On episode 71 of the CCO Buzz, Compliance Consultant Adam Stutz joins us to discuss compliance considerations for robo-advisers.
CCO Buzz: Hello and welcome back to the CCO Buzz! We hope everyone is staying healthy out there, and if you’re stuck inside for a while, you might as well listen to a few CCO Buzz episodes! On this episode, Compliance Consultant Adam Stutz takes the time to discuss with us some compliance considerations for robo-advisers.
Adam Stutz: The popularity of robo-adviser platforms has grown immensely in the last decade. While there are varying opinions about their staying power in the marketplace, robo-advisers continue to remain a popular option for first-time investors, especially millennials, and one thing that is certain is that regulators expect robo-advisers to meet their regulatory obligations in the same manner as traditional advisers. Here are some key areas for robo-adviser platforms when thinking about compliance:
One, adequate disclosures are an important aspect of both traditional and robo-adviser businesses because they help inform the client about the nature of the service being provided, fees, risks, important regulatory and legal disclosures, and conflicts of interest. Robo-advisers, in particular, need to take into consideration the limited interactions that they can have with clients as well as the fact that their platforms rely on algorithms and they should ensure that their disclosures include important information, such as:
- An explanation of the business model including information regarding the algorithm that the robo-adviser employs including its assumptions, risks, limitations, and instances in which the robo-adviser will override the algorithm;
- Fees that will be charged by the robo-adviser and costs incurred by the client;
- Use of any third-party services in conjunction with management of the robo-adviser;
- The degree to which human advisers are involved;
- How information is gathered with respect to the client’s investment objectives, restrictions that can be placed on the account by the client, and how clients can contact the robo-adviser if their investment objectives, restrictions, and/or financial circumstances change; and,
- Where, when, and how key disclosures are presented to the clients.
Another area that is essential is the provision of suitable advice to clients and how the robo-adviser provides such advice and administers documentation of such advice. Robo-Advisers need to consider some key considerations including:
- Whether the online questionnaires used by the robo-adviser to gather information about the clients’ investment objectives, risk tolerance, and restrictions is adequate and addresses important information about expenses and other essential facts about the clients’ financial situation;
- Whether the information presented in the questionnaire is clear and concise;
- Whether there are procedures in place to address any inconsistencies in the questionnaire responses; and,
- How a client can update their investment objectives and why the robo-adviser remains a suitable option for the client.
Lastly, robo-advisers need to bear in mind important considerations for their compliance programs, specifically focused on their robo-advisory business, including:
- Making sure that the robo-adviser’s policies and procedures not only address compliance requirements for traditional investment advisers but also address specific aspects of their business including:
- Back testing algorithms and monitoring performance;
- Reviewing questionnaires to ensure that the investment advice being provided to the clients remains suitable;
- Making sure to periodically review and update disclosures regarding the robo-adviser platform including any changes to the algorithm;
- Performing due diligence on third-party service providers, especially those service providers who are instrumental to the administration of the algorithm;
- Evaluating and administering cybersecurity and privacy policies and procedures to ensure protection of client PII and other sensitive information; and
- Reviewing social media and other marketing channels to ensure that information being provided is not misleading and remains fair and balanced.
Here are some tips and suggestions on how compliance departments for robo-advisers can review their current compliance programs in light of these considerations:
- Collaboration with senior management, legal counsel, and/or your consultant to review, and if necessary, revise your disclosures in both your Form ADV and also on your websites and marketing materials to ensure clarity and consistency for clients;
- Review the most current investment questionnaires to ensure that they are asking the right questions of clients and that the information is easily understood by the client;
- If it hasn’t already been done, perform a review of the current client questionnaires [and] ensure that the investment objectives for the client remain suitable;
- Collaborate with your investment team to back test the algorithm, as well as performance, to verify that the algorithm is continuing to function properly;
- Review your policies and procedures manual to determine if your manual contains policies and procedures that specifically address your robo-adviser platform; [and]
- Make sure that you are performing regular due diligence on any third-party service providers who are involved in administering the algorithm or any other aspect of your robo-adviser platform.
These are just a few suggestions that may help you in administering compliance for your robo-adviser platform. As always, it is important to remember that your policies and procedures should be customized based on your specific business model because there is no one-size-fits-all solution for each firm. For additional assistance with robo-adviser compliance, please contact Core Compliance & Legal Services at (619) 278-0020 or visit us on the web at www.corecls.com.
CCO Buzz: Well that’s it for this week’s episode. If you’d like additional information, please check out our website at www.corecls.com. You can also follow us on Facebook, LinkedIn, or Twitter @CoreCls. Thank you, and we hope you tune-in to next week’s episode of the CCO Buzz.