Electronic investment advice, automated investment tools, digital advice services — whatever you call them, robo-advisors have experienced explosive growth in the investment advisory space in recent years. And regulators are struggling to keep up.
How long will this period of loose regulatory oversight continue? Will this current period of market volatility reveal fault lines that spur regulators to take a closer look? There are signs that increased regulatory scrutiny of robo-advisory platforms may be on the horizon.
The term “robo-advisor” means different things to different people. For our purposes here, think of robo-advisors as automated investment platforms — available online or through an app — that rely on computer algorithms to determine asset allocation models that align with investors’ investing experience, investment objectives, risk tolerance and investment time horizon, among other things (i.e., suitability information).
The asset allocation models selected through these automated investment tools usually consist of appropriately weighted, diversified baskets of ETFs.
Because robo-advisors charge low (or no) fees, typically require low minimum balances and include helpful features like automatic investing/rebalancing, they have become increasingly popular investment tools for retail investors.
Indeed, by any measure, the robo-advisory market segment has exploded in recent years, and the pace of growth appears to be accelerating. According to Statista, in 2019 U.S. robo-advisors had $283 billion in assets under management (up 10% over 2018 and up roughly 16% since 2017).
LearnBonds estimates that AUM of U.S. robo-advisors could jump as high as $1 trillion in 2020. And we should expect corresponding rises in the number of users/investors — from 13.1 million users in 2017 to an anticipated 70.5 million users in 2020, and as many as 147 million users by 2023. (It is worth noting, of course, that recent market events could meaningfully depress the actual figures for 2020.)
The staggering growth of the industry has given rise to new services (like interest-bearing savings accounts or debit cards issued by robo-advisors), new fee structures and new market entrants — indeed, nearly every major U.S. bank now has a digital advice service.
A Closer Regulatory Look?
But regulators haven’t kept up with innovation in the robo-advisory space. There has been precious little scrutiny of robo-advisory firms or platforms, and the few examples of enforcement actions involving robo-advisors largely reflect instances of regulators applying elements of the existing regulatory framework to these innovative investment platforms.
Indeed, there have been only six noteworthy enforcement actions against robo-advisors (four by the Financial Industry Regulatory Authority and two by the Securities and Exchange Commission), and all involve fairly routine charges: failure to create or provide customer records, failure to report trade data, failure to preserve electronic communications, reliance on misleading marketing materials or advertisements that overstate performance and, reliably, failure to develop or implement adequate written supervisory procedures.
There have been no enforcement actions that really drive at the heart of the robo-advisory model.