SEC Finds Widespread Deficiencies Among Robo-Advisors

The Securities and Exchange Commission’s exam division highlighted Tuesday in a risk alert compliance deficiencies among robo-advisors — namely their advertising practices, as well as a lack of policies and procedures around rendering investment advice.

In the risk alert, the division states that while advisors have been providing automated digital investment advisory services to retirement plan participants and retail investors for more than two decades, the division “has recently observed a significant increase in the number of investment advisers choosing to provide automated digital investment advisory services to their clients.”

These advisors either exclusively provide online services or supplement their traditional investment advisory services by using proprietary software, third-party software or a combination.

“Millions of investors, individually and through their employer-sponsored retirement plans, now entrust their savings to advisers that provide their investment advisory services online, via mobile applications, or both (also known as robo-advisers),” the alert states.

The exam staff, as part of their Electronic Investment Advice Initiative, focused on how robo-advisors were upholding their fiduciary duty to provide clear and adequate disclosure regarding the nature of the advisors’ services and performance history and act in their clients’ best interests.

Nearly all of the examined advisors received a deficiency letter, with observations most often noted in the areas of:

• compliance programs, including policies, procedures and testing;
• portfolio management, including, but not limited to, an advisor’s fiduciary obligation to provide advice that is in each client’s best interest; and
• marketing/performance advertising, including misleading statements and missing or inadequate disclosure.

For instance, the SEC found that robo-advisors either lacked written policies and procedures that would allow the firms to develop a reasonable belief that the investment advice being provided to clients was in each client’s best interest based on the client’s objective, or adopted policies and procedures that were inadequate or not followed.

“A review of practices revealed that, while advisers commonly used questionnaires to collect client data, some firms relied on just a few data points to formulate investment advice,” the alert states. “This raised the concern that the questions did not elicit sufficient information to allow the adviser to conclude that its initial and ongoing advice were suitable and appropriate for that client based on the client’s financial situation and investment objectives.”

Further, many advisors “did not periodically evaluate whether accounts were still being managed in accordance with the clients’ needs, such as by inquiring about any changes in their financial situation or investment objectives or having clients update or retake their questionnaires,” the alert states.

The exam also found that more than one-half of the advisors had advertisement-related deficiencies.

For example, the staff observed that the advisors:

• made misleading or prohibited statements on their websites, such as: using vague or unsubstantiated claims that could cause an untrue or misleading implication or inference to be drawn regarding the advisory services provided, investment options available, performance expectations, and costs incurred in investing (e.g., a comparative analysis of adviser-offered versus other products and services);
• misrepresented Securities Investor Protection Corp. (SIPC) protections by implying that client accounts would be protected from market declines;
• used press logos (e.g., ABC, CNN, Forbes) without links or disclosure that would explain their relevance; and
• referred to, or provided links to, positive third-party commentary, without disclosing the relevance, any conflict of interest (e.g., advisor compensation), or both.