I recently read with interest Melanie Waddell’s Oct. 7 story, “Under ’40 Act, Robo-Advisors Are Fiduciaries: Morgan Lewis Lawyers,” about a new white paper by that New York-based international law firm titled “The Evolution of Advice; Digital Investment Advisers as Fiduciaries.” Like most folks in the advisory industry these days, I suspect, I’m curious about so called robo advisors, and the role that they will eventually play in retail advice giving. And having written over the past couple of years a number of articles about the potential and shortcomings of today’s robos, the paper’s title caught my eye, since it contradicts conclusions made by other observers.
The paper’s authors, Jennifer Klass and Eric Perelman, do a nice job of detailing why robos qualify as investment advisers under the Investment Advisers Act of 1940 and therefore are, in fact, fiduciaries for their clients. “The fact that digital advisers do not interface with their clients in the same way as traditional advisers does not mean that they are not fiduciaries to their clients,” they wrote, “or that they cannot fulfill the fiduciary standards that govern an investment advisory relationship.”
Yet I have to admit to being a bit puzzled by some of their descriptions of how robos meet those duties. “One of the positive features of digital advisers from a fiduciary perspective is that they typically present fewer conflicts of interest. As fiduciaries, all advisers owe their clients a duty of loyalty. At common law, this involves refraining from acting adversely or in competition with the interests of clients, and not using clients’ property for the adviser’s benefit or for that of a third party. The duty of loyalty consists of the principles that advisers deal fairly with clients and prospective clients,” they wrote.
“By emphasizing transparent and straightforward fee structures, prevailing digital advice business models inherently minimize conflicts of interest associated with traditional investment advisers,” they continued. “Digital advisory offerings are typically comprised of ETFs that, in comparison to mutual funds, offer little room for revenue streams and payment shares that would otherwise create a conflict of interest for investment advisers (e.g., 12b-1 fees, subtransfer agent fees). The absence of such compensation factors means that comparatively fewer conflicts of interest are present even where digital advisers are affiliated with some of the ETFs that they recommend. […] Moreover, digital advisory solutions eliminate the representative-level conflicts of interest typically present in the nondigital advisory context because there is little or no role for financial advisors who receive incentive-based compensation in an online offering.”