SEC EXAMS Risk Alert Regarding Electronic Investment Advice: Implications of Evolving Policies and Practices

• Published in: The Investment Lawyer 2022-07, Vol.29 (7), p.28-36
• Main Authors: Perlow, Mark D, Sherman, Michael L, Rodriguez, Ashley N, Belokon, Elona
• Format: Article
• Language: English
• Subjects: Algorithms; Automation; Business models; Compliance; Duty of care; Fiduciary responsibility; Information technology; Investment policy; Portfolio management; Questionnaires; Regulation of financial institutions; SEC registration; Third party; Wrap accounts
• ISSN: 1075-4512

The Staff of the Securities and Exchange Commission's (SEC) Division ofExaminations (Division or EXAMS) released a risk alert on November 9, 2021 (Risk Alert) discussing the Staff's observations and findings from the Division's recent electronic investment advice initiative (eIA Initiative), a series of examinations of investment advisers that provide "automated digital investment advisory services to their clients" (often referred to as robo-advisory services).1 The elA Initiative focused on helping the SEC obtain a better understanding of the operations of, and services provided by, these firms, as well as on how firms providing electronic investment advice are satisfying their regulatory obligations and fulfilling the fiduciary duties that advisers owe to their clients. Risk Alert eIA Initiative Intent and Focus In the Risk Alert, the Division expressed its intention that the eIA Initiative would provide the Division with a "broad understanding" of advisers providing electronic advice through its examination of a diverse set of advisers (for example, varying bases for registration, business models, investment practices, client types, assets under management) that offer robo-advisory services, sell, license or otherwise grant access to interactive digital platforms (Platforms) to third-party advisers, broker-dealers, and banks and/or that provide advisory or sub-advisory services to such Platforms. According to the SEC, in order to provide advice that is in a client's best interest, the adviser must have a reasonable understanding of the client's "investment profile"-the client's financial situation, level of financial sophistication, investment experience, and financial goals. The eIA Initiative examinations followed these themes and included a broad review of the selected firms' adherence to their fiduciary duties to their clients and other compliance matters, with specific consideration of: * The reasonableness of the adviser's compliance programs; * Annual testing of the compliance program; * How advisers formulate investment advice (including whether sufficient information was gathered to form a reasonable belief that the advice was in a client's best interest); * The adequacy and accuracy of disclosures as to conflicts of interest and "customization;" * Whether marketing (including performance advertising) complied with Advisers Act Rule 206(4)-1 (Advertising Rule) and, where relevant, whether "securities selection and portfolio management techniqu