Finra issues report on digital investment advice for financial firms and investors

Financial services firms that want to offer better digital investment advice must focus on training and education to better serve clients, according to the Financial Industry Regulatory Authority Inc.

Finra on Tuesday released a report providing guidance for advisers on digital investment platforms and the steps to properly incorporate them into a practice. As digital technology becomes more prevalent in the industry, the self-regulatory organization said firms and their advisers will need to evaluate numerous issues that arise with these platforms, including accuracy, potential conflicts of interest and the relationship between clients and the firms’ digital advice tools.

Whether investors can rely on the software and how advanced the platforms are in knowing the clients also will be key issues, Finra said.

“As these services develop, firms need to ensure that the core principles of investor protection — such as understanding and responding to customers’ needs and objectives — serve as the foundation of these new tools as well,” Richard Ketchum, chairman and chief executive of Finra, said in a statement.

Susan Axelrod, executive vice president of regulatory operations, said that Finra looks at similar points when conducting regular regulatory routines for advisers, and the regulator oversees all aspects of a financial firm’s business, including digital advice.

“As a regulator, our key obligation is to stay on growing trends,” she said.

When it comes to the algorithms these robo-advisers use, Finra’s report suggests advisers have an initial review where they assess the tool, data inputs and results. This should be followed up by periodic reviews on those supervising the tool, the way these platforms respond to market changes and ensuring the advice remains consistent on an ongoing basis.

Finra observed broker-dealers span the spectrum on firm policies for these tools, according to the report. One firm only allowed advisers to use two pre-approved platforms while another allowed them to use any platform.

CONFLICTS OF INTEREST
Finra flagged conflicts of interest as another concern for using digital advice platforms, particularly the hybrid models that incorporate a financial adviser for providing advice. This can be avoided by instilling a process for digital advice tools that determine portfolio characters, establishes criteria for included securities, has a person select appropriate securities or supervise an algorithm that does it instead, and monitor packaged portfolios.

Other areas of concern included investor profiling and rebalancing. The regulator notes firms should highlight training and education around these platforms. An investor’s involvement is just as important in using these tools.

“Some of the financial professional-facing tools Finra observed can deliver sophisticated analytics,” the report stated, “but using them effectively and communicating with clients about their output is dependent on the financial professional understanding the assumptions that go into the analytics and the potential limitations on the results.”

“Since conflicts of interest may exist in the investment advice they receive, investors should evaluate whether those conflicts compromise the objectivity of that advice,” the report said. “Digital investment advice tools do not necessarily eliminate conflicts of interest.”