Spotlight hits technology platforms as U.S. mulls fiduciary standard

December 8, 2015

It was during a congressional hearing in June that U.S. Labor Secretary Tom Perez spoke about how technology companies can help investors in making better choices about their investments. Perez said several times that automated portfolio advice services, or “robo-advisors,” can help the government to meet its goal of getting firms to offer retail investors suitable products at an affordable price.

“Not only is it possible to provide fiduciary service at low cost to small investors nationwide, but that the market rewards these efforts,” Perez said.

The comments from the Labor Secretary put a focus on the role of robo-advisors and how technology can help to achieve a fiduciary standard. Until then, robo-advisors — who use automated algorithms to construct a portfolio for investors — had received little coverage in the fierce battle over the fiduciary standard rules.

A survey of 36 wealth management executives by the research consultancy AITE Group found that many firms plan to launch their own robot-advisor services or launch one that works in conjunction with a human advisor in the next three years. Twenty three percent of the respondents said they already allowed clients to invest in fee-based accounts through their portal. Forty percent said they were investing in technology that gave them the capability. AITE predicted that more than half of the firms plan to give clients a digital portfolio management service within two to three years.

The Labor Department says the financial industry needs a fiduciary standard because existing brokers are only required to offer suitable products to their clients under the existing rules. The department believes a standard that is based on suitability creates a conflict of interest, where brokers are recommending products that will pay them higher commissions instead of those that fit their clients’ needs.

In April, the department issued a proposal that would require brokers who offer retirement investment advice to put their investors’ financial interests above their own. The rule is designed to protect investors from being steered into high-fee products that are not suitable for their needs.

The financial industry, however, says a uniform fiduciary standard would drive up compliance costs and legal liabilities on retirement accounts. It says the rule will harm smaller investors because many firms will find it too expensive to serve them.

The Labor Department’s proposal “would ultimately harm investors by raising the cost of saving,” said the Securities Industry Financial Markets Association, which represents broker dealers, banks, and asset managers.

Wealthfront, an SEC registered investment advisor cited by Perez in his June testimony, says its robo-advisor platform helps smaller investors to select investments according to their specific needs. The company says every trade a client makes is automatically vetted against the investment strategy that was promised to the client when the account was opened.

“We leverage the same type of technology that has helped companies like Facebook and Google scale personalized service to billions of users,” said its Chief Executive Officer Adam Nash, in an email.

The company has been active in the fiduciary standard debate and its representatives have attended meetings in Washington to speak to officials at the Treasury, Labor Department, and the Securities and Exchange Commission.

Another tech company that could benefit from the fiduciary issue is the New York startup Betterment. Unlike Wealthfront, the company’s platform is available to both advisors and consumers. It has no relationship with fund companies and it doesn’t receive fees or commissions on products, averting the potential for conflicts, says Joe Ziemer, the company’s spokesman.

“We choose the best ETF’s for our customers, regardless of who makes them. We do not charge for trades or sell order flow,” he said.

Long time investor advocate Barbara Roper says technology companies can be part of the solution in helping smaller investors to receive affordable financial advice. But she cautioned that not every company that claims it is a robo-adviser has a business model that puts clients’ interests first.

“One of the big arguments in this debate is that you can’t afford to offer fiduciary investment advice to small-account holders. That is one of the industry’s responses … That (under a fiduciary standard) small investors will lose access to advice and brokers will exit the field. There are a lot of problems with that argument but it has been a very effective message for the industry,” said Roper, the director of investor protection at the Consumer Federation of America.

“The robo advisers are part of the response to that argument. The industry is evolving very rapidly to meet the needs of small account holders and technology plays a very important role in that. It makes it less expensive to offer some of the core services … They’re bringing down the cost of smaller accounts. In that sense they are part of the solution.”

Technology companies are not only helping advisers and clients during account opening. Some are helping advisers to comply with the law. Hearsay Social uses its platform to help advisors and compliance officers monitor social media communications between sales reps and their clients. One feature of the platform notifies compliance officers if reps post messages on social media that violates the firm’s advertising rules.

The company’s co-founder and chief technology officer Steve Garrity says the Labor Department’s rule would put more pressure on the fees that firms receive for recommending products and many companies will have to adopt technology to keep costs down.

“Our technology has always been designed to build space and time for advisers to focus on their relationships … The DOL (rule) will make it more necessary for advisers to do that. Advisers will need to get more efficient and use technology more frequently,” he said.

(This article was produced by Thomson Reuters Regulatory Intelligence and initially posted on Dec 2. Regulatory Intelligence provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 400 regulators and exchanges. Follow Regulatory Intelligence compliance news on Twitter: @RiskMgment)

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