By: Hunter Becker
Swiss bank company UBS has agreed to buy U.S digital automated wealth management provider Wealthfront, which has more than $27 billion in assets under its management. The acquisition will be an all-cash deal worth $1.4 billion with Wealthfront, which has more than 470,000 clients in the United States and caters to well-off millennial and Gen Z investors. The deal is set to close in the second half of 2022. Not too far before this acquisition the Securities and Exchange Commission (“SEC”), published a risk alert from its Division of Examinations focusing on robo-advisor services and the potential risk and concerns, in November of 2021.
Financial technology used for investment management can be first credited to Nobel laureate and Stanford University professor William Sharpe with his creation of Financial Engines, LLC. The firm introduced one of the first retirement digital financial technology platforms to give working people access to advanced portfolio management strategies in 1996. Around 2008, a new category of financial investment technology emerged called robo-advisors, a similar concept to Financial Engine. Robo-advisors are digital platforms that provide automated, algorithm-driven personal financial planning services with little to no human supervision. Robo-advisors collect information from clients about their financial situation and future goals through a survey and then use the data to offer advice and automatically invest client assets. These surveys primarily focus upon risk tolerance and length of investing, as well as possible tax implications. Since robo-advisors are faster and have more computing power than a human advisor, the robo-advisor provides great benefits at low index cost passage management of long-term investments while taking advantage of tax benefits.
While an innovative technology, it does not come without human error in execution. Both Wealthfront and SoFi were found to violate section 206(2) of the Investment Advisers Act which prohibits investment advisers from directly or indirectly engaging “in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client.” Wealthfront’s tax-loss harvesting capabilities were programmed and monitored incorrectly. They were supposed to monitor all the accounts it manages for clients to avoid any transactions that might trigger a wash sale, but it did not monitor them all, leading to wash sales in some accounts and not in others. Generally, a wash sale occurs when an investor sells a security at a loss and, within 30 days of this sale, buys the same or a substantially identical security to reduce tax costs. SoFi was in violation because of the inclusion of SoFi-sponsored ETFs to replace third-party ETFs that had a different asset allocation, which favored some funds over others. SoFi Wealth failed to provide its clients with full and fair disclosure of its conflicts of interest relating to the transactions and was thus fined and required to remedy the issue within 30 days.
These enforcement actions, UBS’s acquisition, and the SEC’s risk alert put robo-advisors in the spotlight. The SEC risk alert found extensive issues with nearly all robo-advisors investigated receiving a deficiency letter. The robo-advisors shortcomings fell into several categories: widespread non-compliance related to policies, procedures, and testing; problems with portfolio management including failing to provide advice in each client’s best interest; and marketing deficiencies including misleading statements and inadequate disclosures. This brings to light the question of if these robo-advisors comply with securities and investment management regulations. It appears that all the robo-advisors investigated fell short of legally mandated obligations under federal securities law and the sound policies in place for investor protection. No matter robo or actual, investment advisors owe a fiduciary duty to their clients, this means they must act within the client’s utmost duty of loyalty and duty of care. However, as the SoFi case has displayed, there is a conflict of interest that can be present thus violating the duty of loyalty.
The SEC needs to create stricter regulations so that these market actors are protecting investors, possibly including more frequent examinations of these companies. Additionally, the SEC needs firms to clearly specify when conflicts are intentionally programmed into their algorithms, with disclosure in Form ADV brochures for example. The brochure exists to educate investors and, to facilitate this purpose, the SEC generally requires brochure disclosures to be as specific as possible. Robo-advisors can make disclosures about conflicts with greater specificity than traditional investment advisers, so they should be obligated to.
Robo-advisors are an incredible technology, one that will not be leaving anytime soon. Therefore, it is imperative that fiduciary interests and the best interests of the client and retail investors are held to the highest standard. Robo-advisors have the capability to monitor their own functions, as seen through their monitoring at the fiduciary level. However, there must be implementations in place for robo-advisors to disclose to clients in the event of self-dealing or mishaps in investing client assets. In this highly technological age, there is no excuse for technology to give with one hand and take away with the other.
Student Bio: Hunter Becker is a second-year law student at Suffolk University Law School. He is a Staffer on the Journal of High Technology Law. Hunter received a Bachelor of Arts Degree in Environmental Science and Policy from Florida State University with a minor in Computer Science.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.
