Tag Archives: Suitability

SEC Staff Issues Guidance on Robo-Advisers

The Securities and Exchange Commission’s Division of Investment Management (“SEC”) recently published information and guidance for investors and the financial services industry on the use of automated advisers, or robo-advisers, which are registered investment advisers (“RIA”) that use computer algorithms to provide advisory services with limited human interaction.

Robo-Advisers are subject to the same fiduciary obligations under the Investment Advisers Act of 1940 (“Advisers Act”) as any other registered investment adviser. Since they rely on algorithms and limited interaction with clients, the model raises certain considerations when seeking compliance with the Advisers Act.

The guidance focuses on the following three issues: (1) the substance and presentation of disclosing to clients the services the RIA offers; (2) the obligation to obtain information from clients to provide suitable advice; and (3) the adoption and implementation of effective compliance programs specifically designed for robo-advisers.

DisclosuresIn order for clients to better understand how a robo-adviser provides its investment advice, the robo-adviser should; (1) explain its business model, including a description of the algorithm used to make recommendations; (2) clearly disclose the scope of its services; and (3) ensure clients understand and read the initial disclosure material and that the questionnaires used elicit a sufficient amount of information.

SuitabilitySimilar to all RIAs, a robo-adviser must act in the best interests of its clients and provide only suitable investment advice based on the client’s financial situation and investment objectives.  However, the questionnaires used by many robo-advisers may not request a sufficient amount of information.  The SEC recommends robo-advisers ensure questionnaires supplied to clients require enough information to make a suitable recommendation.

Compliance ProgramsRobo-advisers may have more risks than traditional RIAs.  These risks need to be addressed in their written policies and procedures in order to comply with Rule 206(4)-7 of the Advisers Act.  Robo-advisers should consider whether to adopt and implement written policies addressing the following areas: (1) the development and testing of the algorithm; (2) the initial investment objective questionnaire; (3) disclosing changes in the algorithmic code that may affect their portfolios; (4) oversight of any third party who develops, owns or manages the algorithmic code; (5) the use of social media in connection with marketing services; (6) the prevention and detection of cyber threats; and (7) the protection of client accounts and key advisory systems.

Robo-advisers represent a fast growing area of the investment advisory industry.  Click here to view the Guidance Update.

Read our other article here:

The Five Most Frequent Compliance Topics Identified in SEC Examinations of Investment Advisers

FINRA’s National Adjudicatory Counsel Amends Sanction Guidelines

On May 12, 2015, FINRA announced that the National Adjudicatory Council (“NAC”) had revised FINRA’s Sanction Guidelines, incorporating several amendments and revisions toughening recommended sanctions for unsuitable or fraudulent conduct.

FINRA publishes the Sanction Guidelines so that member firms, associated persons, and counsel can become familiar with the types of disciplinary sanctions applicable to various violations. Importantly, the guidelines provide direction and guidance for adjudicators imposing the sanctions in disciplinary proceedings. The Sanction Guidelines act as guidance and do not provide predetermined or fixed sanctions for particular violations.

NAC initiates periodic reviews of the Sanction Guidelines to ensure that the guidelines reflect recent developments, comport with changes in FINRA’s rules, and accurately reflect the levels of sanctions imposed in FINRA disciplinary proceedings. The NAC’s recent amendments are the result of NAC’s inquiry into whether sanctions imposed in disciplinary proceedings achieve deterrence from further violations and reflect current sanction trends in both settled and litigated cases. The amendments, summarized in Regulatory Notice 15-15, reflect FINRA’s policy of imposing escalated sanctions on member firms and associated persons whom engage in misconduct or evidence reckless disregard for regulatory requirements. The new amendments include:

-Revisions to Sanction Guideline Related to Fraud, Misrepresentations or Material Omissions of Fact

  • For intentional or reckless fraud by individuals, the amendments change the guidance from individuals should be “considered” for a bar, to adjudicators should “strongly consider” a bar (in egregious cases). A similar amendment was made to the guidance concerning intentional or reckless fraud by firms. In the alternative, if a bar is deemed excessive, the revised guidelines provide for the suspension of an individual for 31 days to two years.

– Revisions to Sanction Guideline related to Suitability – Unsuitable Recommendations

  • For associated persons who violate FINRA’s suitability rule (FINRA Rule 2111), the range of the suspension has increased from one year to two years. Further, adjudicators are advised to strongly consider barring an individual respondent where aggravating factors predominate. In the case of firms (in egregious cases) adjudicators are “to strongly consider” suspension from any or all activities for longer than 90 days or even ordering expulsion.

– Revisions to General Principals

  • NAC revised the Sanction Guidelines’ General Principles, emphasizing that the FINRA disciplinary system is designed to protect investors, deter misconduct, and uphold high standards of business conduct.

– Indexing of Monetary Sanctions

  • The Sanction Guidelines “will implement indexing of the high-end of the monetary sanctions for each sanction guideline to the Consumer Price Index.” RN 15-15.