What if a human adviser dispensed portfolio recommendations based solely on the answers to 10 or 12 written questions?
Direct-to-consumer robo-advisers are not being held to the same fiduciary standard as human advisers. This fact is unfair to human advisers and ultimately harmful to the investing public.
In February 2017, the Securities and Exchange Commission issued a guidance update designed to highlight unique issues that robo-advisers face in meeting their fiduciary duties under the Investment Advisers Act of 1940. In it, the SEC observed:
• "Some robo-advisers provide investment advice directly to the client with limited, if any, direct human interaction between the client and the investment advisery personnel."
• "Robo-advisers may provide investment advice based primarily, if not solely, on client responses to online questionnaires."
• "Some of these questionnaires are not designed to provide a client with the opportunity to give additional information or context concerning [their] responses.
• "Robo-advisers may not be designed so that advisory personnel may ask follow-up or clarifying questions … address inconsistencies … or provide a client with help."
• "An investment adviser's fiduciary duty includes an obligation to act in the best interests of its clients and to provide only suitable advice."
• "An investment adviser must make a reasonable determination that the investment advice provided is suitable for the client's financial situation and investment objectives."
Has there ever been a questionnaire that was so artfully drafted that, based solely on the answers to its questions, an adviser could:
• Determine a client's financial situation;
• Determine a client's investment objectives; and
• Determine a suitable portfolio for the client?
Keep in mind that robo-questionnaires often contain no more than 10 or 12 questions.
What would happen if a human adviser dispensed portfolio recommendations based solely on the answers to 10 or 12 written questions, and never saw or spoke directly to the client? Would the SEC consider this adviser to have discharged his or her fiduciary obligations to have reasonably determined the client's financial goals and investment objectives? Would they find portfolio recommendations made in this way suitable? These questions answer themselves.
There is a double standard at work here. The SEC is looking the other way while direct-to-consumer robo-advisers are falling short in living up to their fiduciary standards. Human advisers are being held to a tougher standard.
Last year the prestigious law firm of Morgan Lewis & Bockius, which represents Betterment, made a valiant attempt to argue that robos fully satisfy their fiduciary obligations. In a paper entitled, The Evolution of Advice: Digital Investment Advisers as Fiduciaries, they argued that fiduciary duties are defined by the scope of a relationship. Since robos disclose that they don't interact directly with the client and offer only a limited set of services, the client is, in effect, agreeing to and accepting a reduced level of fiduciary service.
Essentially what Morgan Lewis is asserting is that robos can disclose and disclaim away the meaningful aspects of a fiduciary relationship. As long as the boilerplate in the client agreement says so, a fiduciary can satisfy its duty of care with a 10-question questionnaire. This guts traditional notions of a fiduciary relationship and leaves the client with none of the benefits or protections historically provided to clients of financial advisers.
The new SEC chairman, Jay Clayton, has signaled that his agency plans to move forward with activities that may result in an expanded fiduciary rule under federal securities laws. Presumably there will be something left of the new DOL fiduciary rule when the dust settles. These new rules could bring thousands of reluctant fiduciaries under the fiduciary umbrella.
If robos can discharge their fiduciary duty of care solely by asking a client 10 or 12 questions, why can't these fiduciary conscripts? What will the regulators say when human advisers claim to have discharged their duty of care with a 10-question questionnaire, while pointing to the robos as justification? We need to look a few moves ahead on the chess board.
By lowering the bar for robos, the SEC is inadvertently establishing a precedent that will dilute the current standard and leave clients unprotected. A debased and devalued fiduciary standard serves no one. The goal should be to expand a truly meaningful fiduciary standard to all advisers who purport to give advice to individual clients.
Instead of pretending robos are fiduciaries, let's recognize them for what they are. They are essentially online vending machines for managed portfolios. The tools they provide help do-it-yourself investors get organized and offer a basic framework for selecting a pre-built managed portfolio. The client experience is exceptional. But what they deliver should not be mistaken for fiduciary guidance and should not become the standard to which fiduciaries are held.
Direct-to-consumer robos simply can't satisfy their responsibilities as fiduciaries. The SEC is clearly aware of the issue. Why else would it have issued the guidance update? Now it needs to fix the problem.
Computers didn't even exist when the Investment Advisers Act of 1940 was enacted. The world has changed dramatically since the current regulatory framework was established. Let's recognize that and carve out a new regulatory niche for robos so they can continue to provide their highly useful services. Trying to squeeze the robo-round-peg into the fiduciary-square-hole harms both financial advisers and the investing public.
Scott MacKillop is CEO of First Ascent Asset Management, a Denver-based firm that provides investment management services to financial advisers and their clients. He is a 40-year veteran of the financial services industry.
