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Regulators scrutinize Betterment after trading delay

Betterment is facing regulatory scrutiny for its Brexit trading delay decision, and the outcome of the case will set an example for the rest of the digital advice industry, observers say.

Just as the New York-based robo adviser announced it was rebooting its RIA offering as Betterment for Advisors last Wednesday, it received a letter from the Massachusetts’ securities regulator which outlined "serious concerns regarding the inconsistent manner," in how it communicated the trading suspension in June.

Advisers were emailed a short note that morning about the delay from Betterment, followed later by a second note explaining the decision with some context. However, retail clients did not get any notice.

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"There is a presumption that Betterment Institutional was privy to information to which the rest of Betterment's clients did not have access," wrote Carole Anne Foehl, a Massachusetts’ securities examiner.

"There is also a presumption that this unequal access creates preferential treatment for some of Betterment's clients. Betterment, as an investment adviser, owes a fiduciary duty to treat all clients in a consistent and equitable manner."

The letter asks Betterment to amend its client communication policy and to send a copy of its changed policy to the regulator by Sept. 30.

William Galvin, Secretary of then Commonwealth of Massachusetts, speaks during a hearing of the House Financial Services Capital Markets Subcommittee on trading practices in the Mutual Fund industry in Washington, DC November 6, 2003. Photographer: Chris Kleponis/Bloomberg News.

When contacted, spokesmen for Betterment and the Massachusetts’ securities regulator said they had no comment on the letter.

Announcing the reboot of its RIA offering, Tom Kimberly, Betterment for Advisors' general manager, said the robo is finalizing a memo on its trading policies that will address concerns over its decision to delay trading.

MarketCounsel CEO Brian Hamburger — who counts Betterment as a client, but is not representing the firm in this matter — says the robo did not break any rules in how it communicated its delay decision.

"There's really nothing wrong, absent specific policies, with furnishing clients information based on their ability to digest and utilize that information," Hamburger says, noting that advisers on Betterment's RIA platform are not clients themselves, but acting as intermediaries. "They are professionals, and that is part of their professional judgment."

He describes the letter's language about fiduciary duty as "examiner bootstrapping," and compared it to letters advisers received seeking details about their business continuity plans in the wake of the 9/11 attacks, though no rules were in place regarding them.

"The fiduciary obligation is intended to ensure advisers are not putting their own interests ahead of clients," Hamburger says. "Regulators routinely use that language."

Ron Rhoades, Western Kentucky University professor and fiduciary advocate, argues the letter to fix practices is appropriate. His assessment is that Betterment breached its fiduciary duty by only informing advisers about the delay, thus indirectly giving one group of its clients more information than others.

"However, it is not clear to me that any clients were harmed by the breach of fiduciary duties," Rhoades says. "Had a communication occurred to all clients, as would have been proper, it does not appear that the outcome for the clients (or any subset of them) would have been different. Hence, the state securities regulator’s remedy appears justified."

The industry at-large will be watching what happens, as these sorts of queries will continue as regulators catch up with digital advice technology, notes Hardeep Walia, Motif co-founder and CEO, who also serves on FINRA's Technology Advisory Board.

"Anybody has to be very careful about going ahead of where they think the regulatory models are going," Walia says. "You can't say, 'We satisfy the fiduciary,' because then the state of Massachusetts says, 'Wait a minute, how do you exactly satisfy it?'"

Rhoades says the robo adviser's trading delay decision invited further scrutiny.

"Betterment’s suspension of trading during the Brexit incident is puzzling to many in the investment advisory community," he says. "There are far too often substantial market swings, in a single day, or over a period of a few days, that may trigger the need to rebalance client portfolios."

"It is not clear to me that any clients were harmed by the breach of fiduciary duties." — Western Kentucky University professor Ron Rhoades

Walia notes that BlackRock, which offers its own B2B robo advice platform, FutureAdvisor, recently called on regulators to scrutinize digital advice providers more carefully. "I think there will be a regulatory discussion about these tools, about how do you think about them, and are they doing enough," Walia says.

Fiduciary concerns about robo advisers were first raised in a white paper by D.C. securities law attorney Melanie L. Fein last year. Since then, FINRA has made its own recommendations about digital advice, while the SEC has said it is examining the technology.

The Massachusetts’ securities regulator has made no secret of its concern about digital investment advisers. In April, it released a policy that stated "fully automated robo advisers, as currently structured, may be inherently unable to carry out the fiduciary obligations of a state-registered investment adviser."

Hamburger notes the Secretary of the Commonwealth William F. Galvin has led state regulators in addressing issues under federal law, namely automated advice platforms and data security.

All robo advice platforms will be affected by the outcome of the new request, Hamburger adds.

"It will be interesting to see how Betterment responds," he says. "Sometimes firms, to placate regulators, take the path of least resistance. But firms have to take a look at what they are agreeing to do."

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