, prior to opening an account, that information is being
requested to verify the customer's identity. See 31 CFR 1023.220
(Customer Identification Program for Broker-Dealers). As part of
broker-dealers' AML compliance programs, they must include risk-
based procedures for conducting ongoing customer due diligence, to
comply with the Customer Due Diligence Requirements for Financial
Institutions (``CDD Rule'') of the Financial Crimes Enforcement
Network (FinCEN). See FINRA Rule 3310 (Anti-Money Laundering
Compliance Program); 81 FR 29398 (May 11, 2016) (CDD Rule Release);
82 FR 45182 (Sept. 28, 2017) (correction to CDD Rule amendments).
Additionally, pursuant to FINRA Rule 2090 (Know Your Customer), all
member broker-dealers must use reasonable diligence, at both the
opening of a customer account, and for the duration of the customer
relationship to know and retain the ``essential facts'' concerning
each customer. Such ``essential facts'' include those that are
necessary ``to (a) effectively service the customer's account, (b)
act in accordance with any special handling instructions for the
account, (c) understand the authority of each person acting on
behalf of the customer, and (d) comply with applicable laws,
regulations, and rules.'' See FINRA Regulatory Notice 11-02 (SEC
Approves Consolidated FINRA Rules Governing Know-Your-Customer and
Suitability Obligations); see also 17 CFR 240.17a-3(a)(17).
\22\ See FINRA Rule 4512 (Customer Account Information). As a
general matter, whether any particular individual is able to enter
into a contract (such as that associated with opening a brokerage
account) is a matter of state law, and not explicitly governed by
the federal securities laws. See also 17 CFR 240.17a-3(a)(17).
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Additional obligations apply for investors to transact in certain
types of securities (e.g., options) or obtain certain services (e.g.,
margin).\23\ For example, broker-dealers must pre-approve a customer's
account to trade options on securities.\24\ Prior to approving a
customer's account for options trading, the broker-dealer must seek to
obtain ``essential facts relative to the customer, [their] financial
situation and investment objectives.'' \25\ Broker-dealers must then
verify the background and financial information they obtain regarding
each customer, and obtain an executed written agreement from the
customer agreeing, among other things, to be bound by all applicable
FINRA rules applicable to the trading of option contracts.\26\
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\23\ Approval obligations also apply for investors to engage in
day-trading. See FINRA Rule 2130 (Approval Procedures for Day-
Trading Accounts).
\24\ See FINRA Rule 2360(b)(16) (Options). FINRA has also
extended the options account approval requirements of Rule
2360(b)(16), by reference, to customers seeking to place orders to
buy or sell warrants. See FINRA Rule 2352 (Account Approval).
Numerous exchanges that facilitate options trading apply similar
standards for customer pre-approval before accepting orders for
options contracts on the exchange.
\25\ See FINRA Rule 2360(b)(16)(B).
\26\ See FINRA Rule 2360(b)(16)(C) and (D). FINRA has also
indicated that in the case of options, broker-dealers should
consider whether they should provide limited account approval to a
customer, based on this information. For example, customers may be
approved to make purchases of puts and calls only, be restricted to
covered call writing, or be approved to engage in uncovered put and
call writing. See FINRA Regulatory Notice 21-15 (FINRA Reminds
Members About Options Account Approval, Supervision and Margin
Requirements).
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With respect to margin, broker-dealers are required to obtain the
signature of the account owner with respect to a margin account \27\
and to obtain a customer's written consent.\28\ These written consents
and signatures are
[[Page 49075]]
generally obtained by broker-dealers when a customer executes a margin
agreement.\29\
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\27\ See 17 CFR 240.17a-3(a)(9).
\28\ The written consent is a condition necessary for the
broker-dealer to be able to hypothecate (i.e., pledge) securities
under circumstances that would permit the commingling of customers'
securities. Broker-dealers are also required to give written notice
to a pledgee that, among other things, a security pledged is carried
for the account of a customer. See 17 CFR 240.8c-1 and 240.15c2-1.
\29\ See 17 CFR 240.8c-1, 240.15c2-1, and 240.17a-3(a)(9).
Margin agreements also typically state that a customer must abide by
the margin requirements established by the Federal Reserve Board,
SROs such as FINRA, any applicable securities exchange, and the firm
where the margin account is established. See also FINRA Rule
4210(f)(8)(B) (Margin Requirements) regarding special margin
requirements for day trading, including special requirements for
``pattern day traders'' (any customer who executes four or more day
trades within five business days, provided that the number of day
trades represents more than six percent of the customer's total
trades in the margin account for that same five business day
period).
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<bullet> Standard of Conduct. Regulation Best Interest (``Reg BI'')
requires broker-dealers that make recommendations of securities
transactions or investment strategies involving securities (including
account recommendations) to retail customers to act in their best
interest, and not place the broker-dealer's interests ahead of the
retail customer's interest.\30\ The use of a DEP by a broker-dealer
may, depending on the relevant facts and circumstances, constitute a
recommendation for purposes of Reg BI. Whether a ``recommendation'' has
been made is interpreted consistent with precedent under the federal
securities laws and how the term has been applied under FINRA
rules.\31\ Broker-dealers satisfy their obligations under Reg BI by
complying with four specified component obligations: A disclosure
obligation; \32\ a care obligation; \33\ a conflict of interest
obligation; \34\ and a compliance obligation.\35\ Additional
suitability obligations are imposed on broker-dealers when recommending
transactions in certain types of securities, such as options, to any
customer.\36\
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\30\ 17 CFR 240.15l-1; Regulation Best Interest: The Broker-
Dealer Standard of Conduct, Exchange Act Release No. 34-86031 [84 FR
33318 (July 12, 2019)] (``Reg BI Adopting Release''). Following the
adoption of Reg BI, which, among other things, incorporated and
enhanced the principles found in FINRA's suitability rule (Rule
2111), FINRA amended Rule 2111 to, among other things, state that
the rule does not apply to recommendations subject to Reg BI. See
Exchange Act Release No. 89091 (June 18, 2020) [85 FR 37970 (June
24, 2020)].
\31\ Reg BI Adopting Release, supra note 30, at 33337. The
determination of whether a recommendation has been made turns on the
facts and circumstances of a particular situation. Id. at 33335
(``Factors considered in determining whether a recommendation has
taken place include whether a communication `reasonably could be
viewed as a ``call to action'' ' and `reasonably would influence an
investor to trade a particular security or group of securities.' The
more individually tailored the communication to a specific customer
or a targeted group of customers about a security or group of
securities, the greater the likelihood that the communication may be
viewed as a `recommendation.' '') (citation omitted); see also NASD
Notice to Members 01-23 (Apr. 2001) (Online Suitability--Suitability
Rules and Online Communications) (providing examples of electronic
communications that are considered to be either within or outside
the definition of ``recommendation''). To the extent that a broker-
dealer makes a recommendation, as that term is interpreted by the
Commission under Reg BI, to a retail customer through or in
connection with a DEP, Reg BI would apply to the recommendation.
\32\ The disclosure obligation requires the broker-dealer to
provide certain required disclosure before or at the time of the
recommendation, about the recommendation and the relationship
between the broker-dealer and the retail customer. 17 CFR 240.15l-
1(a)(2)(i).
\33\ The care obligation requires the broker-dealer to exercise
reasonable diligence, care, and skill in making the recommendation.
17 CFR 240.15l-1(1)(a)(2)(ii).
\34\ The conflict of interest obligation requires the broker-
dealer to establish, maintain, and enforce written policies and
procedures reasonably designed to address conflicts of interest
associated with its recommendations to retail customers. Among other
specific requirements, broker-dealers must identify and disclose any
material limitations, such as a limited product menu or offering
only proprietary products, placed on the securities or investment
strategies involving securities that may be recommended to a retail
customer and any conflicts of interest associated with such
limitations, and prevent such limitations and associated conflicts
of interest from causing the broker-dealer or the associated person
to place the interest of the broker-dealer or the associated person
ahead of the retail customer's interest. 17 CFR 240.15l-
1(a)(2)(iii).
\35\ The compliance obligation requires the broker-dealer to
establish, maintain, and enforce written policies and procedures
reasonably designed to achieve compliance with Reg BI. 17 CFR
240.15l-1(a)(2)(iv).
\36\ See, e.g., FINRA Rule 2360(b)(19).
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<bullet> Disclosure Obligations. Broker-dealers are subject to a
number of customer disclosure obligations, including disclosures at the
inception of the customer relationship,\37\ disclosures that must be
made in conjunction with recommendations of securities transactions or
investment strategies involving securities,\38\ and certain product- or
activity-specific disclosures pertaining to among others, options,
margin, and day trading.\39\ Additionally, broker-dealers are liable
under the anti-fraud provisions for failing to disclose material
information to their customers when they have a duty to make such
disclosure.\40\ Broker-dealers are also required to make disclosures to
customers of their order execution and routing practices.\41\
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\37\ Disclosure obligations include Form CRS relationship
summary (describing the broker-dealer's services, fees, costs,
conflicts of interest and disciplinary history). See 17 CFR 240.17a-
14.
\38\ See 17 CFR 240.15l-1 (Reg BI).
\39\ See, e.g., FINRA Rule 2360(b)(16)(A) (requiring broker-
dealers to provide certain risk disclosures when approving customers
for options transactions); FINRA Rule 2264 (Margin Disclosure
Statement) (specifying disclosures in advance of opening a margin
account for a non-institutional customer); 17 CFR 240.10b-16
(requiring disclosures of all credit terms in connection with any
margin transactions at account opening); FINRA Rule 2270 (Day-
Trading Risk Disclosure Statement) (requiring that a disclosure
statement be provided to any non-institutional customer that opens
an account at a broker-dealer that promotes a day-trading strategy).
\40\ See Basic v. Levinson, supra note 18. Generally, under the
anti-fraud provisions, a broker-dealer's duty to disclose material
information to its customer is based upon the scope of the
relationship with the customer, which depends on the relevant facts
and circumstances. See, e.g., Conway v. Icahn & Co., Inc., 16 F.3d
504, 510 (2d Cir. 1994) (``A broker, as agent, has a duty to use
reasonable efforts to give its principal information relevant to the
affairs that have been entrusted to it.'').
\41\ See generally 17 CFR 242.605 and 242.606 (Regulation NMS
Rules 605 and 606). For example, under NMS Rule 606, broker-dealers
must provide public reports concerning the venues to which they
route customer orders for execution and discuss material aspects of
their arrangements with these execution venues, including PFOF that
broker-dealers receive from the venues. Pursuant to amendments
implemented in 2020, these reports require enhanced specificity
concerning PFOF and other types of practices that may present
broker-dealer conflicts of interest. See Exchange Act Release No.
78309 (Nov. 2, 2018) [83 FR 58338, 58373-6 (Nov. 19, 2018)].
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<bullet> Reporting and Other Financial Responsibility Requirements.
Broker-dealers are subject to comprehensive financial responsibility
rules, including reporting requirements under Exchange Act Rule 17a-5,
minimum net capital requirements under Exchange Act Rule 15c3-1, and
customer protection requirements under Exchange Act Rule 15c3-3.\42\
Broker-dealers are also subject to various rules relating to margin,
including, for example, disclosure and other requirements when
extending or arranging credit in certain transactions,\43\ disclosure
of credit terms in margin transactions,\44\ a description of the margin
requirements that determine the amount of collateral
[[Page 49076]]
customers are expected to maintain in their margin accounts,\45\ and a
requirement to issue a margin disclosure statement prior to opening a
margin account.\46\
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\42\ Rule 17a-5 has two main elements: (1) A requirement that
broker-dealers file periodic unaudited reports about their financial
and operational condition using the FOCUS Report form; and (2) a
requirement that broker-dealers annually file financial statements
and certain reports, as well as reports covering those statements
and reports prepared by an independent public accountant registered
with the Public Company Accounting Oversight Board (``PCAOB'') in
accordance with PCAOB standards. 17 CFR 240.17a-5. The objective of
Rule 15c3-1 is to require a broker-dealer to maintain sufficient
liquid assets to meet all liabilities, including obligations to
customers, counterparties, and other creditors and to have adequate
additional resources to wind-down its business in an orderly manner
without the need for a formal proceeding if the firm fails
financially. See 17 CFR 240.15c3-1. Rule 15c3-3 requires a carrying
broker-dealer to maintain physical possession or control over
customers' fully paid and excess margin securities. The rule also
requires a carrying broker-dealer to maintain a reserve of funds or
qualified securities in an account at a bank that is at least equal
in value to the net cash owed to customers. 17 CFR 240.15c3-3.
\43\ See 17 CFR 240.15c2-5 (Disclosure and other requirements
when extending or arranging credit in certain transactions).
\44\ See 17 CFR 240.10b-16 (Disclosure of credit terms in margin
transactions).
\45\ See FINRA Rule 4210 (Margin Requirements). See also 12 CFR
220.1 et seq. (Federal Reserve Board's Regulation T regulating,
among other things, extensions of credit by brokers and dealers);
\46\ See FINRA Rule 2264 (Margin Disclosure Statement). See also
FINRA Regulatory Notice 21-15 (FINRA Reminds Members About Options
Account Approval, Supervision and Margin Requirements).
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<bullet> Communications with the Public Rules. Broker-dealers are
subject to a number of rules governing communications with the public,
including advertising or marketing communications. These rules apply to
broker-dealers' written (including electronic) communications with the
public and are subject to obligations pertaining to content,
supervision, filing, and recordkeeping.\47\ All communications must be
based on principles of fair dealing and good faith, be fair and
balanced, and comply with a number of other content standards.\48\
Through its filings review program, FINRA's Advertising Regulation
Department reviews communications submitted either voluntarily or as
required by FINRA rules.\49\ In the case of communications relating to
options, broker-dealers are subject to certain heightened
obligations.\50\
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\47\ See, e.g., FINRA Rule 2210 (Communications with the
Public). FINRA has provided guidance regarding the applicability of
the communications rules in the context of social media and digital
communications. See FINRA Regulatory Notice 19-31 (Disclosure
Innovations in Advertising and Other Communications with the
Public); FINRA Regulatory Notice 17-18 (Social Media and Digital
Communications); FINRA Regulatory Notice 11-39 (Social Media
websites and the Use of Personal Devices for Business
Communications); FINRA Regulatory Notice 10-06 (Social Media
websites); see also 17 CFR 240.17a-4(b)(4). Paragraph (b)(4) of Rule
17a-4 requires a broker-dealer to preserve originals of all
communications received and copies of all communications sent (and
any approvals thereof) by the broker-dealer (including inter-office
memoranda and communications) relating to its business as such,
including all communications which are subject to the rules of an
SRO of which the broker-dealer is a member regarding communications
with the public. The term ``communications,'' as used in paragraph
(b)(4) of Rule 17a-4, includes all electronic communications (e.g.,
emails and instant messages). See Recordkeeping and Reporting
Requirements for Security-Based Swap Dealers, Major Security-Based
Swap Participants, and Broker-Dealers, Exchange Act Release No.
87005 (Sept. 19, 2019) [84 FR 68550, 68563-64 (Dec. 16, 2019)].
\48\ Among other requirements and prohibitions, firms may not
``make any false, exaggerated, unwarranted, promissory or misleading
statement or claim in any communication;'' firms ``must ensure that
statements are clear and not misleading within the context in which
they are made, and that they provide balanced treatment of risks and
potential benefits;'' and firms ``must consider the nature of the
audience to which the communication will be directed and must
provide details and explanations appropriate to the audience.'' See
FINRA Rule 2210 (Communications with the Public).
\49\ FINRA reviews communications for compliance with applicable
regulations. Broker-dealers must submit certain retail
communications to FINRA for its approval at least ten business days
prior to first use or publication. In addition to reviewing filed
communications, broker-dealer communications can also be subject to
spot-check reviews by FINRA. See FINRA Rule 2210(c).
\50\ See FINRA Rule 2220 (Options Communications). For example,
when making retail communications concerning the sale of options
products, broker-dealers must submit certain of those communications
to FINRA for its approval at least ten calendar days prior to use.
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<bullet> Supervision Obligations and Insider Trading Procedures.
Broker-dealers must ``establish and maintain a system to supervise the
activities of each associated person that is reasonably designed to
achieve compliance with applicable securities laws and regulations, and
with applicable FINRA rules.'' \51\ Among other things, broker-dealers
must establish, maintain, and enforce written procedures to supervise
the types of business in which they engage and the activities of their
associated persons that are reasonably designed to achieve compliance
with applicable securities laws and regulations, and with applicable
FINRA rules.\52\ Broker-dealers must also establish, maintain, and
enforce written policies and procedures reasonably designed to prevent
the misuse of material, nonpublic information by the broker-dealer or
its associated persons.\53\
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\51\ See FINRA Rule 3110 (Supervision). Under Exchange Act
Sections 15(b)(4)(E) and 15(b)(6), the Commission institutes
administrative proceedings against broker-dealers and supervisors
for failing reasonably to supervise, with a view to preventing
violations of the federal securities laws. 15 U.S.C. 78o(b)(4)(E)
and 78o(b)(6).
\52\ See FINRA Rule 3110(b)(1).
\53\ See Exchange Act section 15(g), 15 U.S.C. 78o(g).
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<bullet> Recordkeeping Obligations. Section 17(a) of the Exchange
Act provides the Commission with authority to issue rules requiring
broker-dealers to make and keep for prescribed periods such records as
the Commission, by rule, prescribes as necessary or appropriate in the
public interest, for the protection of investors, or otherwise in
furtherance of the purposes of the Exchange Act. Rules 17a-3 and 17a-4
prescribe the primary recordkeeping requirements for broker-
dealers.\54\
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\54\ Exchange Act Rule 17a-3 (delineating certain records that
broker-dealers must make and keep current, including customer
account records, copies of customer confirmations, records of
customer complaints, and records related to every recommendation of
any securities transaction or investment strategy involving
securities made to a retail customer); Exchange Act Rule 17a-4
(specifying the time period and manner in which records made
pursuant to Rule 17a-3 must be preserved, and identifying additional
records that must be maintained for prescribed time periods.). See
17 CFR 240.17a-3 and 240.17a-4.
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<bullet> Customer Complaints. Broker-dealers are required to have
procedures to document and capture, acknowledge, and respond to all
written (including electronic) customer complaints,\55\ and report to
FINRA certain specified events related to customer complaints, as well
as statistical and summary information on customer complaints.\56\
Broker-dealers must also make and keep a record indicating that each
customer has been provided with a notice with the address and telephone
number to which complaints may be directed.\57\
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\55\ See FINRA Rule 3110(b)(5).
\56\ See FINRA Rule 4530; see also FINRA Rule 4311(g)
(addressing certain requirements for carrying agreements relating to
customer complaints).
\57\ See 17 CFR 240.17a-3(a)(18) (requiring broker-dealers to
make and maintain a record for each written customer complaint
received regarding an associated person, including the disposition
of the complaint).
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<bullet> Privacy and Cybersecurity. Regulation S-P requires broker-
dealers to disclose certain information about their privacy policies
and practices, limits the instances in which broker-dealers may
disclose nonpublic personal information about consumers to
nonaffiliated third parties without first allowing the consumer to opt
out, and requires broker-dealers to adopt written policies and
procedures that address administrative, technical, and physical
safeguards for the protection of customer records and information.\58\
Regulation S-P also limits the re-disclosure and re-use of nonpublic
personal information, and it limits the sharing of account number
information with nonaffiliated third parties for use in telemarketing,
direct mail marketing, and email marketing.\59\ Broker-dealers are also
required, under Regulation S-ID, to develop and implement a written
identity theft prevention program designed to detect, prevent, and
mitigate identity theft in connection with certain existing accounts or
the opening of new accounts.\60\
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\58\ See 17 CFR 248. Regulation S-P implements the consumer
financial privacy provisions, as well as the customer records and
information security provisions, of Title V of the Gramm Leach
Bliley Act (``GLBA''). It also implements the consumer report
information disposal provisions (Section 628) of the Fair Credit
Reporting Act (``FCRA'') as amended by the Fair and Accurate Credit
Transactions Act of 2003 (``FACT Act'').
\59\ See 17 CFR 248.11 and 248.12.
\60\ See 17 CFR 248.201. Regulation S-ID implements the identity
theft red flags rules and guidelines provisions (Section 615(e)) of
the FCRA as amended by the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010 (``Dodd-Frank Act'').
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[[Page 49077]]
2. Existing Investment Adviser Obligations
The Investment Advisers Act of 1940 (``Advisers Act'') establishes
a federal fiduciary duty for investment advisers, whether or not
registered with the Commission, which is made enforceable by the anti-
fraud provisions of the Advisers Act. The fiduciary duty is broad and
applies to the entire adviser-client relationship, and must be viewed
in the context of the agreed-upon scope of that relationship.\61\ As a
fiduciary, an investment adviser owes its clients a duty of care and a
duty of loyalty.\62\ Under its duty of loyalty, an adviser must make
full and fair disclosure of all material facts relating to the advisory
relationship and must eliminate or make full and fair disclosure of all
conflicts of interest which might incline an investment adviser--
consciously or unconsciously--to render advice which is not
disinterested such that a client can provide informed consent to the
conflict. An adviser's duty of care includes, among other things: (i) A
duty to provide investment advice that is in the best interest of the
client, based on a reasonable understanding of the client's objectives;
\63\ (ii) a duty to seek best execution of a client's transactions
where the adviser has the responsibility to select broker-dealers to
execute client trades (typically in the case of discretionary
accounts); and (iii) a duty to provide advice and monitoring at a
frequency that is in the best interest of the client, taking into
account the scope of the agreed relationship.\64\ We discussed the
fiduciary duty and these aspects of it in greater detail in a
Commission interpretation.\65\
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\61\ For example, to the extent that an adviser provides
investment advice to a client through or in connection with a DEP,
then all such investment advice must be consistent with the
adviser's fiduciary duty.
\62\ This fiduciary duty ``requires an adviser to adopt the
principal's goals, objectives, or ends.'' See Commission
Interpretation Regarding Standard of Conduct for Investment
Advisers, Advisers Act Release No. 5248 (June 5, 2019) [84 FR 33669,
33671 (July 12, 2019)] (``IA Fiduciary Duty Interpretation'')
(internal quotations omitted). This means the adviser must, at all
times, serve the best interest of its client and not subordinate its
client's interest to its own. See id.
\63\ In order to provide such advice, an investment adviser must
have a reasonable understanding of the client's objectives. See id.
at 33672-3.
\64\ See id. at 33669-78.
\65\ See id.
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Rules adopted under the Advisers Act also impose various
obligations on registered investment advisers (or investment advisers
required to be registered with the Commission), including:
<bullet> Disclosure Requirements. Registered investment advisers
are subject to a number of client disclosure obligations, including
disclosures before or at the time of entering into an advisory
contract, annually thereafter, and when certain changes occur. These
disclosures include information about a number of topics, including an
adviser's business practices, fees, conflicts of interest, and
disciplinary information, and about advisory employees and their other
business activities.\66\
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\66\ See, e.g., 17 CFR 275.204-3 (requiring an adviser to
deliver a Form ADV Part 2A brochure to advisory clients); 17 CFR
275.204-5 (requiring an adviser to deliver Form CRS to each retail
investor).
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<bullet> Reporting Requirements. Investment advisers register with
the Commission by filing Form ADV and are required to file periodic
updates.\67\ Like all market participants, investment advisers are
subject to reporting obligations under the Exchange Act under specified
circumstances,\68\ as well as trading rules and restrictions under the
Exchange Act.\69\
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\67\ See, e.g., 17 CFR 275.204-1.
\68\ These include, for example, Schedule 13D or Schedule 13G
reporting of ``beneficial ownership'' of more than 5 percent of
shares of a voting class of a security registered under Section 12
of the Exchange Act and Form 13F quarterly reports filed by
institutional investment managers that manage more than $100 million
of specified securities. See 17 CFR 240.13d-1(a)-(c) and 240.13f-1.
\69\ These include prohibitions and restrictions on market
manipulation and insider trading. See, e.g., 17 CFR 240.10b5-1 and
240.10b5-2.
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<bullet> Marketing Requirements. Rule 206(4)-1, as amended in
December 2020, governs investment advisers' marketing practices.\70\
This rule contains seven general prohibitions on the types of activity
that could be false or misleading that apply to all advertisements. The
rule also prohibits advertisements that contain testimonials,
endorsements, third-party ratings, and performance information, unless
certain conditions are met.
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\70\ The compliance date for amended rule 206(4)-1 under the
Advisers Act is November 4, 2022. Until then, advisers that do not
comply with amended 206(4)-1 must comply with existing rule 206(4)-
1, which governs adviser's advertisements, and rule 206(4)-3, which
governs cash payments for client solicitations.
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<bullet> Compliance Programs. Under rule 206(4)-7, an investment
adviser must adopt and implement written policies and procedures
reasonably designed to prevent violation of the Advisers Act and the
rules thereunder by the firm and its supervised persons.\71\ Among
other things, an adviser's compliance policies and procedures should
address portfolio management processes, including allocation of
investment opportunities among clients and consistency of portfolios
with clients' investment objectives, disclosures by the adviser, and
applicable regulatory restrictions. This rule requires review of such
policies and procedures at least annually, and the designation of a
chief compliance officer responsible for administering such policies
and procedures.
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\71\ See 17 CFR 275.206(4)-7.
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<bullet> Supervision Obligations and Insider Trading Procedures.
Investment advisers have a duty to reasonably supervise certain persons
with respect to activities performed on the adviser's behalf.\72\ In
addition, section 204A of the Advisers Act requires investment advisers
(registered with the Commission or not) to establish, maintain, and
enforce written policies and procedures reasonably designed to prevent
the misuse of material, nonpublic information by the investment adviser
or any of its associated persons.
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\72\ See Advisers Act section 203(e)(6), 15 U.S.C. 80b-3(e)(6).
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<bullet> Recordkeeping Requirements. Under rule 204-2, investment
advisers must make and keep particular books and records, including
certain communications relating to advice given (or proposed to be
given), the placing or execution of any order to purchase or sell any
security, and copies of the advertisements they disseminate.\73\
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\73\ See 17 CFR 275.204-2.
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<bullet> Privacy and Cybersecurity. Advisers registered or required
to be registered with the Commission are also subject to Regulation S-P
and Regulation S-ID, which are discussed above in the context of
broker-dealers.
Questions: Current Regulatory Compliance Approaches
3.1 How are firms approaching compliance relating to their use of
DEPs and the related tools and methods, in order to ensure compliance
with their obligations under federal securities laws and regulations,
including those identified above? For example, how do firms supervise
communications or marketing to retail investors through or in
connection with DEPs? Do firms approach compliance relating to the use
of DEPs and related tools and methods differently from how they
approach compliance relating to other engagement with customers or
clients? If so, how do the approaches differ? For example, do such
approaches differ based on any unique risks associated with or innate
characteristics of DEPs and the related tools and methods?
3.2 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?
How do firms
[[Page 49078]]
supervise the design, development, and use of these features, tools,
and methods after implementation and adoption for continued compliance?
In what ways do firms' policies and procedures, controls, and
supervision differ with respect to their use of DEPs and related tools
and methods from other policies and procedures, controls, and
supervision that the firms employ?
3.3 Do firms implement registration or certification requirements
for personnel primarily responsible for the design, development, and
supervision of DEPs? If so, what are the requirements? What type of
training do firms offer to their personnel in connection with the
design, development, and use of DEPs and related tools and methods? Do
firms outsource the design or development of DEPs? Do firms outsource
the design and development of DEPs outside the United States?
3.4 What policies, procedures, and controls do firms have in place
with respect to the use of DEPs that are designed to promote or that
could otherwise direct retail investors to higher-risk products and
services, for example, margin services and options trading? What
policies, procedures, and controls do firms have in place with respect
to the use of DEPs that are designed to promote or that could otherwise
direct retail investors to securities or services that are more
lucrative for the firm such as: Proprietary products, products for
which the firm receives revenue sharing or other third-party payments,
or other higher fee products? To what extent do these policies and
procedures consider or address the characteristics of retail investors
to whom such products and services may be promoted or directed? For
example, do the policies and procedures place controls around how DEPs
may be utilized to promote or otherwise direct certain products or
services to certain types of retail investors?
3.5 What disclosures are firms providing in connection with or
specifically addressing DEPs and the related tools and methods
(including with respect to any data or information collected from the
retail investor)? How are such disclosures presented to retail
investors? Does such disclosure address how the use of DEPs or the
related tools and methods may affect investors and specifically their
trading and investing behavior? Does such disclosure differ from other
disclosures that firms provide? How do firms currently disclose
information such as risks, fees, costs, conflicts of interest, and
standard of conduct to retail investors on their digital platforms? To
what extent and how do firms use DEPs to make such disclosures?
3.6 Do broker-dealers consider the observable impacts of DEPs when
determining if they are making ``recommendations'' for purposes of Reg
BI? How does the fact that a DEP might impact the behavior of a
statistically significant number of retail investors affect this
determination? What statistical concepts, tools, and quantitative
thresholds do broker-dealers use in making this determination?
3.7 Are there particular types of DEPs that broker-dealers avoid
using because they would be recommendations? If so, which DEPs and why?
What are broker-dealers doing to ensure that the DEPs they adopt comply
with Reg BI and other sales practice rules, where applicable?
3.8 Do investment advisers consider the observable impacts of DEPs
when determining if they are providing investment advice? How does the
fact that a DEP might impact the behavior of a statistically
significant number of investors affect this determination? What
statistical concepts, tools, and quantitative thresholds do investment
advisers use in making this determination?
3.9 Are there particular types of DEPs that investment advisers
avoid using because they would constitute providing investment advice?
If so, which DEPs and why? How do investment advisers satisfy their
fiduciary duty when using DEPs and related tools and methods? How do
investment advisers take into account their fiduciary duty when
designing and developing DEPs?
3.10 When providing investment advice or recommendations to a
retail investor, do firms adjust that investment advice or
recommendation to take into account any data they have about how their
DEPs affect investor behavior and investing outcomes? If so, how is
such investment advice or recommendation adjusted?
3.11 How do firms using DEPs obtain sufficient retail investor
information and provide sufficient oversight to satisfy their
regulatory obligations, including, for example, applicable anti-fraud
provisions and account opening or approval requirements?
3.12 How does the recordkeeping process used by firms in connection
with DEPs and the related tools and methods compare to the
recordkeeping process used in connection with firms' traditional
business? Do firms generate and retain records with respect to the
development, implementation, modification, and use of DEPs, including
the testing of, or due diligence with respect to, the technology that
they use for those purposes? Do firms generate and retain records with
respect to retail investor interaction with such DEPs? If so, what
types of records?
Questions: Suggestions for Modifications to Existing Regulations or New
Regulatory Approaches To Address Investor Protection Concerns,
Including
3.13 What additions or modifications to existing regulations,
including, but not limited to, those identified above, or new
regulations or guidance might be warranted to address investor
protection concerns identified in connection with the use by broker-
dealers and investment advisers of DEPs, the related tools and methods,
and the use of retail investor data gathered in connection with DEPs?
What types of requirements, limitations, or prohibitions would be most
appropriate to address any such identified investor protection
concerns?
3.14 Are there regulations that currently prevent firms from using
DEPs and related tools and methods in ways that might be beneficial to
retail investors? If so, what additions or modifications to those
regulations would make it easier for firms to use DEPs and related
tools and methods to benefit investors? Are there regulatory approaches
that would facilitate firms' ability to innovate or test the use of new
technology consistent with investor protection?
3.15 To the extent commenters recommend any modifications to
existing regulations or new regulations, how should DEPs and the scope
of tools and methods be defined to capture practices and tools and
methods in use today and remain flexible to adapt as technology
changes? Should any such modifications or new regulations specifically
and uniquely address DEPs or the related tools and methods (i.e.,
distinct from regulation of interactions with retail investors such as
marketing, investment advice, and recommendations)? If so, how? Should
any such modifications or additional regulations be targeted
specifically to address certain types of DEPs or certain tools or
methods? If so, how? For example, should specific DEPs be explicitly
prohibited or only permitted subject to limitations or other regulatory
requirements (e.g., filing or pre-approval)?
3.16 Should any such modifications or additional regulations be
targeted specifically to address particular risks, such as those
related to certain types of securities (e.g., options, leveraged and
[[Page 49079]]
inverse funds, or other complex securities), services (e.g., margin),
or conflicts (e.g., payment and revenue sources)? If so, how? Should
any such modifications or additional regulations be targeted
specifically to increase protection for certain categories of investors
(e.g., seniors or inexperienced investors)? If so, how?
3.17 Are there laws, regulations, or other conduct standards that
have been adopted in other contexts, fields, or jurisdictions that
could serve as a useful model for any potential regulatory approaches?
3.18 To the extent commenters recommend any modifications to
existing regulations or new regulations, what economic costs and
benefits do commenters believe would result from their recommendations?
Please provide or identify any relevant data and other information.
III. Use of Technology by Investment Advisers To Develop and Provide
Investment Advice
The Commission is also issuing the Request to assist the Commission
and its staff in better understanding the nature of analytical tools
and other technology used by investment advisers to develop and provide
investment advice to clients, including (1) oversight of this
technology; (2) how investment advisers and clients have benefited from
technology; (3) potential risks to investment advisers, clients, and
the markets more generally related to this technology; and (4) whether
regulatory action may be needed to protect investors while preserving
the ability of investors to benefit from investment advisers' use of
technology.\74\
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\74\ While we recognize that broker-dealers similarly use
analytical tools and other technology for purposes of developing and
providing recommendations, those issues are not the focus of Section
III of the Request. However, the Commission welcomes comments on
these issues relating to broker-dealers as part of the General
Request for Comment as set forth in Section IV below.
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A. Issues for Consideration
Financial technology enables investment advisers to develop and
provide investment advice in new ways or complements existing methods
or tools for developing and providing advice,\75\ including by allowing
digital platforms to connect clients, their investment advisers, and
third-party service providers.\76\ We describe below some recent
changes in delivery and development of investment advice and the role
of analytical tools and other technology in each. These changes are
those that we understand may directly affect clients' receipt of
investment advice, and some may overlap depending on an adviser's
particular business model and services.
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\75\ The International Organization of Securities Commissions
(``IOSCO'') has stated that the terms financial technologies or
``Fintech'' are ``used to describe a variety of innovative business
models and emerging technologies that have the potential to
transform the financial services industry.'' IOSCO Research Report
on Financial Technologies (Fintech) at 4 (Feb. 2017), <a href="https://www.iosco.org/library/pubdocs/pdf/IOSCOPD554.pdf">https://www.iosco.org/library/pubdocs/pdf/IOSCOPD554.pdf</a>.
\76\ Many investment advisers also increasingly use third-party
service providers to generate investment models (e.g., model
portfolios) or strategies, and may use software based on, or
otherwise incorporating, AI/ML models.
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While the increased role of technology has presented investment
advisers and clients with benefits, it may also present risks. We
recognize that some of these risks may be presented, or be presented
differently, for advisers providing traditional investment advice that
does not rely on technology. We understand as well that investment
advisers may weigh differently those potential benefits and risks,
including those described below, in determining how to use technology
in developing and providing investment advice. We therefore are seeking
comment to understand better the tools used by investment advisers to
develop and provide investment advice and investment advisers'
understanding and oversight of these tools and the related benefits and
risks. In addition, we seek comment on other ways in which technology
has changed investment advisers' development and provision of
investment advice to their clients.
1. Robo-Advisers
Some investment advisers, which we refer to here as robo-advisers,
provide asset management services to their clients through online
algorithm-based platforms.\77\ The number of robo-advisers (also
referred to as digital investment advisers, digital advisers, or
automated advisers) has increased over the past several years.\78\
Robo-advisers operate under a variety of business models and have
varying degrees of human interaction with clients as compared to
traditional advisers, and some rely exclusively on algorithms to
oversee and manage individual client accounts.\79\ In some cases, human
personnel may have limited ability to override an algorithm, even in
stressed market conditions, and there is limited, if any, direct
interaction between the client and the adviser's personnel. In other
cases, robo-advisers offer hybrid advisory services, which pair
algorithm-generated investment options with human personnel who can
answer questions, discuss and refine an algorithm-generated investment
plan (e.g., clarify information where client questionnaire responses
seem conflicting or address risk tolerance levels based on client
reaction to stressed market conditions), or provide additional
resources to clients. Some robo-advisers offer clients a choice between
hybrid and non-hybrid services, at different price points.
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\77\ An algorithm can be defined as a routine process or
sequence of instructions for analyzing data, solving problems, and
performing tasks. See Dilip Krishna et al., Managing Algorithmic
Risks: Safeguarding the Use of Complex Algorithms and Machine
Learning at 3, Deloitte Development LLC (2017) (``Deloitte
Report'').
\78\ See, e.g., Investment Adviser Association, 2020 Evolution
Revolution at 8 (2020), <a href="https://higherlogicdownload.s3.amazonaws.com/INVESTMENTADVISER/aa03843e-7981-46b2-aa49-c572f2ddb7e8/UploadedImages/resources/Evolution_Revolution_2020_v8.pdf">https://higherlogicdownload.s3.amazonaws.com/INVESTMENTADVISER/aa03843e-7981-46b2-aa49-c572f2ddb7e8/UploadedImages/resources/Evolution_Revolution_2020_v8.pdf</a> (noting that by 2020, ``two of the
top five advisers as measured by number of non-high net worth
individual clients served [were] digital advice platforms,
representing 7.5 million clients, an increase of 2.7 million clients
from [the prior year].''); Robo-Advisers, IM Guidance Update No.
2017-02 (Feb. 2017), <a href="https://www.sec.gov/investment/im-guidance-2017-02.pdf">https://www.sec.gov/investment/im-guidance-2017-02.pdf</a>.
\79\ A robo-adviser or a third party may develop, manage, or own
the algorithm used to manage client accounts. In some business
models, a robo-adviser may provide its algorithm or its digital
platform to another investment adviser. That investment adviser may
then (i) use the robo-adviser's existing investment options (e.g.,
asset allocation models), (ii) use the algorithm or digital platform
as a tool to create its own investment options, or (iii) use a
combination of these features.
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In addition to using analytical tools to engage with clients, robo-
advisers may use technology (including AI/ML tools) for a variety of
other functions. For example, an adviser may use these tools to match
clients to individual portfolios based on client inputs or determine
how or when to trade for individual client accounts. An adviser also
may use these tools to determine asset allocations, determine how to
fill allocations, generate trading signals, or make other strategic
decisions.\80\
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\80\ In addition, FINRA has observed client-facing digital
advisers that incorporate trade execution, portfolio rebalancing,
and tax-loss harvesting. See FINRA, Report on Digital Investment
Advice at 2 (Mar. 2016), <a href="https://www.finra.org/sites/default/files/digital-investment-advice-report.pdf">https://www.finra.org/sites/default/files/digital-investment-advice-report.pdf</a> (describing digital investment
tools as tools within two groups: Financial professional-facing
tools and client-facing tools).
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All Commission-registered robo-advisers are subject to all of the
requirements of the Advisers Act, including the requirement that they
provide advice consistent with the fiduciary duty they owe to
clients.\81\ Because robo-advisers rely on algorithms, provide advisory
services over the internet, and may offer limited, if any, direct human
interaction to their clients, they may raise novel issues when seeking
to comply with the
[[Page 49080]]
Advisers Act. For example, advisers may need to consider whether and
how automation affects the development of digital advice and the
potential risks that such automation may present. An automated
algorithm may produce investment advice for a particular client that is
inconsistent with the client's investment strategy or relies on
incomplete information about the client that depends on limited input
data. Increased reliance on automated investment advice may result in
too much importance being placed on clients' responses to account
opening questionnaires and other forms of automated client evaluation,
which may not permit nuanced answers or determine when additional
clarification or information could be necessary. This reliance may also
result in a failure to detect changes in clients' circumstances that
may warrant a change in investment strategy.
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\81\ See IA Fiduciary Duty Interpretation, supra note 62, at
n.27.
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Robo-advisers also must determine how to effectively understand and
oversee use of their algorithms (including those developed by third
parties) and the construction of client portfolios, including any
potential conflicts of interest. For example, robo-advisers' algorithms
may result in clients being invested in assets in which the adviser or
its affiliate holds interests or advises separately (e.g., mutual funds
and exchange-traded funds). In these circumstances, the adviser would
have a conflict of interest that it must eliminate or fully and fairly
disclose such that the client can provide informed consent. In
addition, any override or material changes to the algorithm must result
in investment advice that is consistent with the adviser's disclosures
and fiduciary duty.
2. Internet Investment Advisers
Some investment advisers may solely use an interactive website to
provide investment advice. These investment advisers, otherwise known
as ``internet investment advisers,'' are eligible for SEC registration
even if they do not meet the assets-under-management threshold if they
satisfy certain criteria, including that they provide advice to all of
their clients exclusively through their interactive website (``internet
clients''), subject to a de minimis exception for other clients.\82\
The Commission has stated that the internet investment adviser
exemption was designed to balance the burdens of multiple state
registration requirements for internet investment advisers with the
Advisers Act's allocation of responsibility for regulating smaller
advisers to state securities authorities.\83\
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\82\ See 17 CFR 275.203A-2(e) (permitting Commission
registration by an investment adviser that (i) provides investment
advice to all of its clients exclusively through an interactive
website, except that the investment adviser may provide investment
advice to fewer than 15 clients through other means during the
preceding twelve months; (ii) maintains specified records; and (iii)
does not control, is not controlled by, and is not under common
control with, another adviser that registers with the Commission
solely because of its relationship with the internet investment
adviser). Internet investment advisers represented only 1.5 percent
of registered advisers in 2021, but have more than tripled in number
since 2010--from 57 in 2010 (approximately 0.5 percent of total
registered investment advisers) to 203 in 2021 (approximately 1.5
percent of total registered investment advisers). Data from Form
ADV, Part 1A, Item 2.A.(11) (based on Form ADV filings through July
2021).
\83\ See Exemption For Certain Investment Advisers Operating
through the internet, Advisers Act Release No. 2091 (Dec. 12, 2002)
[67 FR 77620, 77621 (Dec. 18, 2002)] (``internet Investment Adviser
Adopting Release'') (``Because an internet Investment Adviser uses
an interactive website to provide investment advice, the adviser's
clients can come from any state, at any time. As a result, internet
Investment Advisers must as a practical matter register in every
state. This ensures that the adviser's registrations will be in
place when it later obtains the requisite number of clients from any
particular state'' that requires state registration.).
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For purposes of the exemption, ``interactive website'' means a
website in which computer software-based models or applications provide
investment advice to clients based on personal information each client
supplies through the website. These websites generally require clients
to answer questions about personal finances and investment goals, which
the adviser's application or algorithm analyzes to develop investment
advice that the website transmits to the client. The Commission has
stated that the exemption is not available to investment advisers that
merely use websites as marketing tools or use internet tools such as
email, chat rooms, bulletin boards, and webcasts or other electronic
media in communicating with clients.\84\ In addition, the Commission
distinguished the interactive website described in the exemption from
``other types of websites that aggregate and provide financial
information in response to user-provided requests that do not include
personal information.''
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\84\ Id. at n.15 and accompanying text. Effective September 19,
2011, Rule 203A-2(f) was renumbered as Rule 203A-2(e). See Rules
Implementing Amendments to the Investment Advisers Act of 1940,
Advisers Act Release No. 3221 (June 22, 2011) [76 FR 42950, 42963
(July 19, 2011)].
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This exemption is limited in scope. In the Internet Investment
Adviser Adopting Release, the Commission stated that internet
investment advisers typically are not eligible to register with the
Commission because they ``do not manage the assets of their internet
clients'' and thus do not meet the statutory threshold for registration
with the Commission. Further, the Commission stated that, in order to
be eligible for registration under this exemption, an investment
adviser ``may not use its advisory personnel to elaborate or expand
upon the investment advice provided by its interactive website, or
otherwise provide investment advice to its internet clients.'' The
exemption generally requires that the investment adviser ``provides
investment advice to all of its clients'' through its website, which
means that the adviser must operate an interactive website through
which advice is given. That is, the exemption is unavailable to
investment advisers lacking such a website.
Despite the limited nature of the exemption, we understand that
some investment advisers may seek to rely on it and to register with
the Commission without meeting the exemption's terms or intended
purpose.\85\ Examinations of investment advisers relying on the
exemption have revealed various reasons for non-compliance with the
exemption's requirements, including: (i) Failure to understand the
eligibility requirements; (ii) websites that were not interactive;
(iii) businesses that became dormant but did not withdraw their
registration; and (iv) client access to advisory personnel who could
expand upon the investment advice provided by the adviser's interactive
website, or otherwise provide investment advice to clients, such as
financial planning.
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\85\ The Commission has cancelled the registrations of advisers
where the Commission found that those advisers did not meet the
terms of the exemption. See, e.g., Order Cancelling Registration
Pursuant to Section 203(h) of the Investment Advisers Act of 1940,
Advisers Act Release No. 5110 (Feb. 12, 2019).
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Some robo-advisers may provide a broader array of advisory services
than those provided by internet investment advisers but not be eligible
for Commission registration unless they can rely on another exemption
or until they have met the statutory assets-under-management
threshold.\86\ Prohibiting these investment advisers from registering
with the Commission in these circumstances could impose burdens that
the internet investment adviser exemption was intended to alleviate.
Finally, because the internet investment adviser exemption was
established almost twenty years ago, we seek to understand better how
[[Page 49081]]
investment advisers are relying on it and whether we should consider
amending the exemption or creating another exemption that reflects
investment advisers' current use of technology in providing investment
advice.
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\86\ Some of these advisers also may be eligible for the
``multi-state adviser exemption'' under 17 CFR 275.203A-2(d). The
multi-state adviser exemption permits an adviser who is required to
register as an investment adviser with fifteen or more states to
register with the Commission.
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3. AI/ML in Developing and Providing Investment Advice \87\
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\87\ Investment advisers' use of AI/ML and other technological
tools must comply with existing rules and regulations. The
Commission is not expressing a view as to the legality or conformity
of such practices with the federal securities laws and the rules and
regulations thereunder, nor with the rules of self-regulatory
organizations.
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Investment advisers may use, or be considering the use of, software
or models based on, or otherwise incorporating, AI/ML (including deep
learning, supervised learning, unsupervised learning, and reinforcement
learning) in developing and providing investment advice, including by
supporting human personnel's decision-making.\88\ Investment advisers
may use such models or software to devise trading and investment
strategies or develop investment advice, including to assess large
amounts of data or to provide clients with more customized service.\89\
In addition, investment advisers may use these tools to monitor client
accounts or track the performance of specific securities or other
investments.\90\
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\88\ Advisers may also use AI as part of their internal
operations, including by reviewing and classifying information
(e.g., in regulatory filings and fund prospectuses), by assisting
with trade matching or custodian reconciliation, for risk
measurement (in part through earlier and more accurate estimation of
risks) and stress testing purposes, and by facilitating regulatory
compliance.
\89\ See, e.g., Treasury RFI, supra note 11, at 16839
(describing potential benefits of financial institutions' use of
AI); see also FINRA AI Report, supra note 11 (highlighting three
broad areas where broker-dealers are evaluating or using AI:
Communications with customers, investment processes, and operational
functions); FSB AI Report, supra note 11, at 27.
\90\ Advisers may obtain these AI/ML tools in connection with
contracting for cloud services. They may use other types of Fintech,
as well, such as financial aggregator platforms that allow advisers
to access information about clients' financial accounts, which can
inform investment advice. Clients may allow such platforms to access
information about their investment accounts and performance to
enable a more fulsome analysis of their financial resources and
investment experience.
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Because ML models learn and develop over time, advisory personnel
may face challenges in monitoring and tracking them, including
reviewing both a model's input to assess whether it is appropriate and
its output to assess accuracy or relevance.\91\ For example, advisory
personnel may lack sufficient knowledge or experience, or rely heavily
on limited personnel, to challenge models' results. In addition, there
may be systemic risks associated with the use of these technologies,
including potential interconnectedness across the financial system and
an emerging dependency on certain concentrated infrastructure and
widely used models, which could propagate risks across the financial
system. Further, different market participants may use technologies of
varying or inadequate quality that could prompt investment advisers to
provide unsuitable advice to their clients.
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\91\ See, e.g., IOSCO, The Use of Artificial Intelligence and
Machine Learning by Market Intermediaries and Asset Managers at 11
(June 2020) (consultation report), <a href="https://www.iosco.org/library/pubdocs/pdf/IOSCOPD658.pdf">https://www.iosco.org/library/pubdocs/pdf/IOSCOPD658.pdf</a> (``Unlike traditional algorithms, ML
algorithms continually learn and develop over time. It is important
that they are monitored to ensure that they continue to perform as
originally intended.'').
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4. Potential Benefits
The use of technology in developing and providing investment advice
has provided certain benefits to investment advisers and, in turn,
their clients. For example, digital advisers and internet investment
advisers may offer lower cost advisory services. They also may provide
attractive, user-friendly design features that clients appreciate, and
may offer advisory services and online access at all hours of the
day.\92\ Digital investment advice may be more accessible than human
advisory personnel to a wider range of clients, including clients who
have greater confidence in digital investment advice; may facilitate
access to a wider range of investment advisers, including through
increased competition and a potential for lower fees; and may permit
clients to easily access information about their account and
investments.\93\ In addition, digital advisers may be less prone to
``behavioral biases, mistakes, and illegal practices'' than human
personnel.\94\ By using AI-based software and methods, advisers may
provide clients more customized advice or advice that benefits from
analysis of more information (or types of information) on a more cost-
effective basis than could be provided using traditional tools. In
addition, investment advisers may use AI/ML to enhance and expand their
services, generate investment strategies, and expand access to
investment advice.\95\ Clients may benefit from investment advisers'
ability to use this this technology to improve trade execution, as
well. In addition, AI-based tools may substantially enhance
efficiencies in information processing, reducing information
asymmetries, and contributing to the efficiency and stability of
markets.
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\92\ See, e.g., Coryanne Hicks, What Is a Robo Advisor and When
to Use One, U.S. News & World Report (Feb. 18, 2021), <a href="https://money.usnews.com/financial-advisors/articles/what-is-a-robo-advisor-and-when-to-use-one">https://money.usnews.com/financial-advisors/articles/what-is-a-robo-advisor-and-when-to-use-one</a>.
\93\ See, e.g., European Securities and Markets Authority
(``ESMA'') et al., Joint Committee Discussion Paper on Automation in
Financial Advice at 16-17 (Dec. 4, 2015) (``ESMA Discussion
Paper''), <a href="https://esas-joint-committee.europa.eu/Publications/Discussion%20Paper/20151204_JC_2015_080_discussion_paper_on_Automation_in_Financial_Advice.pdf">https://esas-joint-committee.europa.eu/Publications/Discussion%20Paper/20151204_JC_2015_080_discussion_paper_on_Automation_in_Financial_Advice.pdf</a>; see also ESMA et al., Report on Automation in Financial
Advice at 8-9 (2016) (``ESMA Report''), <a href="https://esas-joint-committee.europa.eu/Publications/Reports/EBA%20BS%202016%20422%20">https://esas-joint-committee.europa.eu/Publications/Reports/EBA%20BS%202016%20422%20</a>(JC%20SC%20CPFI%20Final%20Report%20on%20autom
ated%20advice%20tools).pdf (discussing views on the benefits and
risks of automated advice from respondents to the ESMA Discussion
Paper).
\94\ S[ouml]hnke M. Bartram, J[uuml]rgen Branke, and Mehrshad
Motahari, Artificial Intelligence in Asset Management, CFA Institute
Research Foundation Literature Review 25 (2020) (``CFA Literature
Review''), <a href="https://www.cfainstitute.org/-/media/documents/book/rf-lit-review/2020/rflr-artificial-intelligence-in-asset-management.ashx">https://www.cfainstitute.org/-/media/documents/book/rf-lit-review/2020/rflr-artificial-intelligence-in-asset-management.ashx</a>; see also ESMA Discussion Paper, supra note 93, at
17 (``A well-developed algorithm may be more consistently accurate
than the human brain at complex repeatable regular processes, and in
making predictions. Automated advice tools therefore could reduce
some elements of behavioural biases, human error, or poor judgement
that may exist when advice is provided by a human. A well-developed
algorithm could ensure equal and similar advice to all consumers
with similar characteristics.''). But see ESMA Report, supra note
93, at 9 (stating that several respondents ``stated that whether or
not automated advice is more consistent and accurate depends on both
the underlying logic of the algorithm and the quality and
completeness of the information inputted''); text accompanying infra
note 97.
\95\ See, e.g., World Economic Forum, The New Physics of
Financial Services: Understanding How Artificial Intelligence is
Transforming the Financial Ecosystem 114-123 (Aug. 2018), <a href="http://www3.weforum.org/docs/WEF_New_Physics_of_Financial_Services.pdf">http://www3.weforum.org/docs/WEF_New_Physics_of_Financial_Services.pdf</a>.
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5. Potential Risks
At the same time, these developments may pose new or different
risks to clients, including risks presented by investment advisers'
reliance on technology and any third parties that provide or service
such technology. For example, digital advisers may limit clients'
access to human personnel, including when clients are considering major
life changes such as retirement or when clients have questions that are
highly fact-specific. Clients of internet investment advisers may have
issues accessing the interactive websites, which can present unique
challenges when the website is the sole means for advice delivery. The
quality of the investment advice may depend on an algorithm that human
personnel may monitor infrequently, incorrectly or face challenges
overseeing.\96\ The use of
[[Page 49082]]
algorithms may be subject to their own risks, including risks related
to the input data (such as a mismatch between data used for training
the algorithm and the actual input data used during operations),
algorithm design (such as flawed assumptions or judgments), and output
decisions (such as disregard of underlying assumptions).\97\ Digital
advisers may encourage clients to trade more to the extent that the
adviser integrates trade execution services, which may benefit the
adviser at the expense of the client.\98\ Depending on the quality,
recency, and thoroughness of a client's information incorporated into
an algorithm, as well as how broadly client risk tolerances or
investment goals are generalized by the algorithm, the use of
algorithms may cause some clients to receive investment advice that is
less individualized than they reasonably expect. Similarly, clients may
face risks when AI/ML models use poor quality, inaccurate, or biased
data that produces outputs that are or lead to poor or biased advice.
In this respect, biased data may be incorporated unintentionally
through use of data sets that include irrelevant or outdated
information, including information that exists due to historical
practices or outcomes, or through the selection by human personnel of
the data or types of data to be incorporated into a particular
algorithm.\99\
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\96\ See, e.g., In the Matter of AXA Rosenberg Group LLC et al.,
Advisers Act Release No. 3149 (Feb. 3, 2011) (settled action); see
also In the Matter of Barr M. Rosenberg, Advisers Act Release No.
3285 (Sept. 22, 2011) (settled action) (finding, in part, that an
adviser breached his fiduciary duty by directing others to keep
quiet about, and delay fixing, a material error in computer code
underlying his company's automated model).
\97\ See Deloitte Report, supra note 77, at 4.
\98\ See CFA Literature Review, supra note 94, at 25 (``At the
same time, because robo-advisors have trade execution services
integrated into them, they often encourage investors to trade more.
This increased trading can be both a benefit, in terms of
encouraging investors to rebalance positions more often, and a
pitfall, because it can lead to excessive trading that benefits
robo-advising systems through commissions at the expense of
investors.'').
\99\ See FINRA AI Report, supra note 11, at 14; see also
Treasury RFI, supra note 11, at 16840 (``Because the AI algorithm is
dependent upon the training data, an AI system generally reflects
any limitations of that dataset. As a result, as with other systems,
AI may perpetuate or even amplify bias or inaccuracies in the
training data, or make incorrect predictions if that data set is
incomplete or non-representative.''); Jessica Fjeld et al.,
Principled Artificial Intelligence: Mapping Consensus in Ethical and
Rights-based Approaches to Principles for AI 47-49 (Berkman Klein
Center for internet & Society at Harvard University, Research
Publication, 2020).
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To the extent that a third party, rather than the investment
adviser, develops the analytical tools, the adviser may face challenges
in understanding or overseeing those third parties or the technology.
For example, there may be challenges in cases where software or a model
is based on an approach or technology that is proprietary to the third
party or is hosted by a third party, or where the investment adviser's
personnel do not have the knowledge or experience necessary to
understand the technology or to challenge its results. These
circumstances may exacerbate exposure of investment advisers and their
clients to cybersecurity and data privacy risks. Further, these risks
may affect more clients than those posed by investment advisers using
traditional methods because of the scale at which investment advisers
are able to reach clients through digital platforms.
Clients' ability to understand these and other risks rests on the
quality and sufficiency of their investment advisers' disclosures,
which may be particularly important to the extent that these
developments reflect the use of underlying technology that is complex
or otherwise requires technical expertise. Disclosure can put clients
in a position to understand the different roles played by technology
and advisory personnel in developing the investment advice that clients
receive. Investment advisers may face challenges in disclosing
sufficiently these types of risks where any such disclosure might be
necessarily technical.
There may also be systemic risks associated with widespread use of
AI/ML, including deep learning, supervised learning, unsupervised
learning, and reinforcement learning, which may affect the maintenance
of fair, orderly, and efficient markets. For example, the Financial
Stability Board has stated that ``applications of AI and machine
learning could result in new and unexpected forms of interconnectedness
between financial markets, for instance based on the use by various
institutions of previously unrelated data sources.'' \100\ In addition,
there could be systemic risk to the extent that digital advisers employ
models (including models from third-party model providers) that rely on
past performance and volatility, which could constitute input data that
is inappropriate for the current market. These and other risks may
continue to grow as the use of AI continues to increase among
investment advisers.
---------------------------------------------------------------------------
\100\ FSB AI Report, supra note 11, at 1.
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We request comment on all aspects of investment advisers' use of
technology, particularly with respect to developing and providing
investment advice, and the potential effect on investor protection and
regulatory compliance. We specifically request comment on the
following:
4.1 How do investment advisers currently use technology in
developing and providing investment advice? What types of technology do
advisers use for these purposes? How do investment advisers use
technology in any quantitative investment processes that they employ?
4.2 Are our descriptions of the potential benefits and risks of
investment advisers' use of technology in developing and providing
investment advice accurate and comprehensive? If not, what additional
benefits or risks to advisory clients are there from such use? What
additional benefits or risks does using these types of technology
provide to investment advisers? How do investment advisers weigh these
benefits and risks in using technology to develop and provide
investment advice? Does technology enable investment advisers to
develop investment advice in a more cost-effective way and are clients
able to receive less expensive advice as a result? Does technology
increase access to investment advice for some clients who would
otherwise not afford it or mitigate (or have the potential to mitigate)
biases in the market that may have prevented access to some clients or
prospective clients? Are there risks associated with the quality of
services clients ultimately receive? If so, what are they and how do
investment advisers address such risks? What factors do advisory
clients consider in choosing to engage a robo-adviser rather than a
traditional investment adviser? In what ways does investment advice
developed or provided by a robo-adviser differ from investment advice
developed or provided by a traditional investment adviser?
4.3 To the extent investment advisers use technology in developing
and providing investment advice, do advisers assess whether the
technology or its underlying models are explainable to advisory
personnel or to clients? Is the technology or underlying model
explainable? To what extent do investment advisers assess whether the
results are reproducible? If so, are the results reproducible? To what
extent do investment advisers rely on third parties to make these
assessments?
4.4 How do investment advisers develop, test, deploy, monitor, and
oversee the technology they use to develop and provide investment
advice? Do investment advisers develop, test, and monitor AI/ML models
differently from how they develop, test, and monitor traditional
algorithms? How do investment advisers assess the effect on client
accounts of any material change to advisers' technology, algorithm, or
[[Page 49083]]
model prior to implementation? Do investment advisers communicate with
clients about such material changes? If so, how?
4.5 What, if anything, do investment advisers do to understand how
AI/ML models will operate during periods of unusual or volatile market
activity or other periods where such models may have less, or less
relevant, input data with which to operate? How does the use of these
models by investment advisers affect the market more generally? What
formal governance mechanisms do investment advisers have in place for
oversight of the vendors that create or manage these models?
4.6 How do investment advisers disclose the use of algorithms or
models to their clients, including the role of advisory personnel or
third parties in creating and managing these algorithms or models? Do
these disclosures address any effects that such use may have on client
outcomes? When investment advice is developed and provided through an
automated algorithm, how do advisers disclose the use of that automated
algorithm? Do investment advisers assess how effective these
disclosures are in informing clients about such use? If so, how
effective are such disclosures? Please provide any available data to
show how effective such disclosures are. What are clients' expectations
for investment advice produced by an investment adviser's automated
algorithm, and how are those expectations shaped by investment
advisers' disclosures?
4.7 How do investment advisers account for the use of any poor
quality, inaccurate, or biased data that are used by AI/ML models, and
how do investment advisers determine the effect of this kind of data on
the algorithms' output or seek to reduce the use of this kind of data?
To what extent can the use of AI/ML models in developing investment
advice perpetuate social biases and disparities? How have commenters
seen this in practice with regard to the use of AI/ML models (e.g.,
through marketing, asset allocation, fees, etc.)? To what extent and
how do investment advisers employ controls to identify and mitigate any
such biases or disparities? For example, do investment advisers
evaluate the output of their models to identify and mitigate biases
that would raise investor protection concerns? Do investment advisers
utilize human oversight to identify biases that would raise investor
protection concerns, in both the initial coding of their models or in
the resulting output of those models?
4.8 Are there any particular challenges or impediments that
investment advisers face in using AI/ML to develop and provide
investment advice? If so, what are they and how do investment advisers
address such challenges or impediments and any risks associated with
them?
4.9 When relying on AI/ML models to develop investment advice, how
do advisers determine whether those models are behaving as expected?
How do advisers verify the quality of the assumptions and methodologies
incorporated into such models? How frequently do advisers test these
models? For example, do advisers test a model each time it is updated?
What model risk management steps should advisers undertake? What is
advisers' understanding of their responsibility to monitor, test, and
verify model outputs? How do advisers' approaches with respect to AI/ML
models differ from other models that advisers may use in developing
investment advice?
4.10 In the context of developing and providing investment advice,
what is the objective function of AI/ML models (e.g., revenue
generation)? What are the inputs relied on by AI/ML models used in
developing and providing investment advice (e.g., visual cues or
feedback)? Does the ability to collect individual-specific data impact
the effectiveness of the AI/ML model in maximizing its objective
functions?
4.11 What cybersecurity and data security risks result from
investment advisers' use of technology in developing and providing
investment advice? How do investment advisers address or otherwise
manage those risks and how do investment advisers disclose these risks
to clients? Do investment advisers believe that delivering investment
advice through email, which may be encrypted, is more secure than
delivery through online client portals? Conversely, do investment
advisers believe that delivery through online client portals is more
secure? How do investment advisers address these concerns when clients
are using mobile apps?
4.12 How do investment advisers generate records to support the
investment advice they develop from using these types of technology?
What types of records do they produce and how do investment advisers
retain them? Does an investment adviser's recordkeeping process differ
based on the type of technology it uses? If so, how?
4.13 Do investment advisers generate and retain records with
respect to the testing of, or due diligence with respect to, the
technology that they use in developing and providing investment advice?
4.14 To what extent do investment advisers market the types of
technology the adviser uses in developing and providing investment
advice? To the extent investment advisers market their use of
technology, do advisers demonstrate that use to clients? To what extent
do prospective and existing clients seek to assess investment advisers'
understanding of the technology, or seek to understand the technology
for themselves, in determining whether to hire or retain an investment
adviser? If prospective or existing clients make such an assessment,
how do they do so?
4.15 How do investment advisers disclose the types of technology
used in developing and providing investment advice? What types of
potential risks and conflicts of interest are disclosed? How are fees
disclosed? To what extent does investment advisers' use of technology
produce conflicts of interest that are similar to those of investment
advisers that do not use such technologies? To what extent does
investment advisers' use of technology produce conflicts that result
from such use?
4.16 In what ways do investment advisers assess whether using these
types of technology to develop and provide investment advice enables
them to satisfy their fiduciary duty to their clients? How do
investment advisers assess their ability to satisfy their duty of care
and duty of loyalty when using these types of technology? How does an
investment adviser determine whether the advice produced by its
automated algorithm is in the best interest of a particular client? To
what extent and how often do advisory personnel review investment
advisers' algorithms to be sure that such advice is in the client's
best interest? In conducting such review, to what extent do advisory
personnel understand the algorithm, how it was created, and how it
operates in practice? How do advisers take into account their fiduciary
duty when developing, testing, monitoring, and overseeing these types
of technology? To what extent do investment advisers rely on technology
vendors or other third parties to provide technical knowledge so that
advisers can understand the algorithms and the information or analysis
they generate? When relying on such vendors or third parties, how do
investment advisers assess whether the investment advisers are able to
satisfy their duty of care and duty of loyalty?
4.17 What types of policies and procedures do investment advisers
[[Page 49084]]
maintain with respect to the technologies they use in developing and
providing investment advice to clients? For example, do these
investment advisers maintain policies and procedures under rule 206(4)-
7 of the Advisers Act that are designed to address the technologies
that they use or provide to clients? How do investment advisers'
policies and procedures address their use of technology and the duties
they owe their clients? Do they address how advisers determine how to
incorporate information or analysis developed by these types of
technologies into investment advice that satisfies their fiduciary
duty? If so, how? How do investment advisers introduce new technology
to their personnel?
4.18 What types of operational risks do investment advisers face
using digital platforms to interact with clients? How do investment
advisers interact with clients when the platform is unavailable--for
example, when the adviser has lost internet service or when the
platform is undergoing maintenance? What alternative means of
communication are available to clients during those times? When issues
arise, is the investment adviser responsible to the client for
resolving those issues, or does the investment adviser rely on others
to resolve the issues or to be responsible to the client? What terms of
service do investment advisers put in place with cloud service
providers in connection with the potential for loss of service or loss
of data? We understand that investment advisers, like other financial
services companies, may rely on a small number of cloud service
providers.\101\ What risks does this reliance present to the industry
(and advisory clients)?
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\101\ See, e.g., Sophia Furber, As `Big Tech' Dominates Cloud
Use for Banks, Regulators May Need to Get Tougher, S&P Global (Aug.
18, 2020), <a href="https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/as-big-tech-dominates-cloud-use-for-banks-regulators-may-need-to-get-tougher-59669007">https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/as-big-tech-dominates-cloud-use-for-banks-regulators-may-need-to-get-tougher-59669007</a>.
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4.19 Under what circumstances do robo-advisers typically override
their algorithm, and in what ways? What steps do robo-advisers take to
ensure that any override of the algorithm is consistent with the
adviser's disclosure and clients' best interest? Do robo-advisers
document their determinations to override the algorithm and, if so,
what specifically is documented? What have robo-advisers found to be
the outcomes from overriding an algorithm?
4.20 When evaluating digital platforms, how do investment advisers
weigh the platform's cost and quality of service?
4.21 Should the Commission consider amending Form ADV to collect
information about the types of technology that advisers use to develop
and provide investment advice? If so, what type of technology and why?
What information about technology should we consider collecting? Should
the Commission require investment advisers to describe their efforts to
monitor the outputs of technology upon which they rely? Should the
Commission consider another method of collecting this information?
4.22 What costs or benefits do investment advisers experience in
registering with the Commission under the exemption for internet
investment advisers? What costs or benefits do clients of internet
investment advisers experience as compared to clients of other
investment advisers registered with the Commission? Do commenters
believe that the exemption for internet investment advisers should be
updated in any way, including to facilitate its use or to modernize it?
Are its conditions appropriate? Should we consider changes to, for
example, the de minimis exception for non-internet clients or the
recordkeeping requirement? Should we consider changes to the
exemption's definition of ``interactive website''? Should the exemption
specify what it means to provide investment advice ``exclusively''
through the interactive website? Would additional guidance on any of
the exemption's conditions or definitions be useful?
4.23 The Commission has stated that an investment adviser relying
on the internet investment adviser exemption ``may not use its advisory
personnel to elaborate or expand upon the investment advice provided by
its interactive website, or otherwise provide investment advice to its
internet clients.'' \102\ Should the Commission consider eliminating or
modifying this language? Should the Commission consider changes to the
exemption that reflect or otherwise address this language? Should the
Commission provide additional guidance about the internet investment
adviser exemption?
---------------------------------------------------------------------------
\102\ Internet Investment Adviser Adopting Release, supra note
83, at 77621.
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4.24 As discussed above, the Commission acknowledged that the
internet investment adviser exemption was designed to balance these
advisers' multiple state registration requirements with the Advisers
Act's allocation of responsibility for regulating smaller advisers to
state securities authorities. Consistent with this design, are there
changes to the exemption that might help to ensure that it encompasses
those investment advisers that provide advice through the internet
while ensuring that advisers that use the internet only as a marketing
tool, for example, remain subject to state registration? Should the
Commission consider creating a registration exemption that reflects
investment advisers' current use of technology in providing investment
advice in a better way than the internet investment adviser exemption?
4.25 To what extent do investment advisers use digital platforms
and other analytical tools in connection with wrap fee programs? \103\
For example, do these programs use model portfolios or portfolio
allocation models (whether developed by the investment adviser or by a
third party that provides such models to the adviser for its use) to
recommend investor allocations? \104\ Do wrap fee programs with an
online presence allow clients to engage directly with the portfolio
manager managing the client's assets or provide access to a wider array
of service providers than the client might otherwise have? Are there
concerns with respect to these programs for clients with minimal or no
trading activity as commissions for trade execution have moved toward
zero? \105\
[[Page 49085]]
Are such concerns different for wrap fee programs sponsored by robo-
advisers as compared to those sponsored by traditional investment
advisers?
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\103\ In a wrap fee program, clients generally are charged one
fee in exchange for investment advisory services, the execution of
transactions, and custody (or safekeeping) as well as other
services. An adviser acting as a sponsor to such a program may
choose the service providers, including other investment advisers,
and provide clients with access to those services through internet-
based platforms that enable clients to engage directly with service
providers.
\104\ A model portfolio generally consists of a diversified
group of assets (often mutual funds or ETFs) designed to achieve a
particular expected return with exposure to corresponding risks that
are rebalanced over time. See Morningstar, 2020 Model Portfolio
Landscape (2020) (noting that, while models can focus on a single
asset class, most models combine multiple asset classes). Model
portfolios are distinct from portfolio allocation models, which can
be educational tools that investors use to obtain a general sense of
which asset classes (as opposed to which specific securities) are
appropriate for the investor to allocate its assets to (e.g.,
appropriate balance of equities, fixed income, and other assets
given age and other facts and circumstances).
\105\ See generally Securities and Exchange Commission, Division
of Examinations, Risk Alert: Observations from Examinations of
Investment Advisers Managing Client Accounts That Participate in
Wrap Fee Programs (July 21, 2021), at 4 (``Infrequent trading in
wrap fee accounts was also identified at several examined advisers,
raising concerns that clients whose wrap fee accounts are managed by
portfolio managers with low trading activity are paying higher total
fees and costs than they would in non-wrap fee accounts.''), <a href="https://www.sec.gov/files/wrap-fee-programs-risk-alert_0.pdf">https://www.sec.gov/files/wrap-fee-programs-risk-alert_0.pdf</a>. The Risk
Alert represents the views of the staff of the Division of
Examinations. It is not a rule, regulation, or statement of the
Commission. The Commission has neither approved nor disapproved its
content. The Risk Alert, like all staff statements, has no legal
force or effect: It does not alter or amend applicable law, and it
creates no new or additional obligations for any person.
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4.26 To what extent do robo-advisers (as well as other sponsors of
investment advisory programs) rely on Rule 3a-4 to determine that they
are not sponsoring or otherwise operating investment companies under
the Investment Company Act of 1940 (the ``Investment Company Act'')?
\106\ If such sponsors do not rely on the rule, what policies and
practices have sponsors adopted to prevent their investment advisory
programs from being deemed to be investment companies?
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\106\ See 17 CFR 270.3a-4. Certain discretionary investment
advisory programs may meet the definition of ``investment company''
under the Investment Company Act, but the Commission has indicated
that investment advisory programs that provide each client with
individualized treatment and the ability to maintain indicia of
ownership of the securities in their accounts are not investment
companies. Whether such a program is an investment company is a
factual determination and depends on whether the program is an
issuer of securities under the Investment Company Act and the
Securities Act. Rule 3a-4 under the Investment Company Act provides
a non-exclusive safe harbor from the definition of ``investment
company'' to investment advisory programs that are organized and
operated in the manner provided in the rule. A note to the rule also
states that there is no registration requirement under Section 5 of
the Securities Act for programs that rely on the rule, and that the
rule is not intended to create any presumption about a program that
does not meet the rule's provisions.
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4.27 To satisfy the conditions of Rule 3a-4, among other things, a
sponsor and personnel of the manager of the client's account who are
knowledgeable about the account and its management must be reasonably
available to the client for consultation. The rule does not dictate the
manner in which such consultation with clients should occur. How do
sponsors and other advisers satisfy this condition? Should we consider
amending Rule 3a-4 to address technological developments, such as
chatbots and/or other responsive technologies providing novel ways of
interacting with clients? Should the Commission address these
developments in some other way? Should the Commission provide
additional guidance about this condition? If yes, what specifically
should this guidance address?
4.28 To satisfy the conditions of Rule 3a-4, among other things,
each client's account must be managed on the basis of the client's
financial situation and investment objectives. Sponsors must obtain
information from each client about their financial situation and
investment objectives at account opening and must contact each client
at least annually thereafter to determine whether there have been any
changes in the client's financial situation or investment objectives.
The Commission stated that the receipt of individualized advice is
``one of the key differences between clients of investment advisers and
investors in investment companies.'' \107\ How do sponsors ensure that
they have sufficient information about a client's financial situation
and investment objectives to provide investment advice that is in the
best interest of the client, including advice that is suitable for the
client? Given the availability of new technology for developing and
providing investment advice, does a sponsor's reliance on Rule 3a-4
heighten the risk of clients receiving unsuitable advice? If so, are
there other requirements or conditions that might address this risk?
---------------------------------------------------------------------------
\107\ See Status of Investment Advisory Programs under the
Investment Company Act of 1940, Investment Company Act Rel. No.
21260 (July 27, 1995), 60 FR 39574 (Aug. 2, 1995). The Commission
also stated that to fulfill its duty to provide only suitable
investment advice, ``an investment adviser must make a reasonable
determination that the investment advice provided is suitable for
the client based on the client's financial situation and investment
objectives. The adviser's use of a model to manage client accounts
would not alter this obligation in any way.'' See Status of
Investment Advisory Programs under the Investment Company Act of
1940, Investment Company Act Rel. No. 22579 (Mar. 24, 1997), 62 FR
15098 (Mar. 31, 1997).
---------------------------------------------------------------------------
4.29 One of the conditions of Rule 3a-4 is that investment advisory
programs relying on the rule be managed in accordance with any
reasonable restrictions imposed by the client on the management of the
client's account. In addition, the client must have the opportunity to
impose reasonable restrictions at the time the account is opened and
must be asked at least annually whether the client might wish to impose
any reasonable restrictions or reasonably modify existing restrictions.
The Commission explained that the ability of a client to impose
reasonable restrictions on the management of a client account is a
critical difference between a client receiving investment advisory
services and an investor in an investment company. Since the rule was
adopted, enhanced technological capabilities and industry practices may
have made it practical for sponsors to provide clients with other means
of receiving meaningful individualized treatment regarding the
management of their accounts. Do sponsors of investment advisory
programs currently provide their clients with ways of customizing or
personalizing their accounts other than through the imposition of
reasonable restrictions? If yes, please provide examples of such
practices. To what extent do clients avail themselves of those options
for individualized treatment and do they find them to be valuable or
important? Should we consider amending Rule 3a-4 to address these
developments or should we address them in some other way, such as by
providing additional guidance about this condition?
4.30 In view of the variety and increasing availability of
technologies used by investment advisers to develop and provide
investment advice, are there other regulatory matters that the
Commission should consider? If so, what are they, and why? To the
extent commenters recommend any modifications to existing regulations
or additional regulations, what economic costs and benefits do
commenters believe would result from their recommendations? Please
provide or identify any relevant data and other information.
IV. General Request for Comment
This Request is not intended to limit the scope of comments, views,
issues, or approaches to be considered. In addition to broker-dealers,
investment advisers and investors, we welcome comment from other
interested parties, researchers and particularly welcome statistical,
empirical, and other data from commenters that may support their views
or support or refute the views or issues raised by other commenters.
By the Commission.
Dated: August 27, 2021.
Vanessa A. Countryman,
Secretary.
Appendix A--Tell Us About Your Experiences With Online Trading and
Investment Platforms
We're asking individual investors like you what you think about
online trading or investment platforms such as websites and mobile
applications (``apps''). It's important to us at the SEC to hear
from investors who trade and invest this way so we can understand
your experiences.
Please take a few minutes to answer any or all of these
questions. Please provide your comments on or before October 1,
2021--and thank you for your feedback!
1. Do you have one or more online trading or investment
accounts?
[cir] Yes, I have one or more accounts that I access online using a
computer.
[cir] Yes, I have one or more accounts that I access using a mobile
app.
[cir] Yes, I have one or more accounts that I access both online
using a computer and using a mobile app.
[cir] Yes, I have one or more accounts that I access online, either
using a computer or a mobile app, but I also access the account(s)
in other ways (e.g., by calling or visiting in person).
[[Page 49086]]
[cir] I have one or more accounts, but I do not access them online
using a computer or using a mobile app.
[cir] No, I don't have a trading or investment account.
2. If your response to Question 1 is ``Yes'', do you think you
would trade or invest if you could not do so online using a computer
or using a mobile app?
[cir] Yes
[cir] No
3. On average, how often do you access your online account?
[cir] Daily/more than once a day
[cir] Once to a few times a week
[cir] Once to a few times per month
[cir] Less often than once a month
[cir] Never
[cir] Other
If Other, Explain:
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4. On average, how often are trades made in your online account,
whether by you or someone else?
[cir] Daily/more than once a day
[cir] Once to a few times a week
[cir] Once to a few times per month
[cir] Less often than once a month
[cir] Never
[cir] Other
If Other, Explain:
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5. If you access your account online, did you have the account
first, and only began to access it electronically later? Or did you
open the account with the idea that you would access it
electronically immediately?
[cir] I had a pre-existing account and downloaded an app or visited
a website to access my account.
[cir] I downloaded an app or visited a website first, and then
opened up an account with the company.
6. My goals for trading or investing in my online account are
(check all that apply):
[squ] Keep the amount of money I have, while keeping up with
inflation
[squ] Save and grow my money for short-term goals (in the next year
or two)
[squ] Save and grow my money for medium- to long-term goals
[squ] Have fun
[squ] Other
If Other, Explain:
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7. What would you like us to know about your experience with the
features of your online trading or investment platform? (Examples of
features are: Social networking tools; games, streaks, or contests
with prizes; points, badges, and leaderboards; notifications;
celebrations for trading; visual cues, like changing colors; ideas
presented at order placement or other curated lists or features;
subscription and membership tiers; or chatbots.)
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8. If you were trading or investing prior to using an online
account, how have your investing and trading behaviors changed since
you started using your online account? (For example, the amount of
money you have invested, your interest in learning about investing
and saving for retirement, the amount of time you have spent
trading, your knowledge of financial products, the number of trades
you have made, the amount of money you have made in trading, your
knowledge of the markets, the number of different types of financial
products you have traded, or your use of margin.)
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9. How much experience do you have trading or investing in the
following products (None, Less than 12 months, 1-2 years, 2-5 years,
5+ years):
--------------------------------------------------------------------------------------------------------------------------------------------------------
Less than 12
Investment products None months 1-2 years 2-5 years 5+ years
--------------------------------------------------------------------------------------------------------------------------------------------------------
Stocks............................................................. [cir] [cir] [cir] [cir] [cir]
Bonds.............................................................. [cir] [cir] [cir] [cir] [cir]
Options............................................................ [cir] [cir] [cir] [cir] [cir]
Mutual Funds....................................................... [cir] [cir] [cir] [cir] [cir]
ETFs............................................................... [cir] [cir] [cir] [cir] [cir]
Futures............................................................ [cir] [cir] [cir] [cir] [cir]
Cryptocurrencies................................................... [cir] [cir] [cir] [cir] [cir]
Commodities........................................................ [cir] [cir] [cir] [cir] [cir]
Closed-End Funds................................................... [cir] [cir] [cir] [cir] [cir]
Money Market Funds................................................. [cir] [cir] [cir] [cir] [cir]
Variable Insurance Products........................................ [cir] [cir] [cir] [cir] [cir]
Business Development Companies..................................... [cir] [cir] [cir] [cir] [cir]
Unit Investment Trusts............................................. [cir] [cir] [cir] [cir] [cir]
--------------------------------------------------------------------------------------------------------------------------------------------------------
10. What is your understanding, if any, of the circumstances
under which trading or investing in your account can be suspended or
restricted?
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-------------------------------------------------------------------------
------------------------------------------------------------------------
11. What else would you like us to know--positive or negative--
about your experience with online trading and investing?
------------------------------------------------------------------------
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------------------------------------------------------------------------
Other Ways to Submit Your Feedback
You also can send us feedback in the following ways (include the
file number S7-10-21 in your response):
Print Your Responses and Mail
Secretary
Securities and Exchange Commission
100 F Street NE
Washington, DC 20549-1090
Print a PDF of Your Responses and Email
Use the printer-friendly page and select a PDF printer to create a
file you can email to: <a href="/cdn-cgi/l/email-protection#b1c3c4ddd49cd2dedcdcd4dfc5c2f1c2d4d29fd6dec7"><span class="__cf_email__" data-cfemail="a0d2d5ccc58dc3cfcdcdc5ced4d3e0d3c5c38ec7cfd6">[email protected]</span></a>
Print a Blank Copy of this Flyer, Fill it Out, and Mail
Secretary
Securities and Exchange Commission
100 F Street NE
Washington, DC 20549-1090
Contact Info (Not Required; to submit anonymously, leave blank)
First Name:------------------------------------------------------------
Last Name:-------------------------------------------------------------
We will post your feedback on our website. Your submission will
be posted without change; we do not redact or edit personal
identifying information from submissions. You should only make
submissions that you wish to make available publicly.
[[Page 49087]]
If you are interested in more information on the proposal, or
want to provide feedback on additional questions, click here.
Comments should be received on or before October 1, 2021.
Thank you!
[FR Doc. 2021-18901 Filed 8-31-21; 8:45 am]
BILLING CODE P
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