Wed, 03/02/2022
The following is a review of On “Confetti Regulation”: The Wrong Way to Regulate Gamified Investing by Kyle Langvardt and James Fallows Tierney, published in Vol. 131 of The Yale Law Journal Forum.
Any player of a multitude of splashy smartphone games that have proliferated in the last decade (think “Candy Crush Saga”) will be familiar with that nagging feeling of wanting to play just one more round. These games rely on a psychological phenomenon known as a “compulsion loop,” providing interlocking systems of reinforcement through the use of rewards alongside pleasurable visuals to keep users engaged and coming back for more. More recently some online trading platforms have integrated these psychological incentives into their user experiences, incorporating casino-like design elements, confetti, and push notifications to encourage users to engage with the platform and conduct frequent, unconsidered trades. Evidence suggests retail investors perform worse the more frequently they trade, and gamification leads to more frequent trading. What then, if anything, should regulators like the Securities and Exchange Commission do to protect consumers?
In their recent piece in The Yale Law Journal Forum, professors Kyle Langvardt and James F. Tierney of the University of Nebraska College of Law argue that SEC should avoid the impulse to engage in “confetti regulation” — “command-and-control style regulation of the aesthetic design of brokerage apps.” Such an approach, the authors argue, could inadvertently provide the court with an opportunity to exercise its deregulatory tendencies and dismantle large areas of the SECs regulatory authority. Instead, the SEC should frame its regulatory approach in more traditional terms, including through the use of tried-and-true prohibitions on brokers placing their interests ahead of investors, and other similar regulatory forms.
The trend toward gamification on some online brokerages is, at least in part, a result of an evolution in the way in which stock brokerages profit from consumer transactions. Chief among these innovations is “payment for order flow,” where third-parties pay the brokerage for information about consumer trading activity or receive preferential access to consumer trading opportunities. Because brokerages receive compensation from third-parties based on the number of consumer trades they facilitate, they are incentivized to encourage investors to engage in a high number of trades. This has led some to incorporate strategies from other apps that receive compensation through user engagement, including utilizing “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.” One prominent platform, Robinhood, at one point rewarded users with confetti upon the execution of a trade and offered a virtual scratch-off ticket to users who won an award.
To some the solution to the incorporation of these gamification elements might appear obvious: the SEC should ban the use of “gamification” elements on online trading platforms in the public interest. Langvardt and Tierney have termed this form of prospective action “confetti regulation,” and they note several problems with this approach. The first is one of line drawing. Take, for example, push notifications — automated messages sent by an application to a user when an app isn’t open. While platforms might abuse push notifications to encourage users to make trades when they otherwise would not, they also could be used to communicate important information about, for example, the status of a user's account.
Tierney and Langvardt also see a potentially more consequential risk in the SEC taking aim at “confetti regulation;” a challenge to such regulation on First Amendment grounds could provide the Supreme Court with an opportunity to invalidate vast areas of securities regulation as impermissible restrictions on freedom of speech. The authors note that, over time, the court has interpreted the First Amendment’s protections as applying to increasingly-diverse areas of communication, from marketing in 1980, to the advice banks give to their investors in 2011. It is easy to imagine that the court might use the opportunity brought on by a challenge to “confetti regulation” to strike down portions of securities law governing the manner in which brokerages communicate with their investors. The authors also draw on the example of audiovisual content to demonstrate how the court has conferred protections on certain mediums of communication, even where the “message conveyed is ambiguous or thin.” The court could hold that a similar logic applies to user-interface design, holding that a platform’s decision to incorporate certain design elements represents expressive communication similar to audiovisual content. If design features are protected communication, then it is only a small leap to imagine that the court could hold that restrictions on certain design elements could constitute viewpoint discrimination, in that visual elements like confetti could be said to be communicating a viewpoint in favor of active user trading, and prohibition of such design elements could effectively “single out the pro-trading ‘mesage’ for suppression.”
While the idea that the use of confetti and slot-machine graphics constitutes protected speech might seem strained to the outside observer, Langvardt and Tierney note that those in favor of a continued role for the SEC in policing the behavior of brokerages should take these arguments seriously. Courts have previously held “that computer source code is speech, that search results are akin to media editorial choice, and that an online marketplace is immunized as a “publisher” for purposes of third-party liability.”
As the authors summed up their concerns:
Confetti regulations’ novelty, combined with the definitional difficulties discussed above, will invite First Amendment challenges. Those challenges, in turn, may tee up opportunities for courts to confine the scope and strength of the SEC’s policy mission through constitutional deregulation.
According to the authors, the consequences of appellate courts using challenges to“confetti regulation” as mechanisms for reconsidering the constitutionality of securities law more broadly would be stark. “In our view, robust expansion of the antiregulatory First Amendment to other traditional areas of economic regulation—like the securities laws—would be destabilizing and undesirable for its substantive effects on markets and its erosion of democratic control over the economy.”
Langvardt and Tierney advise the SEC to take a tact of “constitutional avoidance,” utilizing existing doctrines that prohibit a brokerage from eliciting overtrading among investors in a way that prioritizes their own interests over those of investors. This doctrine traditionally applied to a practice known as “churning,” where a broker with discretionary control over an account “trades excessively to generate commission revenue.” The authors note that the same underlying logic could be applied to a set of practices they term “behavioral churning,” utilizing gamified elements to induce excessive consumer trading in a manner that is damaging to investors yet profitable to the brokerage.
The authors recognize that the court may head in a deregulatory direction regardless of the approach adopted by the SEC. Nevertheless, they argue, the commission does have some control over the pace of change by avoiding “provocative incursions into the law of software (that will) intensify the regulatory barrage and accelerate the damage.” And in an area that currently appears so vulnerable to judicial reappraisal, perhaps delay is the best that can realistically be achieved.
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