Are regulators equipped to monitor robo-advisers as fiduciaries?

Academics encourage agencies to boost their digital exam tools now, before automated platforms get even bigger

Jun 30, 2017 @ 4:27 pm

By Liz Skinner

Securities rules require robo-advisers to act as fiduciaries in providing investment advice to clients, but a new research paper calls into question whether regulators have the necessary tools to monitor these platforms to see if they really are providing advice in clients' best interests.

Regulators need to implement new procedures to assess the algorithms and the data about financial products and consumers that are incorporated into the decisions automated-advice platforms disburse, a recent paper by the Institute for Law and Economics at the University of Pennsylvania Law School found.

"A robo-adviser will always provide the advice that it is programmed to provide," authors Tom Baker, a University of Pennsylvania Law School professor, and Benedict G.C. Dellaert, a marketing professor at the Erasmus University Rotterdam, wrote in the May 2017 research paper.

For their part, digital-advice providers say they uphold the nation's securities laws, including the fiduciary standard of care for investors.

Automated-advice firms register with the Securities and Exchange Commission as investment advisers and are subject to the Investment Advisers Act, which requires clients' interests come first when providing recommendations, among other standards. Debate about whether the SEC and other regulators need to add more or different rules for digital platforms has increased as robos continue to gain in popularity.

(More: Robo-advisers sound off to SEC about rule changes for automated advice)

Robos and mostly digital advice firms have captured more than $100 billion in client assets since they were introduced beginning around 2011. They're expected to reach about $385 billion by the end of 2021, according to Cerulli Associates.

It would be best for regulators to devise these procedures now, "when the stakes are smaller," and before potential solvency and systemic risks are at stake with hundreds of thousands or even millions of consumers choosing their financial products based on similar models, the authors said.

One concern is that many robo-advisers are developed by or bought by consumer financial product intermediaries that have financial incentives to steer consumers to certain investments.

For example, are regulators equipped to study the algorithms baked into the nation's largest automated platform, Vanguard Personal Advisor Services, to ensure the mostly digital advice provider doesn't favor Vanguard products?

(More: Robo-advisers with the most client assets)

"It would be naïve to simply assume that intermediaries will always choose the algorithms and architecture that are best for consumers, rather than those that are best for the intermediaries," the authors wrote.

Steve Dunlap, president of technology and asset management firm FolioDynamix, said it's reasonable to raise questions about whether robo-advisers really act as a fiduciary.

"I've opened a few robo-accounts, and it's clear that it's a very standardized type of process that takes into account a few questions that you answer and then sticks you in a portfolio," he said. "That's very different than sitting down with a human adviser who goes through all your information and comes up with a recommendation."

He believes regulators should keep the same standards for human providers and digital-advice platforms.

Regulators should be examining how well advice is tailored to the consumer and how well those recommendations keep up with the changing needs of the client over time, Mr. Dunlap said.

Some regulators have wondered aloud whether regulatory tweaks were needed to accommodate digital advisers. But so far, the SEC has decided to issue only guidance to automated-advice providers.

The SEC guidance in February warned robo-advisers to be overtly clear with the public about how their algorithms recommend portfolios, and asked them to consider whether their questionnaires really ask for enough information to give advice that's in clients' best interests.

This year, for the first time, the SEC also added robo-advisers to its annual list of examination priorities.

(More: Robo-advisers and human advisers adopt each others' biggest advantages)

A separate paper by Scott MacKillop, chief executive of First Ascent Asset Management, said digital platforms "fall short" of fiduciary standards and suggested a new regulatory category was needed for robos that only offer digital advice without any live investment guidance.

"The robo foot simply doesn't fit into the fiduciary glass slipper," he wrote in a December 2016 paper.

Digital providers that include human advice should continue to be regulated as investment advisers, he said.


What do you think?

View comments

Recommended for you

Upcoming Event

Mar 13



InvestmentNews is honoring female financial advisers and industry executives who are distinguished leaders at their firms. These women have advanced the business of providing advice through their passion, creativity, inclusive approach and... Learn more

Featured video


What investment tools should you add in 2018?

As you look ahead to 2018, what types of financial products would you like to add to your quiver? Financial advisers at the MarketCounsel Summit offered their perspective, but one thing is clear "choice is power."

Video Spotlight

Help Clients Be Prepared, Not Surprised

Sponsored by Prudential

Recommended Video

Path to growth

Latest news & opinion

RIAs struggle to keep clients grounded amid stock market euphoria

With equities at record levels, financial advisers are confronted with realities of greed and fear.

Regulators showing renewed interest in cracking down on investment fees

SEC, Finra targeting high-fee share classes, 12b-1 fees and failure to give sales load discounts and waivers to investors.

Tax update: Brady says sales tax deduction in final bill

Taxpayers will be able to deduct state income taxes or state sales taxes in addition to property levies — up to a $10,000 cap.

Complexity of new indexed annuities causing concern

Insurers are using 'hybrid' indices as a way to differentiate themselves, but critics contend the products are less transparent, more confusing and don't add financial benefit.

Critics say regulation hasn't curbed overly rosy projections for indexed universal life insurance

They say rule didn't go far enough and more stringent measures may be necessary.


Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print