As robo-advisers continue to
grow in popularity with investors, especially millennial investors, at least
one regulator is taking a closer look. On July 14, 2016, Massachusetts
Secretary of the Commonwealth William Galvin issued a policy statement
addressing the use by investment advisers under his jurisdiction of third-party
robo-advisers.
This follows a similar policy statement by Secretary
Galvin in April 2016 addressing fully-automated robo-advisers. The more
recent guidance urges IAs to provide highly-specific disclosures to clients
about a firm’s relationships with robo-advisers, the purported benefits and
limitations of using a robo-adviser, and, perhaps most importantly, the
multiple layers of fee structures.
A robo-adviser provides an
automated service, without the need for traditional advisor relationships, by
employing asset-allocation models and algorithms to invest client
portfolios. According to the Massachusetts policy statement,
robo-advisers have experienced significant growth “based in large part on their
perceived simplicity, their ease of accessibility, and their ability to service
investment advisory clients who may not have sufficient assets to establish a
relationship with a traditional investment adviser.” Massachusetts has
stressed that robo-advisers are investment
advisers, and that they owe the fiduciary duties of loyalty and care to their
current and prospective investment advisory clients.
The state’s guidance makes
clear that, to satisfy their fiduciary obligations, investment advisers
registered in Massachusetts have a high disclosure burden any time they enter
into a sub-advisory relationship with a robo-adviser. This includes the
following:
The IA should identify the
proposed robo-adviser to its clients and provide a detailed explanation of its
services. Specifically, the IA should explain: (i) why it chose the
proposed robo-adviser as opposed to others; (ii) any conflicts of interest that
may arise; (iii) any additional fees that may be incurred; and (iv) the
perceived advantages and disadvantages of the robo-adviser relationship.
These disclosures should be made to the client before the robo-adviser
relationship has been established.
The IA should inform those
clients, such as retail investors, who can receive robo-adviser services
directly that such services can be obtained without an intermediary, and
without paying an additional layer of advisory fees.
The IA should explain the ways
in which it provides value to its client over and above the value provided by
the robo-adviser. This might include, for example, assisting the client
in establishing financial and investment goals, providing financial planning
services, or evaluating the client’s overall investment portfolio. These
investment adviser services should be distinguished from those services that
will be provided by the robo-adviser.
The IA should explain the
services that it does not provide when it uses a robo-adviser. Most
robo-advisers use proprietary algorithms to make asset allocation
determinations in the client’s account, and most of them—or their broker-dealer
affiliates—effect trades in the client’s robo-adviser account. These
services typically would not be provided by the IA.
The IA should explain the type
of investment products used by the robo-adviser in its portfolio
structure. It is common for robo-advisers to use a pool of ETF securities
for client portfolios, the weightings of which are adjusted and rebalanced
algorithmically over time. The IA should consider, consistent with its
fiduciary obligations, whether such investment products are appropriate for its
individual clients.
The IA should avoid
boilerplate disclosures that are not tailored specifically to its robo-adviser
relationships. Many IAs use the services of compliance consultants to
assist in preparing regulatory disclosures—but they cannot delegate those
regulatory responsibilities, and bear the full responsibility of satisfying
their disclosure obligations, when they engage robo-advisers.
The guidance provided by
Secretary Galvin applies to investment advisers under his jurisdiction in
Massachusetts, but IAs not registered in Massachusetts should also be aware of
these issues and prepare for the inevitability of similar guidance from other
state and federal regulators. Massachusetts is ahead of the pack on this
issue, but will not be alone for long. We expect this to be a harbinger
of things to come.
The Massachusetts Policy
Statement can be found here:https://www.sec.state.ma.us/sct/sctpdf/Policy-Statement-State-Registered-Investment-Advisers-Use-of-Third-Party-Robo-Advisers.pdf
A version of this blog post
appeared in Compliance Reporter on Aug. 8, 2016. It can be accessed here.
No comments:
Post a Comment