1.20.25

SIFMA/SIFMA AMG Comments on IOSCO DEP Consultation

QUESTION 1: How would you define DEPs? What should the scope of this definition cover?

On behalf of the Securities Industry and Financial Markets Association (“SIFMA”) and the Asset Management Group of SIFMA (“SIFMA AMG”), we appreciate the opportunity to provide input on the International Organization of Securities Commissions’ (“IOSCO”) November 2024 Consultation Report on Digital Engagement Practices (“Report”).

Acknowledging the need for a common vocabulary, we believe that Digital Engagement Practices (“DEPs”) can be most accurately described as methods of customer engagement, advertising, and education facilitated through digital means. This description accurately reflects our position that DEPs are nothing more than the natural evolution of customer engagement practices. For instance, push notifications about portfolio movements have replaced phone calls from brokers, digital lists of top-traded stocks have supplanted similar lists published in newspapers, and the publication of peer information is comparable to chatting with friends about the stock market.

Ultimately, we do not believe that a common regulatory definition is appropriate or necessary. DEPs will continue to evolve with investor demands and technology. This makes it difficult to establish a useful definition that will not quickly become outdated. That is why principle-based, technology-agnostic frameworks that do not rely on technical or specific definitions are better suited than DEP-specific regulations to address the concerns raised in the Report.

QUESTION 2: Do you agree with the findings of the Consultation Report and the proposed Guidance? Are there any significant issues, gaps, or emerging risks that should be further  explored in the report?

We strongly agree with the Report’s finding that DEPs can improve the aggregate welfare of investors by encouraging capital market participation, increasing financial literacy, and enabling positive investor outcomes We acknowledge that the use of DEPs can present certain risks. These risks, however, can be effectively mitigated by well-designed, principle-based, technology-agnostic regulatory frameworks. In jurisdictions where such frameworks are in place, DEP-specific regulatory requirements would be unnecessary and duplicative.

The Report describes certain mechanisms that may encourage retail investors “to trade more frequently to the benefit of the firm when it may not be in investors’ best interest to do so, therefore creating a potential conflict of interest between the firm and the investor.” The Report also discusses practices that could steer retail investors toward unsuitable products that are more profitable to the firm, or change investment strategies without full consideration of the risks involved. As an industry, we acknowledge the need to address these potential conflicts. DEPs should never mislead clients and should always present information in a manner that is fair and balanced.

Importantly, these potential conflicts of interest are not new to the industry. Rather, the conflicts described in the Report are the same types of conflicts that can arise in connection with any medium or form of communication or engagement with a client. In the United States, broker-dealers and investment advisers are subject to an extensive set of laws and regulations that are designed to protect investors across the range of client engagement practices, including DEPs. SEC Regulation Best Interest (“Reg BI”) requires broker-dealers, when making recommendations to retail customers, to act in the best interest of the retail customer at the time the recommendation is made, without placing the financial or other interest of the broker-dealer ahead of the interests of the retail customer. Similarly, registered investment advisers owe a federal fiduciary duty of care and loyalty to clients, described by the SEC as an obligation to “act in the ‘best interest’ of its client at all times.” There are also numerous SEC and FINRA rules, along with the anti-fraud provisions under the federal securities laws, designed to protect investors from deceptive or manipulative practices. Overall, we believe that this existing regulatory framework sufficiently addresses the potential risks associated with DEPs.

For this reason, we agree with some elements of the proposed Guidance, though other elements of the Guidance may not be necessary. We agree that market intermediaries should ensure that DEPs used to communicate investment advice or recommendations do not benefit of the market intermediary at the detriment of retail investors, and that DEPs should not be intentionally designed solely to increase transaction volume and resulting fees. We also strongly support the recommendation that market intermediaries should ensure that DEPs used to provide investment advice or recommendations are in line with the relevant jurisdictional regulatory frameworks. However, we do not agree that additional requirements beyond relevant jurisdictional frameworks such as DEP-specific policies and procedures, risk management systems, testing, and disclosures are necessary to achieve IOSCO’s investor protection goals.

Regarding issues and topics that could be further explored in the Report, we recommend a more comprehensive and holistic analysis of the existing academic and regulatory literature on DEPs. In the following paragraphs, we highlight five examples where a more thorough summary of the cited research would be beneficial to the public and regulatory discourse on DEPs.

First, the Report claims that research has shown “retail investors’ behavior in response to the use of DEP’s may deviate from standard rational models of behavior.” Report at 12-13. None of the cited materials, however, suggest that retail investors exist in a natural state of rationality and self-interest. Instead, they begin with the premise that retail investors are naturally irrational and can be influenced by a variety of social, cognitive, and emotional factors. See, Federal Research Division, Behavioral Patterns and Pitfalls of US Investors (2010) at 1 (“behavioral finance set[s] out to challenge the prevailing assumptions of rational expectations theory [and] emphasize[s] the social, cognitive, or emotional factors that lead investors to depart from the rational behavior that traditional economists presume”); see also, FCA, Applying behavioral economics at the Financial Conduct Authority (2013) at 4 (“People do not always make choices in a rational way.

In fact, most human decision-making uses thought processes that are intuitive and automatic rather than deliberative and controlled.”). We acknowledge that DEPs can hypothetically be designed to take advantage of human tendencies, but the Report should not imply that DEPs are the reason retail investors make economically irrational decisions.