What you need to know about robo-advisers

Robo-advisers represent a substantial segment of the financial services industry, and their rise presents challenges to the investment advisers who operate them and the investors who use their services.

Popular especially with younger, tech-savvy investors, robo-advisers use computer algorithms to provide investment advisory services online, often with limited human interaction. These services may charge lower fees but may not provide the level of personal service that traditional investment advisers deliver.

Information and guidance related to robo-advisers for both investment advisers and investors was published Thursday by the SEC.

The SEC’s Division of Investment Management issued guidance for investment advisers on meeting disclosure, suitability, and compliance obligations under the Investment Advisers Act of 1940. The guidance includes suggestions that a robo-adviser:

• Should consider providing clients with a statement that an algorithm is used to manage individual client accounts, a description of the algorithmic functions used, and a description of the assumptions and limitations of that function.
• May wish to consider whether its client questionnaires elicit sufficient information from clients to conclude that its investment advice is suitable and appropriate for the client.
• Should consider adopting written policies and procedures in addition to those that address issues relevant to traditional investment advisers. Additional policies and procedures may address areas such as the development, testing, and backtesting of the algorithmic code; disclosure to clients of changes to the algorithmic code that may affect their portfolios; and cybersecurity issues.

Meanwhile, the SEC’s Office of Investor Education and Advocacy issued an investor bulletin containing information investors may need to make good decisions if they consider using robo-advisers. According to the bulletin, investors may wish to consider:

• How much human interaction is important to them, their level of financial literacy, and how often they will have contact with the robo-adviser.
• What information the robo-adviser is using to create its investment recommendations.
• What the robo-adviser’s approach is to investing.
• What fees and costs the robo-adviser will charge.
• Information about the robo-adviser’s licensing and registration.

“As technology continues to improve and make profound changes to the financial services industry, it’s important for regulators to assess its impact on U.S. markets and give thoughtful guidance to market participants,” SEC Acting Chairman Michael Piwowar said in a news release.

—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.