April 2017

New SEC guidance provides effective ways for advisors to comply with disclosure regulations

Robo-advisors continue to represent a fast-growing trend in the investment advice industry, changing the way firms engage with and service their clients. However, given the automated and online nature of their business models, there are unique considerations for robo-advisors when complying with traditional regulations.

Following collaboration with industry participants, the Securities and Exchange Commission’s (SEC) Division of Investment Management released a Guidance Update on February 23, which includes suggestions to help robo-advisors meet disclosure, suitability and compliance obligations under the Investment Advisers Act of 1940 (IM Guidance Update No 2017-2).

The result of this collaborative approach is a constructive and practical guidance that we believe is beneficial for both the industry and its target customers. The SEC guidance focuses on three areas: disclosure requirements, provision of suitable advice and compliance programs. In the following series of blog posts, we’ll outline the implications of the SEC guidance in each of these areas as they affect the ways robo-advisor platforms facilitate compliance and provide a compelling user experience. In this post, we’ll focus on the first area of disclosure.

Disclosure requirements for robo-advisors

The SEC guidance reiterates that robo-advisors, like any investment advisor, have a fiduciary duty to make full and fair disclosure of all material facts and to employ reasonable care to avoid misleading clients.

  • To address potential gaps in a client’s understanding of how robo-advisors provide investment advice, the SEC guidance now recommends they disclose information regarding their business practices and related risks, including:
  • A description of the algorithmic functions used to manage client accounts (e.g., that the algorithm generates recommended portfolios and is responsible for portfolio rebalancing)
  • An explanation of the algorithm used (e.g., if the algorithm is based on modern portfolio theory, as well as a description of the assumptions behind and the limitations of that theory)
  • A description of when the robo-advisor might override the algorithm
  • An explanation of the degree of human involvement in the oversight and management of client accounts
  • A description of how the robo-advisor uses the information gathered from a client to generate a recommended portfolio and any limitations (e.g., if a questionnaire is used and whether the responses to the questionnaire may be the sole basis for the robo-advisor’s advice)
  • Whether the robo-advisor has access to other client information or accounts (and if so, how that information is used in generating investment advice)

Additionally, under the SEC’s guidance, robo-advisors must be clear about the scope of their advisory services. For example, they must be careful not to mislead clients by implying that the robo-advisor is providing a comprehensive financial plan if it is not, or that a tax-loss harvesting service provides comprehensive tax advice.

Given the typical robo-advisor’s reliance on online interaction as the primary mode of communication with clients, the guidance also provides some practical considerations about how the disclosures are presented. The SEC specifically reminds robo-advisors that disclosures should be designed to be effective — in other words, they should not be incomprehensibly worded, buried at the end of a document or tagged in small print to the end of a webpage.

An online interface provides some unique opportunities to ensure important information is presented in effective ways. In this regard, the SEC suggests a variety of design affordances that meet the “effectiveness” requirement but can also keep the user experience educational and engaging. For instance, the update states that robo-advisors may wish to consider whether key disclosures are specially emphasized (through design features like pop-up boxes), whether some disclosures should be accompanied by interactive text (like tool tips that expand when a cursor hovers over a particular section) or whether an FAQ section might be included for clients seeking more information.

The overarching theme of this guidance is that robo-advisors must carefully consider the best way to call attention to relevant information at the relevant stage in the online process. Accordingly, certain key disclosures should be made prior to the sign-up process so that information necessary to make an informed investment decision is available to clients before they make an investment with the robo-advisor. Jemstep itself is not a direct-to-consumer robo-advisor. We provide a configurable, white-label digital advice solution that advisors can use to serve their clients and reach new prospects. Our platform enables clients to reach out to an advisor when needed, and conversely, for advisors to reach out to their clients. This ability to connect online and offline can make communications around disclosure easier for both advisors and clients. For example, clients have easy access to disclosures throughout the onboarding process, and human advisors can respond to questions over the phone or, in some cases, online chat. Nonetheless, even for advisors who seek to rely on technology for the successful enrollment of clients with minimal human touch, we believe that the SEC guidance enables firms to comply with disclosure regulations without sacrificing a convenient and engaging user experience. With thoughtful design and careful consideration of their clients’ needs, understanding disclosures can become even easier for investors using digital advice solutions. In the next parts of this blog series, we will cover the SEC’s guidance for robos on the provision of suitable advice and compliance programs.


Important information

Jemstep, Inc. provides a digital solution for investment advisors. Jemstep is a wholly owned, indirect subsidiary of Invesco Ltd.

A robo-advisor is an online service that offers automated, algorithm-based portfolio management advice.

Modern portfolio theory refers to the idea that risk-averse investors can build portfolios to optimize their expected return based on a given level of market risk.


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