FINRA Gives Tips for Robos

Firms that offer digital investment advice need sound governance and supervision, says the organization.

The Financial Industry Regulatory Authority (FINRA) emphasizes in a new report that financial services firms using digital advice tools need effective ways to oversee suitability of recommendations, conflicts of interest, customer risk profiles and portfolio rebalancing. Training and education are crucial for financial professionals who use digital investment advice tools, the report cautions.

FINRA issued the report to share effective practices related to digital investment advice services and remind member firms of their obligations under FINRA rules. The report notes that global spending on digital wealth management services is expected to increase significantly.

The report addresses regulatory principles and effective practices in five areas.

  • Governance and supervision of algorithms, including initially assessing the methodology of digital tools and the quality and reliability of data inputs, as well as ongoing evaluation such as testing the tools to ensure they are performing as expected, and determining whether models used by a tool remain appropriate as market conditions change;
  • Customer profiling, including assessing both a customers’ risk capacity and risk willingness, and addressing contradictory or inconsistent responses in customer-provided information;
  • Governance and supervision of portfolios and conflicts of interest, including determining the risk, return and diversification characteristics of a portfolio that is suitable for a given investor profile, and mitigating—through avoidance or disclosure—conflicts that can arise through the selection of securities for a portfolio; 
  • Rebalancing, including providing descriptions of how the rebalancing works and procedures that define how the tools will act in the event of a major market movement; and
  • Training that enables financial professionals to understand the key assumptions and limitations of individual digital investment advice tools, and determine when use of a tool may not be appropriate for a client.

The report also suggests that investors evaluate whether their financial services firm is gathering enough information to understand their needs and risk tolerance. Investors should be aware that conflicts of interest can exist even with digital investment advice, and that the advice they receive depends on the investment approach and underlying assumptions used in the digital tool. In addition, the report recommends that investors understand the fees they are paying and services they are receiving, including such features as portfolio rebalancing.

“We trust that the report will provide information and guidance for FINRA member firms and investors about key aspects of the rapidly growing arena of digital investment advice,” says Richard Ketchum, chairman and chief executive of FINRA. “As these services develop, firms need to ensure that the core principles of investor protection—such as understanding and responding to customers’ needs and objectives—serve as the foundation of these new tools as well.”

FINRA is, a non-governmental agency that regulates the securities industry.