As with most aspects of the workplace, employee benefits are going digital. From online enrollments and administration for all types of benefits, to electronic educational tools, employers are increasingly seeking ways to use new technologies to enhance their benefits programs, increase efficiencies and employee engagement. Among these innovations is the proliferation of computer-driven, digitally-based investment advisers, or so-called “robo advisers.” The market for robo-advisers is growing fast with many new companies entering the space with increasing frequency. Well-established companies are also developing and offering their own automated investment services which can be available to assist individual investors or participants in an employer-sponsored savings plan. Plan sponsors will increasingly be presented with robo-adviser services for their participant-directed retirement plans, and they must be prudently selected.
Robo-advisers are not without their critics. There is an ongoing debate whether robo-advisers can meet the fiduciary standards of a trained professional who provides investment advice to investors in their best interest. For example:
- On March 15, 2016, the Financial Industry Regulatory Authority (FINRA) released a report regarding digital investment advice which raised questions concerning the standard of care that applies to broker-dealers and investment advisers under federal securities laws with regard to investment advice that they provide and the application of same to digital services used either in conjunction with a financial professional or on its own. The FINRA report recognizes that digital investment advice tools will play a significant role in wealth management and that investor protections must be paramount and should include a foundation for understanding customer needs, with sound methodological groundings and recognition of the tools’ limitations.
- On April 1, 2016, the Massachusetts Securities Division issued a policy statement and declared that robo-advisers may be inherently unable to act as fiduciaries and perform the functions of a state-registered investment adviser without the necessary due diligence and personalization to act in the best interest of their clients.
- On April 6, 2016, The Department of Labor also released its final rule regarding investment advice fiduciaries (the “Rule”). The Rule itself continues to come under attack and on June 1, 2016, eight industry and trade groups filed a lawsuit in Texas federal court challenging the Rule and asserting that the DOL overstepped its authority in issuing the Rule, the Rule will increase costs and litigation, and that the Rule will not help investors. (See Chamber of Commerce of the United States of America et al. v. Thomas E. Perez et al., case number 3:16-cv-01476, in the U.S. District Court for the Northern District of Dallas.) Whether the Rule survives pending challenges remains to be seen. In the meantime, robo-advisers that make investment recommendations are fiduciaries under the Rule which provides that fiduciary communications such as recommendations can be initiated by a computer software program.
It is also important to note that while the DOL also released a Best Interest Contract (BIC) exemption from its prohibited transaction rules to allow investment advisers to continue to provide advice and earn compensation such as commissions, sales loads, 12b-1 fees and revenue sharing payments without running afoul of conflicts of interest standards so long as certain requirements are met, this BIC exemption does not apply to the provision of investment advice solely through digital means unless the robo-adviser charges level-fees and is a “level-fee fiduciary.” It appears that the pre-existing rules for “eligible investment advice arrangements” under Section 408(g) of ERISA provide an alternative path for robo-advisers to follow in order to avoid running afoul of the prohibited transaction rules.
For plan sponsors that desire to incorporate digital investment advice services into their retirement program in the near future, several issues, at a minimum, should be considered, including:
- Assess the need for investment advice services versus provision of non-fiduciary educational tools, or determine an approach that incorporates both services
- Ensure that the plan fiduciaries follow an objective process to elicit information necessary to assess the robo-adviser’s qualifications and credentials, quality of services offered and reasonableness of fees and costs charged for the services
- Evaluate the robo-adviser’s investment approach embodied in the design of the tool
- Assess whether the digital investment advice tool is paired with access to a human investment professional who is able to assess the plan participant’s needs in a manner that goes beyond the limitations of the digital tool, and, who is trained to utilize the tool effectively
- Review any conflicts of interests
- Determine if the robo-adviser charges level fees and meets the requirements of the BIC exemption or whether it meets the requirements of an “eligible investment advice arrangement” under ERISA which either charges level-fees or uses a compliant computer-model
- Review service agreements including fiduciary, indemnification, audit, record retention and data privacy and security provisions
- Confirm that the robo-adviser acknowledges fiduciary status and that the participants are provided with any required disclosures
- Establish a procedure for prudent ongoing monitoring of the robo-adviser service
For plan sponsors who already offer robo-adviser services to their plan participants, now is the time to review the arrangement under the evolving guidance and implement prudent changes.
In this environment, the fate of the Rule, and the standards for robo-advisers, will continue to evolve and new developments must be monitored. Whether the robots know best is a question yet to be answered.