Global Trustee and Fiduciary Services News and Views Issue 48

Global Trustee and Fiduciary Services News and Views

| Issue 48 | 2017

investors with a general overview of robo-advisers

and other automated investment tools.

The staff of the SEC’s Division of Investment

Management (IM Staff) recently issued a

Guidance Update to assist SEC-registered

robo-advisers in meeting their regulatory and

compliance obligations under the Advisers

Act.

Through the Guidance Update, the IM

Staff seeks to inform robo-advisers and other

investment advisers using algorithms to

provide investment advice of certain unique

considerations they should take into account

in meeting their legal obligations under the

Advisers Act.

In addition, the Guidance Update

offers suggestions for how these advisers may

address some of these issues.

As an initial matter, the IM Staff notes in the

Guidance Update that robo-advisers have certain

“unique considerations” in seeking to satisfy

their legal obligations under the Advisers Act.

In particular, the IM Staff explains that certain

hallmarks of the typical robo-adviser business

model — such as reliance on algorithms, delivery

of advisory services over the internet and limited,

if any, direct human interaction — create novel

regulatory and compliance issues that generally

do not arise in connection with more common

advisory business models. It is with these unique

considerations in mind that the IM Staff provides

guidance to robo-advisers.

In the Guidance Update, the IM Staff addresses

three discrete regulatory and compliance issues:

• First, the substance and presentation of

disclosures to clients about the robo-adviser

and the investment advisory services it offers.

• Second, the information obtained from clients

to support the robo-adviser’s duty to provide

suitable investment advice.

• And third, the adoption and implementation

of an effective compliance programme

reasonably designed to address the particular

concerns relevant to providing automated

investment advice.

Below, we provide an overview of the regulatory

and compliance challenges identified by the IM

Staff with respect to these three discrete areas

together with their suggestions as to how robo-

advisers can address these challenges. Finally,

although the topic was only briefly addressed in the

Guidance Update, we provide an overview of the

regulatory and compliance considerations for robo-

advisers under Rule 3a-4 under the Investment

Company Act of 1940, as amended (Rule 3a-4).

Substance and presentation of disclosures

The fiduciary duty that binds all investment

advisers, including robo-advisers, creates a duty

to make full and fair disclosure of all material

facts to, and employ reasonable care to avoid

misleading, clients.

This disclosure must include

substantive information that gives the client

an opportunity to make an informed decision

about whether to enter into, or continue, an

investment advisory relationship with the robo-

adviser. The key aspects of the disclosure must

also be readily apparent to the client.

With respect to the substance and presentation of

disclosure, the IM Staff stated that the typical robo-

adviser business model creates a number of unique

regulatory and compliance challenges, including:

To address these regulatory and compliance

challenges, the IM Staff provides several

suggestions for the content of a robo-adviser’s

disclosure, and how it can be presented to

increase client awareness. Some examples of

these suggestions include the following.

• With respect to disclosures regarding the

robo-adviser’s business model, there should

be a description of:

The assumptions and limitations of the

algorithm used to manage client accounts,

e.g. if the algorithm is based on modern

portfolio theory, a description of the

assumptions behind the theory and the

limitations of that theory.

The particular risks inherent in the use of

an algorithm to manage client accounts, e.g.

that the algorithm might rebalance client

accounts without regard to market conditions

Limited or non-existent interaction with

the advisory personnel, which means

a client’s ability to make an informed

decision regarding entering into an advisory

relationship may be solely dependent

on electronic disclosures, i.e. advisory

personnel may not be available to explain or

reinforce important disclosures.

And the risk that the client maymisunderstand

the robo-adviser’s business model or its

scope of services, or that information may be

buried or incomprehensible for the client.