Regulatory and Compliance Risks for Digital Advisers

February 13, 2017

Digital advisers (sometimes referred to as robo-advisers or internet advisers) face increasing regulatory scrutiny, as well as unique compliance risks. Within a year, the U.S. Securities and Exchange Commission (“SEC”), Financial Industry Regulatory Authority (“FINRA”), and the Massachusetts Securities Division (“MSD”) have each issued guidance and statements addressing digital advisers.

  • The SEC and FINRA joint investor alert on Automated Investment Tools in May 2015 warned investors to be wary of certain terms, limitations, and information safeguarding concerns when using automated investment tools.
  • FINRA’s Report on Digital Investment Advice in March 2016 addressed both broker-dealer and investment adviser firms that use digital investment advice tools. In the report, FINRA made several recommendations to digital advisers regarding governance, supervision, suitability, and employee training.
  • In the Robo-Advisers and State Investment Adviser Registration policy statement issued in April 2016, the MSD expressed its concern regarding digital advisers’ ability to meet its fiduciary obligations.
  • In the State Registered Investment Advisers’ Use of Third Party Robo-Advisers policy statement issued in July 2016, the MSD provided guidance to such state registered investment advisers on how to best comply with the Massachusetts Uniform Securities Act and meet the fiduciary duties owed to clients.
  • Former SEC Chair Mary Jo White indicated at the SEC’s public forum on financial technology (“Fintech”) in November 2016 that the SEC was focusing on digital advisers with respect to fiduciary obligations, disclosures, client investment suitability, compliance program, safeguarding client data, and business continuity planning.
  • The SEC’s Examination Priorities for 2017 specifically stated that the SEC will examine registered investment advisers and broker-dealers that offer electronic investment advice including robo-advisers. The exams will focus on compliance programs, marketing, investment recommendations, data protection, conflicts of interest, and oversight of algorithms.

As digital advisers continue to grow in size and number (some estimate the industry will grow to $2.2 trillion by 2020), we expect increased regulatory scrutiny. Digital advisers are encouraged to review their compliance programs in light of the regulators’ comments in order to ensure compliance and examination preparedness. In ACA’s opinion, the following areas present significant compliance risks to digital advisers:

  • Know your client and suitability;
  • Meeting fiduciary obligations;
  • Operating an unregistered investment company;
  • Oversight and control of algorithms;
  • Cybersecurity and safeguarding client information;
  • Business continuity and disaster recovery planning;
  • Fund manager due diligence and selection, as well as any conflicts with allocating to affiliated entities;
  • ERISA compliance related to 401Ks and IRAs;
  • Best execution;
  • Operational issues related to supporting smaller accounts;
  • Website and social media marketing; and
  • Employees inexperienced with compliance.

How Can ACA Help?
ACA is a leading global provider of regulatory compliance products, performance services, cybersecurity and technology risk assessments, and technology solutions to the financial services industry. Founded in 2002 by former SEC examiners and state regulators, ACA’s products are developed and provided by a team comprised of former SEC, FINRA, FSA, NYSE, NFA, and state regulators, as well as former senior managers and technologists from prominent financial institutions and consulting firms. ACA serves a diversified base of leading investment advisers, private fund managers, commodity trading advisors, investment companies, and broker-dealers.

For More Information
If you have any questions about compliance for digital advisers or ACA's consulting services, please contact Giselle Casella, Senior Principal Consultant or your ACA consultant.