SEC Staff Issues Guidance on Robo-Advisers

On Behalf of | Mar 10, 2017 | Financial News

The Securities and Exchange Commission’s Division of Investment Management (“SEC”) recently published information and guidance for investors and the financial services industry on the use of automated advisers, or robo-advisers, which are registered investment advisers (“RIA”) that use computer algorithms to provide advisory services with limited human interaction.

Robo-Advisers are subject to the same fiduciary obligations under the Investment Advisers Act of 1940 (“Advisers Act”) as any other registered investment adviser. Since they rely on algorithms and limited interaction with clients, the model raises certain considerations when seeking compliance with the Advisers Act.

The guidance focuses on the following three issues: (1) the substance and presentation of disclosing to clients the services the RIA offers; (2) the obligation to obtain information from clients to provide suitable advice; and (3) the adoption and implementation of effective compliance programs specifically designed for robo-advisers.

DisclosuresIn order for clients to better understand how a robo-adviser provides its investment advice, the robo-adviser should; (1) explain its business model, including a description of the algorithm used to make recommendations; (2) clearly disclose the scope of its services; and (3) ensure clients understand and read the initial disclosure material and that the questionnaires used elicit a sufficient amount of information.

SuitabilitySimilar to all RIAs, a robo-adviser must act in the best interests of its clients and provide only suitable investment advice based on the client’s financial situation and investment objectives.  However, the questionnaires used by many robo-advisers may not request a sufficient amount of information.  The SEC recommends robo-advisers ensure questionnaires supplied to clients require enough information to make a suitable recommendation.

Compliance ProgramsRobo-advisers may have more risks than traditional RIAs.  These risks need to be addressed in their written policies and procedures in order to comply with Rule 206(4)-7 of the Advisers Act.  Robo-advisers should consider whether to adopt and implement written policies addressing the following areas: (1) the development and testing of the algorithm; (2) the initial investment objective questionnaire; (3) disclosing changes in the algorithmic code that may affect their portfolios; (4) oversight of any third party who develops, owns or manages the algorithmic code; (5) the use of social media in connection with marketing services; (6) the prevention and detection of cyber threats; and (7) the protection of client accounts and key advisory systems.

Robo-advisers represent a fast growing area of the investment advisory industry.  Click here to view the Guidance Update.

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The Five Most Frequent Compliance Topics Identified in SEC Examinations of Investment Advisers

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