Market business trends: Expect regulatory guidance to accelerate | Katten Muchin Rosenman LLP

Gamification tactics and investment advice from social media influencers and chat rooms are just a few of the disruptive technologies and behaviors that are grabbing the attention of regulators in 2021 and forcing them to take a closer look and to react. For the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), the question is to what extent this new generation of traders should be allowed to take advantage of these new tools, applications and open exchanges, and how what safeguards need to be in place to protect investors and ensure market integrity? The consensus is that we can expect regulatory guidance to accelerate in 2022.

During the panel on “hot topics” in the market at the annual Katten Financial Markets Litigation and Enforcement Symposium Series, Katten attorneys discussed developments in the field of financial markets. execution and payment order flow, disruptive technology, a new generation of traders and the most controversial activity of the year, the GameStop trading frenzy.

Five points to remember

1. A New Generation of Traders and the GameStop Frenzy

In 2020, a clearing house said it opened six million new accounts, a 137% increase from 2019. One million of those new accounts were Gen Z with an average age of 19. With so many people interested in trading in the market, a significant number of whom are inspired by social media, it’s no surprise that 2021 has brought some unexpected developments. Among them was GameStop’s commercial frenzy fueled by social media platforms and socio-economic nuances.

On Reddit’s Internet discussion board “WallStreetBets,” retail investors reveled that GameStop, a dying breed of brick-and-mortar video game stores, was heavily bypassed in 2020 and vulnerable to a short squeeze. Wanting to “stick” to hedge funds, Wall Street and the “1%”, these new investors encouraged each other to buy the stock and push it higher. The activity caused a massive price spike – up 928% – in the first weeks of 2021 and effectively forced short sellers, including large hedge funds, to pull their short positions and buy stocks. . In turn, the surge has led to unprecedented market volatility and resulted in significant losses for large investors.

Following the rise of GameStop, clearing houses and brokerage firms have started to point the finger at each other. But an October 2021 report released by the SEC after Congressional hearings on the matter concluded that the price spike was actually caused by a large group of individual retail investors drawing inspiration from social media. While the report did not make specific policy recommendations, regulators are likely to respond.

2. The dubious role of “fin-fluenceurs”

Likewise, 2021 has seen a significant increase in the number of social media influencers entering the financial space. In general, social media influencers have established their credibility in a specific industry, have access to a large audience, and can persuade others to act on their recommendations. While influencers have been around for a while, financial influencers are quite new.

The “Fin-fluencer” social media activity spans the gamut of upside stocks and how to get rich quick, from sharing educational material to personal stories. On the bright side, some believe fin-fluencers fill a gap in financial literacy, despite the lack of formal qualifications for the most part. On the other hand, there is a lack of transparency regarding the risks associated with the products and the investment strategies they recommend and the potential of pumping and dumping systems.

Additionally, with the growth of the influence of fins, more and more companies are adding them to their marketing mix. There is no better way to reach the new generation of marketers than through social media. Businesses and brokers use (and pay) fin-fluencers to talk about stocks and services on their behalf. Regulators are now looking at broker practices and have issued requests for information, asking for a detailed history of relationships with influencers, how they first identified them, how they are paid and any SEO deal in which they can be engaged. Investigation letters also give several pages to privacy concerns regarding sharing customer information with influencers. This is certainly an area ripe for further regulation and guidance in the near future.

3. Gamification

Gamification, also known as digital engagement practices, is closely related to financial investment advice and chat room investment advice. Similar to a fitness tracker, investing apps using gamification tactics can track an individual’s trading activity and encourage transactions, send alerts, use rankings, and reward the user with badges when they are achieved certain milestones. The regulatory issues involved are numerous. For example, is an app that encourages an investor to trade considered a broker recommendation under a regulated activity? We expect FINRA and the SEC to issue more guidance on gamification in the near future.

4. Best execution requirements

FINRA 2021 Regulatory Notice 21-23 provided specific guidance on payment for order flow (PFOF) and best execution requirements. One observation is that FINRA places price as the main consideration, above many other criteria, in assessing the quality of workmanship. Meanwhile, SEC Chairman Gary Gensler recently sent a directive to staff to determine if additional best execution requirements or guidelines are needed to promote investor protection, which alludes to possible requirements. additional best execution to come.

5. Payment for the order flow

PFOF, which over time has survived calls for a ban on the practice, has faced a new push that would include rule changes or a total ban on the practice in 2021. Calls for review have followed suit. uproar and volatility in the market created by the GameStop episode. While the connection between the GameStop saga and PFOF is unclear, in October SEC chairman Gensler said the agency was indeed seeking to determine whether PFOF should be changed or banned, with the goal of creating a more competitive market.

The growth in payment size linked to retail order flow will be further examined in 2021. In the first three quarters of 2021, PFOF increased by 41% compared to the same period in 2020. A significant percentage of this increase is related to option trades which increased by more than 25%, largely due to the increase in the number of retail investors. trading options. Regulators fear that brokers will encourage retail investors to enter these complex and risky derivative markets without understanding the risk. Commissioner Gensler suggested that there could be two potential regulations in the near future, one for investment advisers and one for brokers.

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