SEC Guidance: Robo-Advisers and the Investment Advisers Act of 1940

February 27, 2017

The U.S. Securities and Exchange Commission (“SEC”) recently issued new guidance for investment adviser firms and individual investors considering the use of robo-advisers. Robo-advisers are becoming increasingly popular among investment adviser firms and clients alike, due to their ability to provide targeted investment advice for a lower investment advisory fee, which increases the accessibility of professional investment advice for frugal investors or investors whose account balances may not meet an investment adviser firm’s required minimum account balance. Robo-advisers are not suitable for every client, however, leading the SEC to issue guidance for investment adviser firms seeking to utilize this new technology.

The new SEC guidance focuses on three areas. First, the SEC recommends that investment adviser firms utilizing robo-advisers carefully consider the content, form, and delivery of required disclosures to investors. Because robo-advisers often offer little or no human interaction, it is vital that investors receive disclosures in easy to read, easy to understand formats in order to increase the likelihood that potential investors have the information they need when contemplating whether to invest with the robo-adviser. Second, the SEC guidance notes that an investment adviser firm utilizing a robo-adviser must make a reasonable determination that the robo-adviser is providing investment advice that is “suitable” for the client and satisfies the investment adviser firm’s fiduciary duty to act in the best interests of its clients. Investment adviser firms should carefully consider whether their robo-adviser platform gathers adequate information, whether there are procedures in place to address inconsistent information provided by a client, and whether (and if so, how) clients will be allowed to select an investment portfolio other than the one recommended by the robo-adviser. Third, the SEC reminds investment adviser firms that adding a robo-adviser service to their offerings adds new compliance considerations. For example, an investment adviser firm’s compliance program may need to be updated to address the specific risks associated with providing investment advice over the internet, as well as the functional limitations of a robo-adviser such as its reliance on algorithms and the limits imposed on human interaction.

Finally, the SEC guidance also reminds investment adviser firms to consider whether the operation or utilization of a robo-adviser may implicate other federal securities law, such as the Investment Company Act of 1940. Click here to read the SEC Guidance Update on Robo-Advisers.

The SEC also issued an Investor Bulletin to help educate consumers on the risks, benefits, and considerations involved in investing with a robo-adviser. The Investor Bulletin reminds investors to ask themselves what level of human contact they are looking for in an investment adviser, what information and algorithms the robo-adviser uses to create recommendations, and what fees and costs are associated with using the robo-adviser compared to a traditional investment adviser firm. Click here to read the SEC’s Investor Bulletin on Robo-Advisers.

If your investment adviser firm utilizes a robo-adviser or is considering adding a robo-adviser to its lineup, RIA Compliance Consultants can help evaluate your current practices and develop a compliance program tailored to your unique needs. For more information, contact your consultant or click here to schedule an introductory call.

Posted by Grant Parr
Labels: SEC