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Advisors Must Tell Clients About Their Robo Use, State Regulator Says

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On the same day that robo-advisor Betterment announced it had hit the $5 billion asset mark, Massachusetts regulators issued guidelines for financial advisors using such services to manage client assets.

Advisors must adhere to the disclosure policies in order to “best comply with the Massachusetts Uniform Securities Act and meet the fiduciary duties owed to their clients,” according to Commonwealth Secretary William F. Galvin, the state’s top securities regulator.

The state’s 700 registered investment advisors also are asked to inform investors of any and all fees connected with the use of third-party robo-advisors. Galvin’s office says it will review all fees charged to determine whether an advisor’s fees “are excessive.”

“My office has recently raised serious concerns as to whether and/or how a robo-advisor can act as a fiduciary, given the structure in which they work. If the state-registered investment advisor fills that gap and provides services not provided by the robo-advisor that is a positive step,” Galvin said in a statement.

“It is vital, however, that investors are fully aware of the role robo-advisors play in the handling of their accounts and the limitations, restrictions and fees which result,” he explained.

As outlined in the state guidance, advisors must:

  • Clearly identify the sub-advisor as a robo advisor and explain the services provided by the third-party robo-advisors;
  • Inform clients that they could receive asset allocation services directly from the third-party robo-advisor;
  • Detail the ways in which state registered advisors provide value to the client for its fees;
  • Specifically identify the services that the advisor cannot provide to the client;
  • Make clear to the client that the third-party robo-advisor may be limited in the types of investment products available to the client: and
  • Use unique, distinguishable language to describe the services of the investment advisor and the third-party robo-advisor.

According to Cerulli Associates’ analysis in 2015, robo-advisors – which rely on asset allocation models and algorithms to invest client portfolios, typically in exchange-traded funds – could see their assets under management jump 2,500% by 2020 to nearly $490 billion.

Fiduciary Focus

Robo-advisors and traditional financial advisors have the same fiduciary duty, the Massachusetts regulators said in a report in April. The Securities and Exchange Commission and the Financial Industry Regulatory Authority jointly cautioned investors last year that such automated tools “may rely on assumptions that could be incorrect or do not apply to [an investor’s] individual situation.” As a result, such tools “may suggest investments (including asset-allocation models) that may not be right” for a client.

As the Massachusetts regulators said in April: “Robo-advisors in the commonwealth cannot fully satisfy their fiduciary obligations if they fail to perform the initial and ongoing due diligence necessary to act in the best interests of their clients. Specifically, robo-advisors’ failure to conduct due diligence, as well as robo-advisors’ depersonalized structure, may render them unable to provide adequately personalized investment advice and make appropriate investment decisions.”

For instance, the online questionnaires used by robo-advisors may limit their ability “to spot clients with diminished capacity or clients who may not understand their financial picture sufficiently to provide accurate answers to the questions asked.”

“Many robo-advisory agreements go so far as to require indemnification by the client for any account losses. Such indemnification agreements have not been commonplace in human advisory relationships and may come as a surprise to current robo-advisory clients,” the state explained earlier this year.

Galvin’s office believes that fully automated robo-advisors “may be inherently unable to act as fiduciaries and perform the functions of a state-registered investment advisor.” Until federal regulators issue rules governing them, his office plans to evaluate them using the policies it has issued “on a case-by-case basis.” 



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