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University of Miami Business Law Review

Rayaan Hossain

Document Type

Note

Abstract

This Note comments on how recent developments in securities regulation deal with today’s securities industry challenges. As usual, the law advances much slower than technology. After decades of debate over heightened standards for broker-dealers giving investment advice, the Securities and Exchange Commission (“SEC”) introduced Regulation Best Interest (Reg BI). Our modern market demands that broker-dealers execute quick trades on behalf of their clients as well as provide broader investment advice. The popularity of online trading platforms (“OTPs”) only exacerbated the need for regulatory changes. The theme of this paper surmises how Reg BI responds to the rise of the retail investor’s trading app.

Part II, the Introduction, will provide a brief history of the American brokerage business. This timeline will demonstrate how equities started out as a market only for the wealthy but eventually turned into an exchange where brokers compete for the everyday person’s business.

Part III will then explore the SEC’s issues with current securities providers. Part III(A) discusses the methods that OTPs use to garner clients and bring in revenue. It will discuss how application designers use “gamification” to retain clients and encourage trading. Brokerages use a free-to-play system that encourages more trading through visual, process, and social media components. Part III(B) will explain the payment for order flow (“PFOF”) model. OTPs allow clients to conduct “cost-free” trading on the OTP while still bringing in revenue for the brokerage. The practice of PFOF involves selling retail market order data to market makers. After all, data is the new oil. In contrast to the expansive regulations in the oil and gas industry, however, Reg BI obligations show a more measured approach. Thus, consumers derive significant cost savings from PFOF even when retailers sell their order data to market makers who in turn sell securities to those same consumers. Part III(C) of this Note will provide insights into market interactions from a behavioral finance perspective. Behavioral finance studies show how OTPs subtly influence investor strategy, execution, and long-term goals. Studies show that the accessibility and visual appeal of online brokerage applications affects investor risk tolerance as well as trading patterns. Firms want their customers to use as many of their applications as possible. The implication is that firms want customers to use their digital applications because then they can influence them to use premium features, other firm products, or engage in behavior that adds more value to the brokerage or its other lines of business. These influences can lead to serious consequences for uninformed customers who cannot properly assess the firm’s financial products or services.

After spending time on the technical aspects of OTPs, Part IV will review the history of stockbroker duties. Part IV(A) goes into common law fiduciary duties: stockbrokers maintained an agency relationship through contract. Thereafter, Part IV(B) discusses circumstances that turn a broker into a fiduciary. A popular analysis—the “trust and confidence test”—determines whether a stockbroker has a fiduciary duty to its customer. In addition to the trust and confidence test, courts look at other control factors to determine whether to impose obligations on brokerages. In Part IV(C), this Note will also expound on the historical dichotomy between broker-dealers and financial advisers. Because brokers perform an increasingly enlarged advisory function, one must understand the different standards brokers and advisers are held to. The historical context gives an added justification for Reg BI’s supplemental obligations to their customers.

Part V will opine on the new SEC rule that requires broker-dealers to only recommend financial products that are in their customers’ best interests. Falling under the Securities and Exchange Act of 1934, Reg BI hopes to safeguard investors and standardize the conduct of broker-dealers who also provide financial advice. This Note will discuss the benefits and criticisms of the new regulation. For the most part, Reg BI adds needed reinforcement of securities laws while not overburdening broker-dealers.

Ultimately, Part VI suggests that we should remain cautiously optimistic about such technologies. No doubt, the market should encourage fintech innovations. Consumer access to markets should remain a large priority given today’s economic climate. Still, financial services remain a highly regulated industry because of the need to protect risk-bearing consumers

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