Robo-advisers have been disrupting the industry with automated investment formulas and low prices, but do they have an unfair advantage at the regulatory level?
Kara Stein, a commissioner with the Securities and Exchange Commission, wondered in a recent speech how robo advisers can fulfill fiduciary duties and avoid conflicts of interest when they “did not even exist when most of the laws applicable to investment advisers were drafted.”
The movement is expected to have a significant impact in the years ahead. Robo-advisers could manage as much as $5 trillion to $7 trillion within a decade from slightly less than $100 billion in 2015, predicts a recent study by Deloitte Consulting LLP. The firm also notes that this amount, which represents 10% to 15% of U.S. retail assets under management, could be a conservative estimate.
One industry observer believes robo-advisers have a leg up in that SEC regulatory guidelines and protections of these services relative to human contact “should be just as easy, if not easier to enforce because the advice is standardized and controlled, and (ideally) based on best practices.”
So says Carla Dearing, founding CEO of an online financial planning service designed for women called SUM180, who favors a hybrid model mixing traditional financial planning with all-digital robo-advice as the most effective approach to investing.
Regardless of whether any changes in oversight are made, some of this nascent industry’s leading startups have proceeded with caution. “We hold our fiduciary responsibility with the highest regard,” says Joe Ziemer, a spokesman for Betterment Institutional, whose automated exchange traded fund portfolios and technology is available to 125 advisers. “We’ve gone to great lengths to build our platform from the ground up, ensuring that we are fully aligned with our customers and clear in the value we offer.”
The SEC frequently creates unintended consequences when it interferes with free markets or technological developments, observes Robert Barker, a lawyer and business consultant in Atlanta who has been following the SEC for more than 30 years.
“In Flash Boys, Michael Lewis documented how the adoption of Reg NMS [Regulation National Market System] was intended to create equal opportunity for investors, but instead created inequality with a super-class of nanosecond traders who could trade faster than prices could be broadly reported,” he says.
Human element
Nevertheless, Barker believes there may be room for regulation to ensure that there’s appropriate disclosure of robo-adviser risks to investors, conflicts of interest and transparency. “Even in robo-advising, there is a human element in the selection of underlying advisers that adds risk,” he explains, “but to the extent that such disclosure is material, one could argue that it should already be provided under existing regulations.”
The challenge for advisers is to avoid “lulling investors into a false sense of complacency” or leading them to believe that “any investment or investment strategy is without risk,” according to Barker. With this in mind, he says “investors should be alerted as to when a stock-picker or fund-picker might make more sense than a robotic application of pre-programmed criteria. And they should be alerted to who makes the rules and picks the funds.”
Daniel Gallagher, who advised clients on broker-dealer regulation before becoming an SEC commissioner, was spot on with his warning about “the greater risk from the commercial debt bubble that has been foisted on too many retail investors,” Barker notes. “We should be worried about investors who rely on robo-advisers if that is not an informed choice.”
While the low cost of robo-advising is understandably appealing to all investors, he cautions that it may not be appropriate for some investors and “there is no substitute for spending time asking what is in one’s portfolio and how it is being managed.”
