How Does a Robo-Adviser Tell You What You Need to Know?: Meeting the Disclosure Requirements, Digitally

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

As a fiduciary, an investment adviser has a duty to make full and fair disclosure of all material facts to clients and make reasonable efforts to avoid misleading the client. An investment adviser’s failure to do so opens them up to liability.  Furthermore, the disclosed facts must be specific enough and presented clearly enough for the customer to understand what they are getting themselves into.

What does this look like when your investment adviser is a digital tool? How does a robo-adviser ensure that it meets these disclosure requirements? What information must it disclose? In what form should a robo-adviser present this information? Without properly presented information regarding both the investment tool being used and the nature of the services provided, an investor cannot make informed decisions about whether to enter into or continue an investment advisory relationship.  Both the content and the presentation of information are important, considering that robo-advisers rely on algorithms to generate advice and use internet to provide the service. These issues are particularly salient when a customer’s decision on whether to use a particular robo-adviser depends only on the robo-adviser’s electronic disclosures made via email, a mobile app, or other electronic media. There may not be a human to talk to.

In their Guidance, the SEC advises robo-advisers to disclose information about their business practices and their associated risks to help investors understand how the algorithmic sausage is made.  Disclose that an algorithm generates the recommendations or invests and rebalances the portfolio. Specify the algorithmic function used and explain the assumptions and limitations that underlie it. State the risks associated with this practice. Disclose any third-party or human involvement in the process and any fees associated with any portion of the service. Tell the customer how her information is used to generate the recommendations and how to keep her information current. Finally, disclose the costs associated with your services.

The SEC further advises robo-advisers to be particularly clear about the scope of the investment services they provide, paying attention not to mislead their customers. Finally, the SEC emphasizes the need for effective presentation of the disclosures. Because most robo-advisers rely on online disclosures, key disclosures should be specially emphasized rather than buried in dense text.  It is also essential that information necessary to make the initial decision to invest is available and effectively presented before a customer makes the initial investment. Merely providing unintelligible information may not be enough to meet the necessary disclosure requirements – ensuring both its timeliness and legibility is essential.