Robo-Adviser as Investment Adviser

Managing one’s investments can be a very time-consuming process, which often leads investors, particularly wealthy investors, to turn to professional financial services providers. However, investors now have a new cost-effective option: robo-advisers. Compared to traditional investment advisers, who generally charge a service fee of 1-2% of assets under management and may even require a certain minimum investment, robo-advisers’ fees typically range from 0.09% to 0.45% depending on the service provider. By lowering the cost of professional investment advising, a greater number of non-wealthy individuals are more likely to invest their funds. However, traditional investment advisers are regulated by the Investment Adviser Act of 1940 (the "Advisers Act") and have to register with the SEC before providing financial services, but are robo-advisers also regulated in the same way? This article will introduce this new form of investment advising, the regime that regulates it and things to note before using a robo-adviser.

What is a Robo-Adviser?

According to the explanation given in the Investor Bulletin and the Guidance Update on robo-advisers by the SEC, the term "robo-adviser" generally refers to an automated digital investment advisory program. "Robo-advisers... use innovative technologies to provide discretionary asset management services to their clients through online algorithmic-based programs." In practice, the program starts with an investor filling out an online questionnaire to provide relevant investment information, such as financial goals, investment horizon, income and other assets and risk tolerance. Based on the provided information, the algorithm underlying the robo-adviser generates and maintains an investment portfolio for the investor. While the services and features of robo-adviser programs vary, they generally contain similar features, such as automatic rebalance and tax-loss harvesting, which vest robo-advisers with the power to automatically make investment decisions and execute transactions to maintain an optimal investment status and realize loss of investment to offset investment gain for tax purposes. The provider and investors agree to the features in the adviser agreement signed by the investor before they use the robo-adviser’s services.

Regulation Regime of Robo-Advisers

Investment firms utilizing robo-advisers are regulated investment advisers under the Advisers Act and should accept the same degree of scrutiny as traditional investment advisers, such as the obligation to register with the SEC using Form ADV to disclose legally required information and maintain compliance with the Advisers Act.

To address the uniqueness of the business model of robo-advisers, the SEC published Guidance on Robo-Advisers to help robo-adviser providers meet the requirements under the Advisers Act. Compliance with the Advisers Act can be divided into three main categories: meeting disclosure obligations, giving suitable investment advice and maintaining an effective compliance program. With regards to disclosure obligations, in addition to making full disclosure of material facts to investors under the robo-adviser's fiduciary duties as required by the Advisers Act, it is important for robo-adviser providers to pay attention to the effectiveness of communications and disclosures. Providers should also make clear the limitations and risks of the automated services by explaining the how the provider operates, incuding the level of human interaction it provides for investors, the way its algorithm generates investment suggestions and the scope and features of services it provides. Secondly, it is an investment adviser's fiduciary duty to provide investors with suitable investment advice that is in the best interest of the investors. For robo-advisers, it is important to design a questionnaire which is able to elicit necessary and sufficient information from investors to be able to provide high quality advice. Lastly, as required by Rule 206(4)-7 under the Advisers Act, a registered investment adviser must establish a compliance program to prevent violations of the Advisers Act, conduct annual reviews and designate a chief compliance officer to administer the implementation of the program. Robo-adviser providers should ensure that their compliance programs tackle the issues unique to their operation, such as monitoring the algorithm's performance and ensuring sufficiency of information elicited by the questionnaire.

The SEC also published an Investor Bulletin to help investors make informed decisions about whether to invest with the assistance of this new technology. Some important considerations that the SEC advises investors to take into account include how much human interaction investors need when determining their investment strategies, what information the robo-adviser considers when generating investment advice and whether the investment advice provided by the robo-adviser covers the investors' concerns or preference in investing, whether the investment approach and features fit their expectations and whether the fees and costs of services are agreeable.

The SEC's Recent Enforcement Actions Against Robo-Advisers

On December 21, 2018, the SEC issued a press release regarding the first enforcement actions initiated against two robo-adviser providers, Wealthfront and Hedgeable, for violations of the Advisers Act, including false disclosure and failure to maintain compliance programs. Wealthfront, the second largest robo-adviser provider based in California, falsely stated its performance of tax-loss harvesting services and failed to submit required documentation for advertisement. Hedgeable, the New York City-based robo-Adviser provider, published misleading information regarding its performance by comparing its rate of return with other providers in a misleading way. Both companies also failed to maintain compliance programs as required by the Advisers Act. Wealthfront and Hedgeable settled their cases with the SEC, accepting penalties of $250,000 and $80,000 respectively. C. Dabney O’Riordan, Chief of the SEC Enforcement Division’s Asset Management Unit, said in a press release by the SEC on Dec. 21, 2018,“Technology is rapidly changing the way investment advisers are able to advertise and deliver their services to clients... Regardless of their format, however, all advisers must take seriously their obligations to comply with the securities laws, which were put in place to protect investors.” Advancements in Fintech have resulted in constant updates of SEC guidance and attempts to educate investors about the risks of new technologies. Investors should also inform themselves of the services they are using and be aware of the underlying risks.

Yi-Yu Wang is an LL.M. candidate for Corporation Law at NYU School of Law. Prior to NYU, she received her LL.B. from National Taiwan University School of Law, the top university and law school in Taiwan. After completing her LL.B., she entered into LCS & Partners, one of the largest law firms in Taiwan, and focused her practice area on M&A and Capital Market. She is admitted to practice law in Taiwan.