On November 9, 2021, the U.S. Securities and Exchange Commission (“SEC”) developed a risk alert in relation to compliance failures observed when providing electronic investment advice to clients. The risk alert was a result of concluding a national initiative where the Division of Examinations (the “Division”) conducted audits of SEC-registered investment advisers who provide electronic investment advice (“Robo-Advisors”). Robo-Advisors can offer impactful benefits including accessible and lower-cost services for investors. However, when Robo-Advisors fail to comply with regulatory obligations, the investors may be at risk.
The Division conducted a series of examinations to assess the practices of advisors providing Robo-Advisory services, focusing on their compliance programs, formulation of investment advice, marketing, and advertising practices, data protection practices, and registration information. Nearly all advisors examined received deficiency letters. Common deficiencies included:
Compliance Programs - Most advisors had inadequate compliance programs, lacked written policies and procedures, or had unimplemented or untested programs.
Portfolio Management - Many advisors were found to not be testing the investment advice generated by their platforms, jeopardizing their fiduciary obligation to the duty of care. Advisors were also found to have inaccurate or incomplete disclosures in many Form ADV filings.
Performance Advertising and Marketing - More than half the advisors examined had misleading or prohibited statements on their websites, materially misleading performance advertisements, and inadequate disclosures about “human” services in their advertising and marketing material.
Cybersecurity and Protection of Client Information - Few advisors were found to have policies/procedures that addressed protecting the firm’s systems. In addition to lacking written policies and procedures, few advisors were found to have tested the system's emergency responses as well.
Registration matters - Many advisors were found to be relying on the Internet adviser exemption but were ineligible to do so. SEC rule 203A-2(e) of the Investment Advisers Act of 1940 creates an eligibility to operate as a registered investment advisor under the Internet Advisor Exemption, provided the elements of that rule are met. The elements of that rule include the following:
Provides investment advice to advisory clients through an interactive website. An interactive website means a site in which computer software-based models or applications provide investment advice based on personal information each client submits through the website.
Provides advice to all of its clients exclusively through the interactive website;
Maintains documentation demonstrating that it provides investment advice to clients exclusively through an interactive website.
Best Practices
The Staff recommended the following to improve compliance:
Adopt, implement, and follow written policies and procedures that are tailored to the advisor’s practice. Paying special attention to portfolio management, custody, and books and records.
Test algorithms periodically to ensure they are operating correctly.
Safeguard algorithms. Employing safeguards to prevent unauthorized algorithm changes.
All in all, the Division recommends that advisors providing electronic investment advice review their portfolio management practices and related disclosures, performance advertising, and marketing materials, written policies and procedures. Advisors relying on the Internet advisor exemption should also review their registration eligibility regularly.
Click here to read the full risk alert.
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