By Dominic Litz
In recent years a new wave of low-cost, low-risk, investment platforms have made it easy for the younger generation to break into the investment world. Unlike your traditional financial advisor, robo-advisors can get a new investor up and running in a matter of minutes after filing out a quick risk tolerance profile and depositing a small amount of money; from there the investments are on autopilot based on an algorithm. Traditionally, a financial advisor will sit down with a client to discuss different investment plan options to maximize their returns albeit for retirement, personal gain, or setting up funds for family. As an advisor, one has a duty to act in their client’s best interest, irrespective of their own financial compensation, which is called their fiduciary responsibility, which has been part of ERISA.
Start-up robo-advisors such as Wealthfront and Betterment will have new investors fill out a risk tolerance questionnaire to determine how to allocate their investments. After your individualized risk profile is complete, a diversified portfolio is set up, mainly of ETF’s and mutual funds, and ones you do not get to choose. So how can you be sure your money is being invested in a way that suits your best interest? Can you really trust an automated, robotic algorithm to invest money, which you may be saving for retirement wisely? As asset manager giant BlackRock, Inc. has pointed out, there is no transparency or strict regulation regarding robo-advisors. BlackRock Vice Chairman contends that “[t]here are no standards or rules of the road on these things, so you either need disclosure that establishes what are the rules or advice on best practices, but these should be up for discussion.”
With the expanded definition of the fiduciary standard, the question is whether or not robo-advisors will be held to the same standard? The DOL has not definitively ruled on whether or not they will classify robo-advisors as fiduciaries and hold them to the same standard but if they do, it could cause some major issues for them. With increased litigation against advisors likely to arise under this ruling for failure to advise a client properly on their investment, a client of a robo-advisor has no one to hold liable. Surely, an individual cannot expect the automated algorithm to be held responsible for poorly investing their funds based on a 10-question risk tolerance questionnaire.
The DOL’s new ruling will be fully implemented by April of 2017, so while there is time to see whether robo-advisors will be effected, until then, these platforms will continue to rapidly grow. Smaller start-up advisors such as Wealthfront and Betterment may see some tough times ahead of them if the DOL decides to hold them to this higher fiduciary standard because, while they grow, clients may want to see where exactly their money is going; similar to what BlackRock vice chairperson was saying. The larger robo-advisors like Schwab Intelligent Advisors, BlackRock, and Vanguard Personal Advisor Services may not be effected as much because they have the underlying traditional advisors who will already be held to this higher standard and are accessible to their clients.
The attractive nature of the low-cost robo-advisors should be held to this higher fiduciary standard. Irrespective of the fact that investors know that a computer will be managing their money, they should be able to know where exactly their investment is going, how it will be effected in changing market conditions and the short and long-term effects. This type of information and higher standard of care for the client’s investment will boost investor confidence and understanding. Initially this may raise costs and fees, the DOL should hold robo-advisors to the same higher fiduciary standard as traditional financial advisors.
Student Bio: Dominic is a staff member of Journal of High Technology Law. He is currently a 2L and received a B.S. in Finance from Loyola University of Maryland.
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.
