Alert – The SEC Division of Investment Management Issues Robo Advisor Guidance Update

Regulators are taking a close look at electronic investment advice. After specifically mentioning the topic in the SEC’s  2017 Exam Priorities Letter, last week the SEC Division of Investment Management issued a Guidance Update covering:

  1. Disclosures to be made about the robo-advisor and the services offered
  2. Advisor’s obligation to obtain client information necessary to providing suitable advice
  3. The need for a compliance program designed to meet concerns specific to providing automated investment advice

Disclosures. Since digital advice/automated advice/robo advisors provide their services through websites and mobile apps with little to no human interaction, advisors are challenged to provide all the types of critical investor information.  More often, these robo investors are inexperienced and/or unsophisticated.  Advisors should not think of disclosures in terms of “legal notices”, but rather as important information these investors must have in lieu of the education/information they would normally receive through human interaction.  A clear explanation of the advisory business model as it applies to the investment algorithm is essential.  Investors must understand what the algorithm does, when it may be overridden, and why. Likewise, an easily-understood explanation of the process for creating/selecting the individual investor portfolio, fees, account opening and asset transfers is also part of the necessary information. Statements to the effect that investors are entering into a managed account relationship are necessary.

It is critical that the advisor balance clarity and regulatory requirements with the space constraints of the website/mobile device. However, the advisor should not expect investors to read extremely long documents in order to understand the investment opportunity (Remember the old “rule” about reading more than one page?). Definitions must be provided for important terms.

Information Gathering for Suitability. Investment recommendations/advice must be suitable for the specific client.  Advisors must create the best possible online questionnaire in order to gather the right investor information. Some advisors’ questionnaires focus on risk scores, some focus on investment objectives.   Can the investor contact the advisor with questions?  Can the advisor contact the investor based on the responses to the questionnaire?  Does the investor “accept” the recommendation, and can the portfolio be adjusted based on some form of interaction?  If the portfolio is a “one and done” recommendation, will the services provided retain the exemption from Rule 3a-4 under the Investment Company Act of 1940?  These are all important issues the advisor should consider.

Compliance Programs. Compliance programs must also be the result of creative thinking.  The program must be developed to meet the challenges posed by the manner in which investors are educated, solicited, and onboarded, and how portfolios are designed and implemented. Since the advisor probably has a software development team, use that team to help design tools to search for inconsistencies in responses to investor questionnaires, inflows and outflows of funds and interactions between investors and customer service staff.  Focus on the website, client portals, client “account pages” is critical.  While the talented software developer may not be the best at designing investor communications, if the Compliance team partners with the developers/product managers, solutions to successful, succinct communications can be achieved.

Robo-advisors and those interested in the business model will find this Guidance Update to be a good presentation of the challenges faced by the business and compliance teams as understood by the SEC Staff.  Used with the OCIE Examination Priorities letter, the Update lays out what we believe will be the elements that are necessary when designing your compliance program.

Oyster has experience with digital advice/robo advisors, and with other FinTech businesses.  We have worked with firms in various stages of evolution, from early creation and registration to firms dealing with early regulatory challenges, or reviews/revisions of compliance programs, audits and changes to regulatory approvals. We can also provide you with compliance automation through our Oyster Solutions platform by integrating risk assessments, policies and procedures and testing programs that are aligned to how you do business.

For more information please contact Harriet Britt or complete our contact form and we will be happy to assist you.

More about Harriet Britt: Harriet has over 30 years of experience in the securities and futures industries, with the last 20 focused on supervision and compliance at broker-dealers and investment advisors. She brings extensive experience at investment banking boutiques in the areas of corporate finance, mergers and acquisitions, institutional sales, trading, research, private client and wealth management services. Harriet has worked with U.S. firms that have affiliate businesses in Europe and the Middle-East. Harriet has also registered wealth management firms, hedge funds and mutual funds. She has created and implemented compliance programs for broker-dealers and investment advisors. She has been the AML officer at multiple organizations, and developed privacy and information security policies and Business Continuity Plans. In addition, Harriet has also managed the legal affairs for investment banks.

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