The Importance of Data Protection and Cybersecurity: How to protect yourself from Cybersecurity risks of Robo-Advisers

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

What kind of information is your robo-adviser collecting from you? How will they store it? What security measures will they take to ensure your data is protected? Are the algorithms your investments are based on protected? These decisions lie in the hands of your robo-adviser – but what can you do?

Because of the sensitive information that is gathered from an investor, it is important for you to select a robo-adviser that will take the necessary security compliance measures to protect your confidential information and will prioritize data integrity.

Hack here, hack there – we hear about it all the time. Any industry is at risk: from the medical sector to the business sector, from the government sector to the military sector.  Only four months into 2017 and the IRS has already experienced a data breach putting nearly 100,000 taxpayers at risk. The increasing use of technology in the case of investors to meet their wealth management is no different than other sectors. And an industry- or sector-specific risk is also a risk for you.

THE SEC has emphasized the need to protect confidential and sensitive information related to these activities from third parties, including information concerning fund investors and advisory clients. These concerns include data protection, privacy and cybersecurity concerns.

What was the SEC’s recommendation in the Cybersecurity Guidance for registered investment companies and registered investment advisers? “An adviser generally should consider and address as relevant the operational and other risks related to cyberattacks.”

The  Guidance  suggests that robo-advisers consider adopting written policies and procedures addressing those risks, covering areas such as the development, testing and backtesting of algorithms and post-implementation monitoring, disclosure to clients of changes to algorithms that could materially affect their portfolios, and the prevention, detection of, and response to cybersecurity threats. The SEC also stressed the importance of including a communication plan with client to notify and update them about significant business disruptions that would materially impact ongoing client services (e.g., periodic updates to websites and customer service lines.)


The Potential Advantages of Robo-Advisers

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

Robo-advisers are overcoming many of the challenges individuals face today by providing solutions catered to a younger, tech-savvier, less financially literate, and less wealthy population. Additionally, robo-advisers are compensating for the decline in pensions offered by employers, providing accessible and cost-effective long-term advice for individuals with increased average life expectancy, and providing alternative vehicles for individuals who are now holding a higher amount of their savings and investments in the form of cash than ever before. Thus, it comes as no surprise that FINRA’s Report on Digital Investment quoted Aite Group’s  projection of global spending on digital wealth management initiatives tripling, rising from $4 billion in 2015 to $12 billion by 2019.

This success, in large part, is evidence of the potential advantages consumers have observed. Some of these potential advantages of using robo-advisers may include:

  • Lower Costs
    • Lower Advisory Fees – Fees are typically significantly lower and depend on account balances and the required account minimum, ranging from 0.00% to 0.75% (for an investment of $5,000). While these fees vary greatly across companies, it is still significantly lower than the minimum-1% charged by human financial advisers.
    • Lower minimum initial deposits – Minimum initial deposits to open an account with a robo-adviser ranges anywhere from $0 to $500 to $100,000, which are often significantly lower than using traditional human financial advisers.
    • Lower minimum investment amounts – Typically, human financial advisers require clients to have a minimum net worth or account balance (typically upwards of at least $50,000 – $100,00) whereas robo-advisers may require a significantly lower minimum balance ($500 or no minimum balance at all.
  • Customized options – Additional options that lead to efficient investment account management through fractional share, single stock diversification, direct indexing and tax management.
  • Efficient Method of Communication with clients – As individuals increasingly rely on written forms of communication (via e-mail and text messages), with many already accessing financial information from apps designed for mobile phones, communication about investments are no different.
  • Accessibility offers Ease and Convenience – Using a digital platform allows clients to conduct the transaction online, from start-to-finish, where they can simultaneously access an endless amount of information and research similar products and services – all in the convenience of their home and around their busy schedule.

Remember, while these may contribute to one individual’s successful investment portfolio, it may not fit your needs. This is why it’s important to weigh both the advantages and disadvantages of using robo-advisers.


The Downsides of Deferring to Robo-Advisers

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

Just like any other product, it’s important to do a cost-benefit analysis of whether this product is right for you. Here are the advantages and disadvantages of using a robo-adviser. Potential disadvantages of using robo-advisers may include:

  • Lack of a personal advisory relationship with a human adviser – While this may be an advantage for some, having a human adviser can be important when a person has questions about their product/portfolio or in cases where technical issues arise and automated answering services are unable to help. Another related disadvantage is that the client may be unable to get clarification about the contract.
  • No extensive information gathering stage – The questionnaire may not include all the necessary initial (or follow up) questions to fully evaluate your investment needs. Additionally, these questions may not be as tailored to your familiarity with investment products and communication style, as you may otherwise get from a human adviser. Furthermore, whereas a financial planner at a full-service firm can help integrate your finances, taxes, estate plans and other non-monetary concerns, a robo-adviser is limited in the services it can provide to you.
  • Limited means of communication – A client may only be able to communicate with an advisor through internet communication.
  • Client’s limited access to funds – robo-advisers can limit a client’s access to their funds in three ways.
    • Robo-advisers may have the discretionary option to delay a client’s access to funds. While it is not uncommon for companies to limit users’ access to their funds, some robo-adviser contracts state that the company has the right to impose a longer waiting periods, during which the client would not be able to trade with or withdraw those funds. More concerning are the agreements that give robo-advisers wide latitude to impose a longer or indeterminate waiting period without disclosing in the agreement what would warrant robo-adviser to take such actions.
    • Robo-advisers may require Clients to hold a certain amount of cash in their portfolio. This can be problematic for two reasons. The first reason is that a client may not be aware of the robo-adviser’s requirement to hold a specific amount or percentage of their portfolio in cash. The second reason is that depending on what triggers the rebalancing in your specific portfolio, this requirement may result in clients being required to hold more cash in accounts managed exclusively by robo-advisers than would be required under the traditional human advisor model. You can read more about FINRA’s view on effective practices and principles regarding rebalancing here.
  • The client may not be entitled to important notices – For example, a robo-adviser may not have to give notice to investor if there’s a change in the advisory agreement.
  • The decision-making responsibility may be shifted heavily from the robo-adviser to the client – As discussed in a previous post, a contract may place what has traditionally been an adviser’s responsibility (to make an informed decision, determine the appropriateness of the product, monitor client’s accounts and make suggestions based on the individual) onto the client.
  • Robo-adviser’s potentially decreased liability – Also discussed in the previous post was the potential for robo-advisers to contractually provide from indemnification provisions and disclaim duties and liabilities, as well as limit the scope of their relationship with the client.
  • Limited Portfolio Options – Because many robo-advisers use a standard formula or set of portfolios, if you have a unique situation, for example with differing time horizons, a robo-adviser’s asset allocation may not be the best fit for your needs.
  • Fees – In addition to advisory fees, it’s important to consider other fees that you may incur (both with human financial advisers and robo-advisers): trading fees, account maintenance fees, account transfer fees, wire transfer fees, checking account service fees, paper statement fees, account closing fees.


On Robo-Advisers: Cautionary Contract Clauses

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

Robo-advisers: are they really providing you with advice? Another look at your customer agreement may indicate otherwise…

Robo-advisers are no different from other product or service providers – you get what you pay for, and what you pay for is outlined in your contract. However, your relationship with your robo-adviser is different because it not only provides its service on a digital platform it’s also a service that may control a large part of your funds. Like any other big purchase, it’s important to read your contract carefully. And if it’s an electronic document, a quick search of keywords can lead you to the correct clause.

One attorney’s evaluation of robo-adviser contracts revealed several clauses that can be problematic for clients. It can be helpful to refer to your contract so you know the answer to the following questions:

  • Who is responsible for making the “right” decision?

Some contracts may shift the responsibility for making the right decision for the client to the client. Your contract may state:

  • The robo-adviser is only obligated to rely on the information that is provided by you and has no obligation to further verify that information.
  • The robo-adviser might also shift the account monitoring responsibility to the client (which can be problematic for clients who believe the robo-adviser has assumed this responsibility.)
  • The robo-adviser may state that it is the responsibility of the client to determine how appropriate the service and/or product offered by the robo-adviser for their individual needs.
  • What (if any) is the robo adviser’s fiduciary duty to you?

A closer look at your contract may reveal that your contract may minimize the robo-adviser’s fiduciary duty or limit the robo-adviser’s liability in another way:

  • The robo-adviser could disclaim a financial relationship with the client by stating that the robo-adviser is an “independent contractor” and thus, has no other relationship with the client.
  • On the other hand, the robo-adviser could claim that the only duty they have to you is a fiduciary duty and disclaim all other duties or liabilities.
  • Many robo-adviser contracts also provide that the client indemnifies the robo-adviser (along with any associated parties) from any claims, losses or damages to the client. This would mean that a client could not hold the robo-adviser responsible for any claims, losses or damages.
  • What happens if there’s a dispute?
    • Many contracts may require the client to waive any legal right to a court-ordered remedy and instead provide for mandatory arbitration of any disputes arising out of the contract or relationship

It is important to remember that these are only some of the different clauses you might find in your contract. While the contract may be a long document, it’s important to read through it carefully to determine what type of relationship you’re entering into with the robo-adviser. Like any successful relationship, both parties must understand the role they play in the relationship. Two keystrokes (simultaneously pressing Ctrl+F on Windows or pressing Command+F on Macs) can instantly search the document for a term, which can help guide you to the right section. Remember, it’s important to read the whole contract, especially definitions for any capitalized terms. This tactic will not only familiarize you with the agreement should you need to refer to it in the future, but this two-key tactic may prevent you from needing to refer to it altogether because both you and the robo-adviser know your respective roles under the agreement.

Taking a second look at your contract can save you money.


Would You Trust an Algorithm to Manage Your Investments?: Investor Tips on Robo-Adviser Use

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

With the rapid growth of automated investment tools, in February 2017, the SEC reissued FINRA’s 2015 Investor Alert, bringing into focus potential risks and limitations of these apparently simple tools. The Investor Alert arms investors with tips on how to navigate this new technological landscape.

Before anything else, both FINRA and SEC advise, make sure you review all disclosures for a particular auto-adviser and understand all of its terms and conditions. Pay particular attention to fees and charges that may be involved. Are there any fees and expenses associated with using the tool or with making an investment transaction? Although cheaper on its face, hidden fees of robo-advisers, including fees associated with a purchase or sale, may leave the service a lot less affordable than appears. If you chose to do so, how can you end your relationship with the robo-adviser? How long would it take for you to cash out on your investments? What is the privacy policy of the particular tool?  If anything is unclear, don’t hesitate to contact the automated tool sponsor directly.

Next, consider the tool’s limitations and assumptions. Every robo-adviser uses a specific methodology to generate its recommendations. This methodology should be revealed in the tool’s online disclosures.  Read these carefully.  Some of the assumptions the tool makes may be incorrect or may simply not reflect your needs or economic reality. A robo-adviser may be programmed not to react to market shifts – thus, while interest rates are raising, the robo-adviser may continue assuming that they remain low. The tool’s recommendations will not reflect economic market reality, and this misguided process will directly affect your wallet. Similarly, the robo-adviser may be programmed to only consider investments offered by an affiliated firm, inherently limiting your pool of options. Make sure you understand these limitations.

A robo-adviser’s recommendations may simply not be right for your financial needs and goals. Different tools assess different factors in generating their recommendations – including age, investment experience, tax situation, need for cash, or willingness to risk losing the investment for a higher return. Some of these factors may be more salient for your situation than others.  The more you understand how the tool works, what its limitations and assumptions are, the more likely it is that your choice will reflect, and meet, your needs.

It is equally important to recognize that the information the robo-adviser seeks from you and the information you provide in response directly affect its recommendations. Pay attention to the questions asked by the robo-adviser – the framing of the question will necessarily dictate your answer which in turn affects the generated recommendation. Carefully input your answers – a single mistake or oversight may result in recommendations not right for you.  Be aware that some tools may ask questions that are designed to fit you into its predetermined options. Again, if anything is unclear, ask the tool sponsor.

Finally, make sure you understand the tool’s privacy policy and protect your personal information. Some robo-advisers may use your information for purposes beyond mere investment advice. Watch out for scams designed to trick you into revealing personally identifiable information. For specific tips on how to safeguard your personal information, read the Investor Bulletin.

It is ultimately up to you to decide whether you wish to rely on a particular robo-adviser in making your investment decisions. How much human interaction – with its personalized service, human judgment, and potential oversight – is important to you?


How Do You Tell a Robo-Adviser What It Needs to Know?: Meeting the Suitability Requirements, Digitally

By Majda Muhic & Qudsia Shafiq, Spring 2017 IAC Student Interns

As a fiduciary, a robo-adviser has a duty to act in the best interest of its customers and to provide suitable investment advice. In order to make suitable recommendations, an investment adviser must first get to know their customer’s financial situation and investment objectives. How can a robo-adviser ensure that it meets these obligations?

Most robo-advisers collect client information through online questionnaires. This information is then used to generate a recommendation.  Considering the limited interaction between the digital tool and its customer, both the content and the framing of the questions are key. Some robo-advisers request only basic data – such as a customer’s age, financial situation, and goals. Others seek more detailed information including risk tolerance and investment horizon. The questions a robo-adviser asks, and the way in which it asks them, shape the customer’s answers and the generated recommendation.  The questions may also be the culprit of unsuitable advice.

Within this context, the SEC advises, it is key that the questions posed to the customer are designed to elicit enough information to ensure that any generated recommendations are appropriate for the individual customer’s financial situation and goals. Robo-advisers should ensure that their questions are framed in a way to do so.   Are the questions clear enough for the customer to understand?  Unless a customer knows exactly what the tool is asking for and has a way to clarify any confusion, the risk of unsuitable recommendation is high.

The SEC further emphasizes the need to flag and resolve any inconsistent customer responses.  If there is an inconsistency, the system should be designed to alert both the customer and the robo-adviser, and find ways to resolve them. Finally, if more than one possible recommendation is generated, or the customer ultimately chooses a portfolio not recommended by a robo-adviser, the SEC recommends that the tool explain to the customer why some portfolios may better suit their stated needs. Because robo-advisers can’t talk, pop-up boxes and various design features become the language of automated investment advice.


Atlanta Bar Association Elects Vath, Iannarone & Cleland (J.D. ’92) to Leadership Positions

Members of the Atlanta Bar Association elected Margaret Vath, instructor of law, as president, Nicole G. Iannarone, assistant clinical professor, as vice president/president-elect, and A. Craig Cleland (J.D. ’92) as treasurer for the 2017-18 term.

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