Robo-Advisers as Fiduciaries Present Challenges and Opportunities

As Baby Boomers push closer to retirement, they are facing a drastically different investing world than the one they grew up in—gaining access to radically different approaches to products and services. 

When Baby Boomers first started saving for retirement, the term “robo-adviser” probably sounded like something out of science fiction; but more and more of the wider financial services industry is embracing this technology, which offers automated investment advice based on complex algorithms and individuals’ unique financial information.

Initially, robo-advice was reserved for retail investors, experts explain, but it is now moving deeper into the individual retirement account (IRA) and 401(k) markets. Traditional advice providers have clearly taken notice of the new entrants, with many moving to implement their own take on robo.  

One of the new entrants, Betterment, earlier this year began offering an automated 401(k) recordkeeping platform, which provides employers with dashboard plan management and participants with an account aggregation tool, allowing them to sync outside financials including IRAs with their Betterment account.

Established brokerage firms are also working to better serve participants pushing closer toward retirement via robo-advice approaches—with a particular eye towards capturing IRA rollovers. According to global research firm Cerulli Associates, investors in 2013 alone rolled $324 billion from 401(k) accounts into the $6.5 trillion IRA market. In an updated 2016 report, the firm projected the digital advice market to exceed $83 billion by the end of the year.   

While robo-advice is viewed by many as a major source of opportunity, it also presents plan fiduciaries with major challenges, such as choosing an appropriate robo-adviser that can comply with the pending Department of Labor (DOL)’s Conflict of Interest rule, which extends fiduciary responsibility to virtually anyone offering advice in a retirement plan. But can robots serve effectively as fiduciaries? Some industry experts believe so, while others aren’t as sure. Global law firm Morgan Lewis argued this point in its white paper “The Evolution of Advice: Digital Investment Advisors as Fiduciaries.”

The firm believes robo-advisers can act as fiduciaries under existing regulations imposed by the Securities Exchange Commission (SEC), including the Adviser’s Act, and the Department of Labor (DOL), because they are essentially offering the same services conducted by human advisers. Moreover, Morgan Lewis argues that the applicable standard of care is not an absolute concept, but rather a flexible one that is “defined by contract” and extends only to the “scope of service agreed to by the client.” The firm notes, “Under common law, the standard of care an agent owes to a principal varies depending on the parties’ agreement and the scope of their relationship.”

Still, critics argue that machines may not be able to gather enough information to make sound, individualized investment advice to meet certain goals such as saving for retirement.

NEXT: Analyzing the machine-adviser effectively 

“The debate is how much information should you collect and what you need to collect to determine whether any advice is appropriate for any particular investor,” suggested Jennifer L. Klass, one of the paper’s co-authors, in an interview with PLANADVISER. “Our position has been that an adviser can solicit as many or as few questions they feel are appropriate to be in the position to provide the advice that they need to provide.”

Morgan Lewis also believes robo-advisers, by design, can present fewer potential conflicts of interest than other approaches to advice deliver. Many robo-advisers are essentially automated managed accounts with portfolios comprised mostly of exchange-traded funds (ETFs). The firm believes that ETFs “in comparison to mutual funds, offer little room for revenue streams and payment shares that would otherwise create a conflict of interest for investment advisers (e.g., 12b-1 fees, subtransfer agent fees).” 

Of course, regulating algorithm-based machines would be different than scrutinizing individual advisers. The Financial Industry Regulatory Authority (FINRA) explores this concept among other topics in its recent publication, “Report on Digital Investment Advice,” which analyzes best practices for broker-dealers.

To remain compliant, FINRA advises that broker/dealers should understand the algorithms that govern digital investment tools and to ensure that the methodology it uses to translate inputs into outputs reflects a firm’s analytical approach to a particular task such as investor profiling and account rebalancing. FINRA also argues firms should understand the assumptions that are made by these machines during “shock events” like global recessions or a geo-political crisis.

In its review of different robo-advisers, FINRA found that most have some committee overseeing the development of algorithms linked to tools, which go through an in-depth vetting and approval process to ensure that “elements such as questionnaire scoring and results perform as expected.”

NEXT: Blending the human touch 

This supervision extends to the portfolios that digital investment tools may present to participants based on risk profiles. FINRA recommends a firm to disclose if the tool favors certain securities along with the reasoning behind its selectivity and whether other investments may have “characteristics, such as cost structure, similar or superior to those being analyzed.”

When it comes to implementing a lot of this thinking, it should also be said that robo-advice is not always completely digital. Several firms such as Fidelity Investments, Vanguard and Financial Engines combine their robo-advice offerings with human components in order to provide plan participants with digital access to their investments as well as access to a human voice.

The combination may benefit plan sponsors by diversifying their options to meet different participant needs, the firms argue. Financial Engines Chief Investment Officer Christopher Jones says the firm has found that older participants, especially those near retirement, value digital advice, but they also appreciate the human touch. Meanwhile, it found that younger clients with higher assets are very active in the digital space. Participants can also benefit from low-fees and low-minim balances typically associated with digital advisers.

Again, this is not to suggest robos are likely to fully replace human advisers anytime soon. Rather, it looks like they will enhance the abilities of traditional financial advisers to grow assets and provide sound investment advice in an increasingly technological world.

The Evolution of Advice white paper can be accessed at

FINRA’s report can be accessed at