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Industry Spotlight > Broker Dealers

FINRA Warns BDs to Follow Robo-Advice Rules

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Noting the proliferation of automated advice, the Financial Industry Regulatory Authority released a report reminding broker-dealers of their digital investment advice obligations under FINRA rules, specifically regarding suitability of recommendations, conflicts of interest, customer risk profiles and portfolio rebalancing.

FINRA Chairman and CEO Richard Ketchum noted in releasing the 17-page report on Tuesday that as robo-advice 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.”

A recently released report by Cerulli Associates noted that as a result of the upcoming release of the Department of Labor’s rule to amend the definition of fiduciary on retirement accounts, large broker-dealers will seek to serve small balances in individual retirement accounts on a flat-fee and fiduciary basis using developing technology, and that digital advisor platforms may provide a solution for broker-dealers to work with low balances in IRAs.

Susan Axelrod, FINRA’s Executive VP for Member Regulation, told ThinkAdvisor in an email comment on Thursday that “the use of digital investment advice tools and services is growing, irrespective of new fiduciary rules.”

The report is designed to remind FINRA member firms offering digital advice services “of their investor-protection obligations under our rules,” Axelrod said.

FINRA told firms to ensure that have policies and procedures in place in the following five areas:

  • Besides testing advice tools’ algorithms, including initially assessing the methodology of digital tools and the quality and reliability of data inputs, FINRA wants firms to perform and “ongoing evaluation” and test such tools to ensure they are performing as expected, and to determine whether models used by a tool remain appropriate as market conditions change.

  • Firms also need to assess both a customers’ risk capacity and risk willingness, and addressing contradictory or inconsistent responses in customer-provided information.

  • Financial professionals at broker-dealers must also understand the key assumptions and limitations of individual digital investment advice tools, and determine when use of a tool may not be appropriate for a client.

  • Broker-dealers are also responsible for determining the risk, return and diversification characteristics of a portfolio that is suitable for a given investor profile, and mitigating – through avoidance or disclosure – conflicts that can arise through the selection of securities for a portfolio.

  • Broker-dealers must provide descriptions of how the tool’s rebalancing works and set out procedures that define how the tools will act in the event of a major market movement.

– Related on ThinkAdvisor: DOL Rule Will Mean Cheaper Annuities, More Robo-Advice: Cerulli


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