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New SEC robo advisor guidance spotlights disclosure, client communication

The SEC has sent perhaps its clearest signal yet that that robo advice platforms are here to stay, offering guidance to the industry, along with an investor bulletin that together seem to legitimize automated investment offerings, while also warning firms about steps they must take to ensure they are in compliance.

In its directives, the SEC notes that firms offering digital advice operate under an array of models, with some offering highly automated, algorithm-driven services, while others layer in a higher level of human interaction.

Taken together, however, the various platforms "represent a fast-growing trend within the investment advisory industry, and have the potential to give retail investors more affordable access to investment advisory services as well as change the competitive landscape in the market for investment advice," the commission says.

Despite the arguments put forward by some industry groups, the SEC notes that robos generally are covered under the 1940 Investment Advisers Act, subjecting them to the same regulatory and fiduciary obligations as traditional shops.

The new guidance puts a focus on how robo offerings communicate with their clients, calling for heightened disclosures of how firms' business models are structured and how they develop their investment strategies.

The robo phenomenon has been the subject of mounting interest at the SEC, with staffers at the compliance and investment management divisions taking a hard look at the issue, which also came under discussion at a financial technology forum convened last November.

The SEC also published an investor bulletin, cautioning consumers to weigh how much human interaction a robo platform offers, the information it collects and how it generates recommendations, as well as the fees it charges.

"This information is designed to help investors tap into the opportunities that fintech innovation can provide while ensuring fairness and investor protection," Michael Piwowar, the acting chair of the SEC, says in a statement.

In some areas, the SEC's guidance updates and amplifies the compliance message it has been sending advisors for decades. The authors stress the importance of thorough disclosures about conflicts of interest with third parties, for instance, but also note that digital advice firms that operate with minimal human interaction with clients might need to take a hard look at how they convey those messages to clients.

"Because of robo advisors' reliance on online disclosures to provide such information, there may be unique issues that arise when communicating key information, risks and disclaimers," the guidance states. "We therefore remind robo advisors to carefully consider whether their written disclosures are designed to be effective."

The guidance calls on robo advisors to develop meaningful disclosures detailing their business models and risks, including an explanation of how algorithms factor into the investment recommendations they produce.

The SEC also expects firms to detail the extent of human involvement in their digital offerings, including the circumstances that might see a human override the recommendations of the platform — a reference to Betterment's controversial decision to temporarily suspend trading the morning after the Brexit vote last June.

The guidance cautions firms against making bogus claims about the scope of the advice they offer through a robo platform, to avoid "creating a false impression" by touting a platform for providing a more wide-ranging service than it actually does, which "may materially mislead clients."

SEC staffers are also suggesting that firms revisit the ways they collect information from clients to develop an investor profile. In the area of robos, this is commonly done via an online questionnaire, though the commission notes that the length and level of detail involved in those documents vary considerably.

Nevertheless, given that robos are subject to the same general regulatory requirements as traditional shops, it is incumbent on firms to ensure that they are collecting sufficiently detailed information about factors like risk tolerance and investment horizon to produce suitable recommendations.

"An investment advisor's fiduciary duty includes an obligation to act in the best interests of its clients and to provide only suitable investment advice," the commission writes. "Consistent with these obligations, an investment advisor must make a reasonable determination that the investment advice provided is suitable for the client based on the client’s financial situation and investment objectives."

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