The Securities and Exchange Commission (SEC) published information and guidance for investors and the financial services industry on the use of robo-advisors.

On February 23, 2017, The Securities and Exchange Commission (SEC) published information and guidance for investors and the financial services industry on the use of robo-advisors, which are registered investment advisors that use computer algorithms to provide investment advisory services online with limited human interaction. Because of the unique issues raised by robo-advisors, the Commission’s Division of Investment Management issued guidance for investment advisors with suggestions on meeting disclosure, suitability and compliance obligations under the Investment Advisors Act of 1940.1 A second publication, and Investor Bulletin, issued by the SEC’s Office of Investor Education and Advocacy, provides investors with information they may need to make the decision to use robo-advisors. These issues include; the level of human interaction important to the investor, the information the robo-advisor uses in formulating recommendations, the approach to investing, and the fees and charges involved.2

Background

Automated advisors, referred to colloquially as robo-advisors, represent a fast growing trend within the investment advisory industry. They have the potential to give retail investors more affordable access to advisory services, as well as change the competitive landscape in the market for investment advice. While many robo-advisors were originally geared to millennials, their popularity has increased among all age groups and classes of investor.

Robo-advisors are typically registered investment advisors, and use innovative technologies to provide asset management services through online algorithmic-based programs. A client would enter personal information and other data into a digital platform, and based on this information, the robo-advisor wouldgenerate a portfolio, and subsequently manage the clients account. These advisors operate under a wide variety of business models and provide a range of advisory services. There are often varying levels of human interaction, and a range of methods of collecting information.3 Given the unique challenges and opportunities presented by these programs, the SEC has been monitoring and engaging with robo-advisors to evaluate how they meet their obligations under the Investment Advisors Act.4 A Fintech (financial technology) forum, hosted by the SEC and held in November 2016 concluded that depending on their business models and operations, robo-advisors should be cognizant of certain unique considerations as they seek to meet their legal obligations under the Advisors Act.5

What this Means

As technology continues to improve and make profound changes to the financial services industry, it is important for regulators to assess its impact on U.S. markets and give thoughtful guidance to market participants,” said SEC Acting Chair Michael Piwowar.6 “This information is designed to help investors tap into the opportunities that Fintech innovation can provide while ensuring fairness and investor protection.”7 The new guidance however puts a focus on how robo-advisor offerings communicate with their clients, and calls for heightened disclosure of how firms’ business models are structured and how they develop their investment strategies.

The SEC’s guidance updates and amplifies the compliance message that it has been sending for some time, and stresses the importance of thorough disclosures about conflicts of interest. Because robo-advisors rely on online disclosures, there may be unique issues that arise when communicating key information, risks and disclaimers. The guidance calls on rob-advisors to develop meaningful disclosures detailing their business models and risks, including an explanation of how algorithms factor into any investment recommendations.8 The SEC also expects advisors to detail the extent of human involvement in any digital offerings, including when there may be a human override of the platform trading – a reference to Betterment’s controversial decision to suspend trading the morning after the Brexit vote last June.9 The guidance also cautions financial advisory firms against making bogus claims about the scope of advice offered through a robo-platform, and that those firms revisit the ways they collect information from clients to develop an investor profile.

Key Observations and Take-aways

Despite arguments put forward by certain industry groups, the SEC confirms that robo-advisors are covered under the Investment Advisors Act, subjecting them to the same regulatory and fiduciary obligations as traditional firms.10 This sends the clearest signal yet that robo-advice platforms are here to stay, and the guidance offered to the industry, while legitimizing automated investment offerings, also warns firms about steps they must take to ensure they are in compliance.

Given that robo-advisors are subject to the same general regulatory requirements as other firms, it is their fiduciary duty to act in the best interests of their clients, and provide only suitable investment advice. It is incumbent on them to collect suitably detailed information about risk tolerance and investment horizons in order to produce appropriate recommendations based on a client’s financial situation and investment objectives.

As the investment advisory industry continues to innovate and develop new ways to provide advisory services to clients, the SEC is expected to continue monitoring these developments and implement safeguards, as necessary, to help facilitate such innovation and protect investors.

 

References

  1. “SEC Staff Issues Guidance Update and Investor Bulletin on Robo-Advisers,” U.S. Securities and Exchange Commission, Press Release, February 23, 2017. Access at: https://www.sec.gov/news/pressrelease/2017-52.html
  2. Ibid
  3. “Robo-Advisers,” U.S. Securities and Exchange Commission, IM Guidance Update, February 2017. Access at:  https://www.sec.gov/investment/im-guidance-2017-02.pdf
  4. Ibid
  5. Ibid
  6. “SEC Staff Issues Guidance Update and Investor Bulletin on Robo-Advisers,” U.S. Securities and Exchange Commission, Press Release, February 23, 2017. Access at: https://www.sec.gov/news/pressrelease/2017-52.html
  7. Ibid
  8. “New SEC robo adviser guidance spotlights disclosure, client communication,” Financial Planning, February 23, 2017. Access at: https://www.financial-planning.com/news/new-sec-robo-adviser-guidance-spotlights-disclosure-client-communication
  9. Ibid
  10. “New SEC robo adviser guidance spotlights disclosure, client communication,” Financial Planning, February 23, 2017. Access at: https://www.financial-planning.com/news/new-sec-robo-adviser-guidance-spotlights-disclosure-client-communication

Newsletter Author: Samantha Regan, Mairi Bryan

Newsletter Contact Person: Nghi Pham

Visit www.accenture.com/RegulatoryCompliance for latest insights on regulatory remediation and compliance transformation.

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