The SEC has issued a new Risk Alert warning about widespread compliance issues among advisers providing robo-advisory services, as well as with those who offer discretionary investment advisory programs.
Noting that it has seen an uptick in the number of advisers providing digital investment advisory services to their clients, the SEC—as part of its Electronic Investment Advice Initiative (dubbed “eIAInitiative”)—set out to gain a better understanding of the practices of advisers providing such services.
This included advisers who provide robo-advisory services to employer-sponsored retirement plans and retail investors, as well as those who sold, licensed or otherwise granted interactive, digital platform access to third parties, such as advisers, broker-dealers and banks. In particular, the SEC examined how robo-advisers were operating their firms, providing advisory services to their clients, and satisfying their regulatory obligations, with a focus on how they were upholding their fiduciary duties and acting in their clients’ best interests.
In the 13-page Risk Alert, Observations from Examinations of Advisers that Provide Electronic Investment Advice, the SEC notes that nearly all examined advisers received a deficiency letter observing issues in the areas of compliance, portfolio management and performance advertising. Among the SEC’s observations:
- most advisers had inadequate compliance programs, typically because of either a lack of written policies and procedures or having ones that were insufficient for their operations;
- many were not testing the investment advice generated by their platforms to clients’ stated or platform-determined investment objectives or otherwise satisfying their duty of care;
- more than half of the advisers examined had advertisement-related deficiencies, including misleading statements or inadequate disclosures; and
- many advisers were relying on, but not acting in accordance with, the Internet adviser exemption and Company Act Rule 3a-4.
Compliance Programs. With respect to electronic investment advice, many advisers did not include elements in their policies and procedures specific to their use of an online platform or other digital tools, such as assessing whether:
- algorithms were performing as intended;
- asset allocation and rebalancing services were occurring as disclosed; and
- data aggregation services did not impair the safety of clients’ assets due to access to clients’ credentials.
The SEC also observes that some advisers failed to undertake a sufficient review of their policies and procedures at least annually, as well as comply with the “Code of Ethics Rule.”
Portfolio Management. Many advisers also 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. The SEC also observed that, in some cases, adopted policies and procedures were either inadequate or not followed.
The SEC notes that while advisers commonly used questionnaires to collect client data, some firms relied on just a few data points to formulate investment advice, raising concerns that the questions “did not elicit sufficient information to allow the adviser to conclude that the advice was suitable and appropriate.” In addition, many advisers 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.
The SEC also observed inaccurate or incomplete disclosures in many advisers’ Form ADV filings, including those related to conflicts of interest, advisory fees, investment practices and ownership structure.
Performance Advertising and Marketing. Noting that more than half had advertisement-related deficiencies, the staff observed that advisers made misleading or prohibited statements on their websites, such as vague or unsubstantiated claims regarding advisory services provided, investment options available, performance expectations and costs incurred in investing.
Registration Matters. While noting that this has been a common finding for many years, the SEC found that nearly half of the advisers claiming reliance on the internet adviser exemption were ineligible to rely on the exemption and many were not otherwise eligible for SEC registration.
Discretionary Investment Advisory Programs. During its examinations on the use of discretionary investment advisory programs, SEC staff assessed, among other things, whether the programs provided each retail client with individualized treatment and enabled clients to maintain certain indicia of ownership of the securities in their accounts as required for reliance on Company Act Rule 3a-4.
Among the SEC’s findings, advisers were observed:
- recommending programs that commonly provided the same or similar investment advice on a discretionary basis to a large number of their advisory clients, frequently using asset allocation portfolios that they, an affiliate or a third-party created;
- claiming that programs they sponsored or operated were relying on Rule 3a-4, but the programs or adviser did not comply with all the provisions of the safe harbor;
- using questionnaires to gather information pertinent to providing individualized advice that included a limited number of data points, potentially increasing the risk of not providing clients with individualized advice or acting in their clients’ best interests; and
- not allowing clients to impose reasonable restrictions or placed obstacles impeding their ability to do so.
Compliance Improvement
The Risk Alert further outlines various compliance practices for advisers to use in developing and maintaining effective policies and procedures under the compliance rule. Among other things, the SEC encourages advisers providing electronic investment advice to review their:
- portfolio management practices and related disclosures;
- performance advertising and marketing materials; and
- written policies and procedures, including the implementation and testing of those policies and procedures, to ensure that they are consistent with the Advisers Act and other federal securities laws.
The SEC also encourages advisers relying on the internet adviser exemption to review their registration eligibility. Moreover, advisers that recommend discretionary investment advisory programs are encouraged to assess whether clients are being provided with individualized advice and whether sufficient policies and procedures are being employed to prevent such programs from being deemed unregistered investment companies and securities.
