The SEC issued guidance for investment advisers addressing robo-adviser programs. Robo-advisers are registered investment advisers that use computer algorithms to provide investment advisory services online with limited human interaction. The guidance focused on advisers operating rob-advisers meeting disclosure, suitability and compliance obligations under the Investment Advisers Act.
An adviser offering a robo-adviser through a web site or other medium, should consider providing the following:
• A statement that an algorithm is used to manage individual client accounts;
• A description of the algorithmic functions used to manage client accounts (e.g., that the algorithm generates recommended portfolios; that individual client accounts are invested and rebalanced by the algorithm);
• A description of the assumptions and limitations of the algorithm used to manage client accounts (e.g., if the algorithm is based on modern portfolio theory, a description of the assumptions behind and the limitations of that theory); A description of the particular risks inherent in the use of an algorithm to manage client accounts (e.g., that the algorithm might rebalance client accounts without regard to market conditions or on a more frequent basis than the client might expect; that the algorithm may not address prolonged changes in market conditions);
• A description of any circumstances that might cause the robo-adviser to override the algorithm used to manage client accounts (e.g., that the robo-adviser might halt trading or take other temporary defensive measures in stressed market conditions);
• A description of any involvement by a third party in the development, management, or ownership of the algorithm used to manage client accounts, including an explanation of any conflicts of interest such an arrangement may create (e.g., if the third party offers the algorithm to the robo-adviser at a discount, but the algorithm directs clients into products from which the third party earns a fee);
• An explanation of any fees the client will be charged directly by the robo-adviser, and of any other costs that the client may bear either directly or indirectly (e.g., fees or expenses clients may pay in connection with the advisory services provided, such as custodian or mutual fund expenses; brokerage and other transaction costs);
• An explanation of the degree of human involvement in the oversight and management of individual client accounts (e.g., that investment advisory personnel oversee the algorithm but may not monitor each client’s account);
• A description of how the robo-adviser uses the information gathered from a client to generate a recommended portfolio and any limitations (e.g., if a questionnaire
is used, that the responses to the questionnaire may be the sole basis for the robo-adviser’s advice; if the robo-adviser has access to other client information or accounts, whether, and if so, how, that information is used in generating investment advice); and
• An explanation of how and when a client should update information he or she has provided to the robo-adviser.
Practical Perspectives: Robo-adviser programs must be carefully designed, implemented and disclosed. Compliance obligations do not go away simply because a robo-program is at work!
SEC Guidance Update: https://www.sec.gov/investment/im-guidance-2017-02.pdf