As with most
aspects of the workplace, employee benefits are going digital. From
online enrollments and administration for all types of benefits, to electronic
educational tools, employers are increasingly seeking ways to use new
technologies to enhance their benefits programs, increase efficiencies and
employee engagement. Among these innovations is the proliferation of
computer-driven, digitally-based investment advisers, or so-called “robo
advisers.”
The market for robo-advisers is growing fast with many new
companies entering the space with increasing frequency. Well-established
companies are also developing and offering their own automated investment
services which can be available to assist individual investors or participants
in an employer-sponsored savings plan. Plan sponsors will increasingly be
presented with robo-adviser services for their participant-directed retirement
plans, and they must be prudently selected.
Robo-advisers
are not without their critics. There is an ongoing debate whether
robo-advisers can meet the fiduciary standards of a trained professional who
provides investment advice to investors in their best interest. For example:
·
On March 15, 2016, the Financial Industry Regulatory
Authority (FINRA) released a report regarding digital investment advice which raised questions
concerning the standard of care that applies to broker-dealers and investment
advisers under federal securities laws with regard to investment advice that
they provide and the application of same to digital services used either in conjunction
with a financial professional or on its own. The FINRA report
recognizes that digital investment advice tools will play a significant role in
wealth management and that investor protections must be paramount and should
include a foundation for understanding customer needs, with sound
methodological groundings and recognition of the tools’ limitations.
·
On April 1, 2016, the Massachusetts Securities Division
issued a policy statement and declared that robo-advisers may be
inherently unable to act as fiduciaries and perform the functions of a
state-registered investment adviser without the necessary due diligence and
personalization to act in the best interest of their clients.
·
On April 6, 2016, The Department of Labor also
released its final rule regarding investment
advice fiduciaries (the “Rule”). The Rule itself continues to
come under attack and on June 1, 2016, eight industry and trade groups filed a
lawsuit in Texas federal court challenging the Rule and asserting that the DOL
overstepped its authority in issuing the Rule, the Rule will increase costs and
litigation, and that the Rule will not help investors. (See Chamber of Commerce of the
United States of America et al. v. Thomas E. Perez et al., case number 3:16-cv-01476, in the U.S. District
Court for the Northern District of Dallas.) Whether the Rule
survives pending challenges remains to be seen. In the meantime,
robo-advisers that make investment recommendations are fiduciaries under the
Rule which provides that fiduciary communications such as recommendations can
be initiated by a computer software program.
It is also
important to note that while the DOL also released a Best Interest Contract
(BIC) exemption from its prohibited transaction rules to allow investment
advisers to continue to provide advice and earn compensation such as
commissions, sales loads, 12b-1 fees and revenue sharing payments without
running afoul of conflicts of interest standards so long as certain
requirements are met, this BIC exemption does not apply to the provision of
investment advice solely through digital means unless the robo-adviser charges
level-fees and is a “level-fee fiduciary.” It appears that the
pre-existing rules for “eligible investment advice arrangements” under Section
408(g) of ERISA provide an alternative path for robo-advisers to follow in
order to avoid running afoul of the prohibited transaction rules.
For plan
sponsors that desire to incorporate digital investment advice services into
their retirement program in the near future, several issues, at a minimum,
should be considered, including:
·
Assess the need for investment advice services versus
provision of non-fiduciary educational tools, or determine an approach that
incorporates both services
·
Ensure that the plan fiduciaries follow an objective
process to elicit information necessary to assess the robo-adviser’s qualifications
and credentials, quality of services offered and reasonableness of fees and
costs charged for the services
·
Evaluate the robo-adviser’s investment approach
embodied in the design of the tool
·
Assess whether the digital investment advice tool is
paired with access to a human investment professional who is able to assess the
plan participant’s needs in a manner that goes beyond the limitations of the
digital tool, and, who is trained to utilize the tool effectively
·
Review any conflicts of interests
·
Determine if the robo-adviser charges level fees and
meets the requirements of the BIC exemption or whether it meets the
requirements of an “eligible investment advice arrangement” under ERISA which
either charges level-fees or uses a compliant computer-model
·
Review service agreements including fiduciary,
indemnification, audit, record retention and data privacy and security
provisions
·
Confirm that the robo-adviser acknowledges fiduciary
status and that the participants are provided with any required disclosures
·
Establish a procedure for prudent ongoing monitoring
of the robo-adviser service
For plan
sponsors who already offer robo-adviser services to their plan participants,
now is the time to review the arrangement under the evolving guidance and
implement prudent changes.
In this
environment, the fate of the Rule, and the standards for robo-advisers, will
continue to evolve and new developments must be monitored. Whether the
robots know best is a question yet to be answered.
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