OPINION: Do Robo-Advisors Need Regulation?


There is nothing like new technology to overturn the apple cart of precedent-based regulation.

US legislators and regulators have spent more than 75 years developing a framework in which investment advisers act as fiduciaries who give personalized investment advice based on the best interests of their clients.

It was only a matter of time with the advancements in artificial intelligence and cloud computing that the advent of robo advisors would eventually test the flexibility of the existing regulatory framework.

Not surprisingly, changing the framework, which incorporates the Securities and Exchange Act of 1934, the Investment Adviser Act of 1940, the Investment Company Act of 1940, and the Employee Retirement Income Security Act of 1974, is daunting, noted Melanie L. Fein, the author of four recently published white papers regarding the regulation of robo advisors.

Fein found that regulators need to clarify their fiduciary standards regarding robo advisers as well as the standards for “suitability” and “best interest” as well.

However, does this boil down to semantics? Many people in the financial services industry bandy about “robo advisers” as if everyone has agreed upon its definition.

Under Section 203 of the Investment Adviser Act, an investment adviser is “any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as the advisability of investing in purchasing, or sell securities, or who, for compensation and as apart of a regular business, issues or promulgates analyses or reports concerning securities…”

Current robo advisor offerings do not tick every box of the definition, especially the “for compensation,” portion.

The term itself, robo advisor, makes one think that it would replace living breathing investment advisers lock, stock, and barrel.

Current robo advisor offerings are tools that automate portions of an investment advisor workload, such as onboarding clients, offering what-if analysis for client portfolios, and fielding client inquiries. In other areas of financial services, insiders would call it straight-through processing.

One could argue that once a particular portion of an investment advisor’s functions is automated than those aggregated tools would be equivalent to an investment advisor. It would require some overly prescriptive regulations, something from which most regulators have been loathed to do historically.

As long as a registered investment advisers review the performance of their automated tools and can press the big red button if something goes wrong, there’s no need to regulate the tools of advisers if they are regulated themselves.

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