FinTech: Robo Advisors and the New DOL Fiduciary Rule

Guest Post by Expert Geoff Winkler

As we have discussed previously, the Department of Labor (DOL) released a new rule requiring anyone providing investment advice to retirement plans and accounts do so under the DOL’s new fiduciary standards. These new standards are centered on protecting consumers from receiving investment advice that may be tainted by a conflict of interest on the part of the financial advisor (FA).

The requirement, as discussed by Fiduciary Expert Dennis Dumas in his recent blog post, creates an obligation to “avoid misleading statements, manage plan assets prudently and with undivided loyalty to the plans and their participants and beneficiaries, and receive no more than reasonable compensation.” Since many of the current FA compensation plans include practices like commissions or revenue sharing, the DOL has issued the Best Interest Contract Exemption to permit FAs and their firms to continue their current compensation models, assuming they meet the exemption terms.

However, many financial institutions are now turning to an emerging technology known as an automated investment advisor or robo advisor (collectively referred to as “robo advisors”) to help ensure compliance with the new rule prior to its April 2017 implementation date (January 2018 for certain provisions). We have previously discussed robo advisors (here, here and here) and their potential impact on the industry, but the new DOL fiduciary rule may just accelerate this transition.

The DOL fiduciary rule has been criticized because it limits an FAs ability to profitably service small accounts. That is where the robo advisors will step in: by being able to offer scalability, minimize human interaction and service more customers, they thereby allow financial firms to still service the smaller investor.

Furthermore, since robo advisors charge a flat fee, many believe that they will comply with the DOL fiduciary rule without the need to justify fees or show that there is no conflict of interest under the Best Interest Contract Exemption. DOL Secretary Thomas Perez, in Congressional testimony on June 17, 2015, said, “Technology is, I think, a linchpin to the innovation that’s enabling more people to get access to advice.”

Robo advisors may also help to reduce regulatory concerns due to the uniformly determined advice and use of low-cost ETFs typical of algorithm-based services. Despite these benefits, the robo advisor area is not without concerns of its own. SEC Commissioner Kara M. Stein raised some questions about the use of robo advisors during at guest lecture at Harvard Law School last winter. Said Stein:

“What does a fiduciary duty even look like or mean for a robo advisor? The idea of a robotic entity that automatically generates investment advice certainly bumps up against what we would traditionally think of as a fiduciary. As this innovation gains more market share (as it seems poised to do), we should be asking whether these new robo advisors can be neatly placed within our existing laws. Or, do we need certain tweaks and revisions?”

FINRA is also reviewing the use of robo advisors and how firms are ensuring that suitability requirements are being addressed while also determining how firms will assess risk tolerance using technology. In her speech at the January 2016 FSI One Voice conference, Dawn Calonge, Surveillance Director at FINRA, stated that FINRA was reaching out to financial firms to see the type of supervisory systems and controls they have in place, specifically with respect to when an investor makes changes to their investment profile or enters contradictory information.

Despite concerns, Commission Stein is a strong proponent of U.S. leadership in FinTech: “Clearly, if we want our markets to remain at the top, we need to embrace innovation” she said to Harvard Law. “Remaining competitive requires both market participants and regulators to thoughtfully evolve with innovation, not react to it way after the fact.”

While there are still a number of questions to be answered, it appears that robo advisors will be a significant part of the financial services industry for years to come.