Like all registered investment advisers, robo-advisers are subject to the legal obligations of the Investment Advisers Act of 1940 in addition to other federal securities laws. They are also subject to FINRA’s rules and regulations. Yet their unique business model – the reliance on algorithms and their limitation and elimination of human interaction – create unique factual scenarios and potential regulatory problems.
The majority of these issues are framed by the inescapable reality of the fiduciary relationship between a robo-adviser, regardless of its non-human nature, and its customers. Like other registered investment advisers, robo-advisers owe fiduciary duties to their customers, and both the regulatory framework and the automated investment business models must account for this.
As a fiduciary, a robo-adviser has a duty to know its customer, to act in their best interest, and to provide suitable investment advice. A robo-adviser further owes a duty to make full and fair disclosures of all material facts to its customers and to make reasonable efforts not to mislead them. A failure to meet any of these obligations may open up a robo-adviser to liability.
The unique issues raised by the non-human fiduciary have generated a lot of discussion and debate. In response, the SEC issued a Guidance setting forth some of the key legal challenges facing investment advisers who have incorporated automated investment advice into their workflow. Some of the key regulatory issues include meeting any disclosure requirements; knowing the customers and providing suitable advice; establishing effective compliance programs designed to deal specifically with robo-advisers; and cyber security and data protection. The upcoming blog posts focus two of these key regulatory issues: the disclosure and suitability requirements of the automated fiduciary. How can a robot tell you what you need to know? And how can you tell the robot what it needs to know to generate recommendations that are tailored specifically to you?