Gamification in Securities Regulation

Abstract

Popular zero-commission stock trading apps like Robinhood innovate in user-experience design, featuring digital engagement practices and prompts that appeal to investors’ psychology and make it easy and fun to trade. These include leaderboards of popular stock, push notifications, and visual flourishes. Design features like these, sometimes called “gamification” or “digital engagement,” have come under increased scrutiny. Regulators have announced plans to examine gamification in retail markets, with the SEC most recently in August 2021 requesting comment on potential responses in broker-dealer regulation.

This attention reflects considerable skepticism about behavioral design in securities markets. At best, it encourages engagement and democratizes the markets. But at worst, it produces a set of interrelated phenomena of concern, like the potential for problem use and significant idiosyncratic losses, as well as lower quality price discovery and distortions in capital allocation. How regulators should respond to behavioral design in investing apps is therefore a high-stakes matter not just for retail investors but for society more broadly, given that interventions in retail investor choice have significant implications for wealth inequality.

Calls to regulate gamification highlight a tension at the core of securities markets. Securities law has largely ceded the field of investor protection to the interests of sophisticated financial intermediaries in producing liquidity and price discovery. By permitting gamification practices that encourage active trading for the broker-dealer’s primary benefit, securities law subordinates its investor protection function to encourage plausibly wasteful investment in achieving ever-smaller improvements in liquidity and price discovery. Regulation of gamification is likely to be socially desirable, I argue, not just given what we know about retail trader behavior and its second-order effects on personal finance and markets—but because it is an opportunity for securities law to recalibrate away from encouraging an all-out arms race in dealer arbitrage.

This article takes up the problem of digital engagement and behavioral design. It extends the literature on retail investment regulation by considering how gamification is the nearly inevitable consequence of fragmented market structure, competition on brokerage commissions, and the rise of retail investors who trade without superior information about a stock’s fundamental value. Calls to regulate “gamification,” I argue, often elide important distinctions between how securities law should treat active-traders who prefer risk, and those with preferences distorted by behavioral design. This article explains how we got here; examines the social-welfare case for regulating gamification, behavioral design, and related digital engagement practices; offers a typology of techniques that securities regulators can adopt in response; and assesses these candidate techniques against existing securities law doctrine and policy, as well as potential reforms that the SEC has recently floated. I also consider, elaborate on, and respond to the techno-optimist claim that gamification can further literacy, the techno-pessimist claim that gamification reduces confidence in markets, and the techno-populist claim that this serves to democratize investing.

Abstract posted earlier under variant title “Behavioral Design in Stock Trading Apps.”

Keywords: Gamification, digital engagement, broker-dealer regulation, Robinhood

JEL Classification: K22, G28, G41