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Report: Robos Not Ready for ERISA Plans

There’s a lot of buzz around robo-advisors, and no small amount of controversy — but a new research paper calls into question not only their favorable positioning under the Labor Department’s fiduciary reproposal, but their suitability for ERISA plans generally.

In the report, “Robo-Advisors: A Closer Look,” attorney Melanie Fein notes that robo-advisors have been criticized for ignoring key information relevant to a user’s investment needs, such as the user’s contribution and withdrawal schedule, dependents, other sources of wealth, monthly expenses, tax situation, and anticipated expenditures (such as college tuition), and that a human adviser can offer personalized investment guidance, and encourage investors to save more, diversify and engage in less speculative trading. She also notes a joint investor alert issued earlier this year by the Securities and Exchange Commission (SEC) and Financial Industry Regulatory Authority (FINRA) cautioning that, among other things, a robo-advisor may give advice based on incorrect assumptions, incomplete information or circumstances not relevant to the user.

As it relates to ERISA plan applications, and the Labor Department’s fiduciary reproposal specifically, Fein notes that, as proposed, the DOL’s best interest contract exemption does not apply to compensation received by a robo-advisor, and that the DOL in its Federal Register notice states that “…such an exemption — and its stringent requirements — is not necessary because the marketplace for robo-advice is evolving in ways that “both appear to avoid conflicts of interest that would violate the prohibited transaction rules, and minimize cost.”

Indeed, Fein, who describes herself as an attorney who advises clients on matters of banking, securities and trust law, and who recently served on the adjunct faculty of Yale Law School teaching banking and financial regulation, goes on to state that the DOL’s position seems to be that, because robo-advisors give investment advice without any personal interaction or advice from an individual adviser, they are not even ERISA fiduciaries, and there is no need to regulate them as fiduciaries under ERISA since they avoid conflicts of interest and minimize cost, though she challenges both assumptions in her paper.

Based on her analysis of the user agreements for three leading robo-advisors (though they are not named), she states that they:


  • do not acknowledge their fiduciary status and indeed some seek to contract it away;

  • do not commit to give advice that is in the customer’s best interest, and are not structured to do so; and

  • do not agree to receive no more than reasonable compensation.


Accordingly, she explains that “despite being touted by the DOL as providing beneficial ‘low-cost’ investment advisory services to retirement investors, the leading robo-advisors do not meet the DOL’s proposed fiduciary standards.”

Fein notes that not only are robo-advisors not structured to comply with the prudent investor standard of care or to act in the client’s best interest, “…they rely on the client to act in his or her own best interest. The DOL’s endorsement of robo-advisors seems especially misplaced in light of the fact, as shown above, that the leading robo-advisors are structured to exclude ERISA retirement accounts for eligibility for their services.” Fein concludes that robo-advisors (at least the three examined) “…are not designed for retirement accounts subject to ERISA and should be approached with caution by retail and retirement investors looking for personal investment advice.”

She explains that “…rather than characterize robo-advisors as providing personal investment advice, it is more accurate to describe them providing online tools for a client to use in determining the client’s own risk tolerance and investment preferences and then enabling the client to subscribe to an investment strategy based on asset allocation formulas recommended for investors with similar preferences.”

In this regard, she notes that robo-advisors are similar to… mutual funds.

Fein notes that this paper was prepared for Federated Investors, Inc. In case Senator Warren is wondering

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