ROBO-ADVISORS: A CLOSER LOOK

BY

MELANIE L. FEIN*

JUNE 30, 2015

Robo-advisors have been touted by the Department of Labor as a

source of investment advice that can benefit retirement investors by
minimizing costs and avoiding conflicts of interest. On the other hand,
they have been labelled as gimmicky and overly simplistic by some critics
who have used them. The Securities and Exchange Commission has
cautioned that robo-advisors may result in investment recommendations
that are based on incorrect assumptions, incomplete information, or
circumstances not relevant to an individual investor.

This paper examines whether robo-advisors in fact provide

personal investment advice, minimize costs, and are free from conflicts of
interest. It also evaluates whether robo-advisors meet a high fiduciary
standard of care and act in the client’s best interest. Based on a detailed
review of user agreements for three leading robo-advisors, this paper
concludes that robo-advisors do not live up to the DOL’s acclaim. They
are not designed for retirement accounts subject to ERISA and should be
approached with caution by retail and retirement investors looking for
personal investment advice.

* Melanie L. Fein is an attorney who advises clients on matters of

banking, securities, and trust law. She recently served on the adjunct
faculty of Yale Law School teaching Banking and Financial Regulation.
This paper was prepared for Federated Investors, Inc.

Electronic copy available at: http://ssrn.com/abstract=2658701

I. INTRODUCTION .......................................................................................... 1
II. OVERVIEW OF ROBO-ADVISORS ............................................................... 2
A. General Attributes ........................................................................... 2
B. General Criticism of Robo-Advisors............................................. 4
C. SEC FINRA Cautionary Alert ........................................................ 6
III. A CLOSER LOOK AT ROBO-ADVISORS ..................................................... 7
A. Robo-Advisors Do Not Provide Personal Investment
Advice ............................................................................................... 8
B. Robo-Advisors Do Not Minimize Investment Costs ............... 12
C. Robo-Advisors Are Not Free from Conflicts of Interest .......... 15
D. Robo-Advisors Do Not Meet a High Standard of Care ........... 21
E. Robo-Advisors Do Not Act in the Client’s Best Interest .......... 23
F. Robo-Advisors Exclude ERISA Accounts .................................. 26
G. Robo-Advisors Do Not Meet DOL’s Proposed “Best
Interest Contract” .......................................................................... 27
H. Robo-Advisors May Be Unregistered Investment
Companies ...................................................................................... 29
IV. CONCLUSION ........................................................................................... 30

Electronic copy available at: http://ssrn.com/abstract=2658701

I. INTRODUCTION
The technology revolution has transformed the marketplace for
investment products and services in significant ways. New Internet tools
have made it possible for individual investors to buy and sell securities
directly in the stock market without the advice of a broker, investment
adviser, or other intermediary. Many individual investors have acquired
the expertise and self-confidence to conduct their own investment
programs online. Some devote hours each day to managing their
investment portfolios. Some have done well for themselves in the stock
market. Many have not. Some view the stock market as little more than a
casino. Most understand that investing in the market is not for amateurs
or the faint of heart. Certainly when it comes to investing one’s retirement
nest egg, caution is advisable.

Robo-advisors have emerged in the marketplace as an alternative

for small investors who are comfortable using Internet technology but
want the reassurance of an investment adviser to guide them. They offer
investment advice and discretionary investment management services
without the intervention of a human adviser, using algorithms and asset
allocation models that are advertised as being tailored to each individual’s
investment needs.

Whether robo-advisors are a suitable investment vehicle for retail

or retirement investors, however, has been questioned. The Securities and
Exchange Commission (“SEC”) and Financial Industry Regulatory
Authority (“FINRA”) have cautioned that robo-advisors may rely on
assumptions that are incorrect or inapplicable to an individual’s financial
situation. As a result, the robo-advisor may recommend investments that
are not appropriate for an individual investor. 1

Nevertheless, the Department of Labor (“DOL”) has touted robo-

advisors as potentially useful tools that can benefit retirement investors by
minimizing costs and avoiding conflicts of interest.2 The DOL has given
robo-advisors regulatory latitude in order to facilitate development of the
robo-advisor marketplace. In a recently proposed “best interest contract”

________________________
1Securities and Exchange Commission Office of Investor Advocacy and
Financial Industry Regulatory Authority, Joint Investor Alert, Automated
Investment Tools, updated May 8, 2015.
2 See, e.g., “DOL Secretary Perez touts [robo-advisor] as paragon of low-cost,

fiduciary advice,” Investment News, June 19, 2015.

exemption from ERISA, for example, the DOL decided not to subject robo-
advisors to cumbersome regulatory requirements that would govern other
investment advisers. Curiously, however, the leading robo-advisors do
not offer their services to ERISA accounts.

This paper examines the general attributes of robo-advisors along

with recent criticism of these new investment vehicles. It then takes a
closer look to assess whether robo-advisors are worthy of the DOL’s
praise or whether investors should be wary of them as the SEC and
FINRA have advised. Based on a review of customer agreements for the
leading robo-advisors, this paper shows that the DOL’s endorsement of
them is based on faulty assumptions. On the other hand, the cautionary
guidance of the SEC and FINRA appears well-grounded.

This paper shows that robo-advisors do not provide investment

advice that is necessarily in the customer’s best interest, are not free from
conflicts of interest, do not necessarily minimize investment costs, and do
not comply with the fiduciary standard of care under well-established
fiduciary principles.

II. OVERVIEW OF ROBO-ADVISORS

A. General Attributes

The term “robo-advisor” refers to any of a growing number of

Internet-based investment advisory services aimed at retail investors that
have emerged in the financial marketplace in recent months. About a
dozen or so of such services currently exist with any significant customer
base. More robo-advisors are expected to appear in the future.

Robo-advisors offer on-line investment advice based on the user’s

responses to a questionnaire filled out online. The questionnaire is
designed to elicit information to establish basic risk parameters and
investment preferences for the user, but does not necessarily elicit
complete information about the user’s financial situation. Based on the
user’s answers, the robo-advisor formulates an asset allocation program
for the user and makes specific investment recommendations. Clients with
similar investment objectives generally receive the same investment
advice and may hold the same or substantially the same investments in
their accounts.

Robo-advisors offer their services through an Internet interface or

platform. A key characteristic of a robo-advisor is the absence of any

2
human contact between the advisor and investors. Robo-advisors are
designed to avoid the necessity of a personal advisory relationship with
the client.

The leading robo-advisors offer discretionary investment services

with the capacity to effect securities transactions and conduct an
investment program for a user. The user must transfer money to the robo-
advisor or its affiliates to be invested in accordance with the
recommended investment program. The account can be structured to
automatically reallocate investments or rebalance according to
information inputs. Securities transactions typically are effected through
the robo-advisor’s affiliated broker-dealer and/or custodian. Less
comprehensive robo-advisors provide asset allocation and rebalancing
recommendations only, which the investor must implement elsewhere.

The investment vehicles recommended or used by robo-advisors in

their investment programs typically include mutual funds and exchange
traded funds (“ETFs”). ETFs and mutual funds are not limited to
passively managed funds but also may include actively managed funds,
and also may include ETFs and mutual funds sponsored and
administered by affiliates. Some robo-advisors also recommend
investments in individual stocks and offer “tax harvesting” services. A
single ETF may be used for each asset category.

The minimum balance required to open a robo-advisor account

typically is small—$1,000-10,000. Some robo-advisors accept accounts
with no minimum balance required. Robo-advisors charge fees ranging
from zero to 50 basis points or more. They may earn additional
compensation through affiliated and nonaffiliated intermediaries that
provide investment services to the robo-advisor’s user, for which the user
pays a fee, and/or from revenue sharing arrangements with mutual
funds. Robo-advisor users also pay fees directly to mutual funds and ETFs
in which they invest through the robo-advisor’s program.

Robo-advisors are required to register as investment advisers

under the Investment Advisers Act of 1940 or applicable state law. As
discussed infra, Robo-advisors also may be required to register as
investment companies under the Investment Company Act of 1940,
although none appear to be so registered at present.

3
 B. General Criticism of Robo-Advisors

Robo-advisors have been criticized for various shortcomings.

Among other things, they have been labelled as gimmicky and overly
simplistic. A leading robo-advisor, for example, has been accused of
offering a “canned” asset allocation generated from a risk tolerance
“personality quiz” that forces the user into a one-size-fits-all rebalancing
algorithm.3

In this regard, the typical robo-advisor questionnaire allows

investors to provide only limited information about their investment
needs and risk tolerance. According to one user, typical questions are
along the lines of the following:

• Are you saving (i) for retirement, (ii) to build an

emergency fund, or (iii) to maintain my
standard of living?

• Do you understand stocks, bonds and ETFs (i) a

lot, (ii) somewhat, or (iii) not at all?

• When you hear “risk” related to your finances,

do you (i) become worried, (ii) remain
indifferent, or (iii) see opportunity?

• Have you ever lost 20% or more of your

investments in one year?

• If you ever were to lose 20% or more of your

investments in one year, would you (i) sell
everything, (ii) do nothing, or (iii) buy more?

• When it comes to making important financial

decisions, do you (i) avoid them, or (ii) make
them?

• How much fluctuation are you confident your

investment will encounter in the next year—(i) a
lot, or (ii) not much?

________________________
3 See
http://www.forbes.com/sites/davidmarotta/2015/04/12/schwab-
intelligent-portfolios-services-not-provided/.

4
 • How long do you expect to keep your money
invested? 4

Critics argue that these questions elicit only superficial information

that can result in no more than superficial asset allocation and investment
recommendations. 5

Robo-advisors also have been criticized for ignoring key

information relevant to a user’s investment needs, such as the user’s
contribution and withdrawal schedule, dependents, other sources of
wealth, monthly expenses, tax situation, anticipated expenditures (such as
college tuition), and the like.

Another key complaint is the absence of person-to-person contact

with a human adviser who can more carefully evaluate an investor’s
investment needs and circumstances. A human adviser can offer
personalized investment guidance, and encourage investors to save more,
diversify, and engage in less speculative trading. A human adviser can be
available to the investor at crucial times such as during market volatility
when investors are most likely to panic and make investment mistakes. 6

Other commenters have pointed out that robo-advisors have been

in existence only during a bull market and are untested in how they
would perform in a downturn. 7

________________________
4 See
http://www.forbes.com/sites/davidmarotta/2015/03/22/schwab-
intelligent-portfolios-built-on-a-faulty-premise.
5 Id.
6 See, e.g., Robert Litan and Hal Singer, “Good Intentions Gone Wrong: The

Yet‐To‐Be‐Recognized Costs of the Department Of Labor’s Proposed Fiduciary

Rule,” (“[T]he decision to stay invested (or not) during times of market stress
swamps the impact of all other investment factors affecting long‐term retirement
savings, including modest differences in advisory fees or investment strategies.
“Robo‐advice,” which the DOL assumes will over time replace human advisors
who find it uneconomic to serve small savers under the new rule, cannot
effectively perform this critical role. (An email or text message in the fall of 2008,
for example, would not have sufficed to keep millions of panicked savers from
selling, with devastating consequences for their nest eggs).”).
7 Letter dated July 21, 2015, from The American Council of Life Insurers to

the U.S. Department of Labor, http://www.dol.gov/ebsa/pdf/1210-AB32-2-

00621.pdf (“Depending on how many people utilize such a resource, there could

5
 C. SEC FINRA Cautionary Alert

The Securities and Exchange Commission (“SEC”) and Financial

Industry Regulatory Authority (“FINRA”) in May of 2015 issued a joint
investor alert cautioning investors to be wary of robo-advisors. 8 Among
other things, the Joint Alert warns investors to be aware that a robo-
advisor may give advice based on incorrect assumptions, incomplete
information, or circumstances not relevant to the user:

Be aware that an automated tool may rely on assumptions

that could be incorrect or do not apply to your individual
situation…An automated investment tool may not assess
all of your particular circumstances, such as your age,
financial situation and needs, investment experience,
other holdings, tax situation, willingness to risk losing
your investment money for potentially higher investment
returns, time horizon for investing, need for cash, and
investment goals. Consequently, some tools may suggest
investments (including asset-allocation models) that may
not be right for you.

For example, an automated investment tool may estimate

a time horizon for your investments based only on your
age, but not take into account that you need some of your
investment money back in a few years to buy a new home.
In addition, automated tools typically do not take into
account that your financial goals may change. 9

The SEC/FINRA Joint Alert warns that the questionnaires used by

some robo-advisors may be misleading and programmed to generate
preset options, and that investors need to be prepared to make their own
investment decisions:

Be aware that a tool may ask questions that are over-

generalized, ambiguous, misleading, or designed to fit
you into the tool’s predetermined options. In addition, be
________________________
be systemic implications which would be particularly devastating to retirees and
pre-retirees, as well as the economy as a whole.”).
8 Securities and Exchange Commission Office of Investor Advocacy and

Financial Industry Regulatory Authority, Joint Investor Alert, Automated

Investment Tools, updated May 8, 2015.
9 Id.

6
 very careful when inputting your answers or information.
If you make a mistake, the resulting output may not be
right for you….While automated investment tools are
programmed to generate outputs based on preset options,
it is up to you to decide whether and when to rely on
these tools in making your investment decisions. 10

The Joint Alert also cautions that robo-advisors do not offer the
benefits of human judgment and oversight or access to value-added
personalized service:

If the automated investment tool does not allow you to

interact with an actual person, consider that you may lose
the value that human judgment and oversight, or more
personalized service, may add to the process. 11

The Joint Alert also points out that an automated investment tool
may be programmed to use economic assumptions that will not react to
shifts in the market. For example if the automated tool assumes that
interest rates will remain low but interest rates rise instead, the tool’s
output will be flawed. 12

The Joint Alert further warns that robo-advisors may be

programmed to consider only limited investment options, such as only
investments offered by an affiliate of the robo-advisor.

A closer look at robo-advisors indicates that the warnings in the

SEC/FINRA Joint Alert are justified.

III. A CLOSER LOOK AT ROBO-ADVISORS

To better assess the services offered by robo-advisors, the author
examined the user agreements and/or disclosure brochures of three
leading robo-advisors. 13 The user contracts and related agreements are
available on the robo-advisors’ websites. The contracts describe the
services to be provided, fees charged, investment risks, potential conflicts

________________________
Id.
10

Id.
11
12 Id.
13 For purposes of this paper, the robo-advisors will be referred to as Robo-

advisors A, B, and C.

7
of interest, and other matters a user should know about the service and
service providers.

Users are required to agree to an online contract. Some contracts

are lengthy. In one case, the user must read, understand, and sign a 140-
page online document that includes myriad disclosures, disclaimers and
indemnification clauses. It is doubtful that most users actually read and
understand the agreements or print them out for their records.

A review of the leading robo-advisor customer agreements shows

that they generally:

• Do not provide personal investment advice

• Are not free from conflicts of interest

• Do not necessarily minimize costs

• Do not act in the best interest of the client

• Do not meet the standard of care for fiduciary

investments

• Are not designed for ERISA retirement accounts

and would not meet the DOL’s proposed “best
interest” contract exemption.

These conclusions are discussed below.

A. Robo-Advisors Do Not Provide Personal Investment Advice

The leading robo-advisors provide discretionary investment

management services whereby they manage money for investors.
Nevertheless, it would be inaccurate to characterize these robo-advisors as
providing personal investment advice.

As one robo-advisor agreement provides, the robo-advisor will

manage the client’s account not in accordance with the client’s financial
situation or needs but “in accordance with the Plan”:

Client appoints [Robo-advisor] to manage the Account on

a discretionary basis and act as Client’s attorney-in-fact
with limited power and authority for Client and on
Client’s behalf to buy, sell, and otherwise effect

8
 investment transactions in the name of the Account in
accordance with the Plan. 14

The “Plan” is based on the robo-advisor’s investment methodology

regarding asset allocation strategies for investors with the client’s risk
profile and investment preferences based on information provided by the
client in response to the questionnaire. However, as the SEC and FINRA
have cautioned, the resulting advice may be based on incorrect
assumptions, incomplete information, or circumstances not relevant to the
user. 15

Moreover, the “Plan” does not purport to meet the individual

client’s investment needs based on an assessment of the client’s complete
individual financial situation. As one robo-advisor provides:

Client understands and agrees that [Robo-advisor’s] only

obligation is to manage the Account in accordance with
the IPS [investment policy statement], and that Client has
not engaged [Robo-advisor] to provide any individual financial
planning services beyond what is provided via the Interface. 16

Another robo-advisor similarly provides:

Client understands and agrees that [Robo-advisor’s] sole

obligation hereunder or otherwise is to manage the
Account in accordance with the Plan, and Client has not
engaged [Robo-advisor] to provide any individual financial
planning services…. 17

The customer agreement specifically states that the client—not the

advisor—is responsible for determining that Plan investments are in the
client’s best interests:

Client is responsible for determining that investments are

in the best interests of Client’s financial needs. 18
________________________
14 Robo-advisor B customer agreement at 26.
15 Securities and Exchange Commission Office of Investor Advocacy and
Financial Industry Regulatory Authority, Joint Investor Alert, Automated
Investment Tools, updated May 8, 2015.
16 Robo-advisor B customer agreement at 24 (emphasis added).
17 Robo-advisor C customer agreement at 4 (emphasis added).
18 Robo-advisor B customer agreement at 26.

9
 Another robo-advisor agreement similarly provides:

Clients use a web or mobile application to determine

whether the Program is appropriate for them and, if so, to
select an investment strategy. Clients complete their
assessment online and therefore clients should carefully
consider whether their participation in the Program is
appropriate for their investment needs and goals. 19

Another robo-advisor’s agreement provides:

Services of the Program shall include provision of

Products and provision of online tools and functionality to
aid Client in determining Client’s investment
preferences. 20

[Robo-advisor’s] online platform enables clients…to fine-

tune their allocation to match to their individual needs. 21

Robo-advisors do not afford an opportunity for a client to have a

personal advisory relationship with a human adviser. As one robo-
advisor’s agreement provides:

Services shall not include in person, telephonic, or other

written consultation to determine the Client’s financial
situation and investment objectives. 22

The primary, if only, means of communication with the robo-

advisor is through postings on the Internet. As one robo-advisory
agreement describes:

Method of Communication. Client agrees that the primary

method of [Robo-advisor’s] communication with Client
will be by posting information on servers accessible from
the Website and, to the extent required by law, sending
Client a notice that directs Client to the Website from
which the information can be read and printed. Client
understands that [Robo-advisor] reserves the right,
________________________
19 Robo-advisor A at 1.
20 Robo-advisor B customer agreement at 25.
21 Robo-advisor customer agreement at 7.
22 Robo-advisor customer agreement at p. 24.

10
 however, to post Account Communications on the
Website without providing notice to Client, send Account
Communications to Client’s postal or electronic mail
address of record or to another Access Device Client has
registered with [Robo-advisor] or [Robo-advisor]
Securities. Client agrees to check the Interface regularly as
Client may have no other means of knowing that
information and Account Communications have been
delivered to Client. Client agrees that all Account
Communications provided to Client in any of the ways
described above will be deemed to have been good and
effective delivery to Client when sent or posted by [Robo-
advisor], by [Robo-advisor] Securities, or by [Robo-
advisor[ on behalf of [Robo-advisor[ Securities, regardless
of whether Client actually or timely receives or accesses
the Account Communication. 23

One robo-advisor affords wealthier clients access to a one-time

personal consultation with its financial planning experts:

Customers with an account balance of $500k or greater

can schedule a one-time personal consultation with one of
our financial planning experts. This is in addition to being
able to talk 7 days a week with our excellent customer
support team, which is available to all customers. 24

This robo-advisor does not indicate whether its “customer support”

team includes trained investment advisers or qualified representatives.

Robo-advisor clients are essentially left on their own to determine

whether the robo-advisor’s investment strategies are appropriate for their
needs. Moreover, robo-advisor clients also get no help in understanding
the contract they are required to sign in order to obtain services. As one
robo-advisor agreement provides:

Client is solely responsible for reviewing and

understanding all of the terms and conditions of these
documents. 25

________________________
23 Robo-advisor B customer agreement at 21.
24 Robo-advisor A customer agreement.
25 Robo-advisor B customer agreement at 35.

11
 The robo-advisor typically reserves the right to change the advisory
agreement without notice to the investor, who must consult the robo-
advisor’s website for the most up-to-date agreement:

Client acknowledges and agrees that [Robo-advisor] may

modify the Advisory Agreement from time to time and
Client agrees to consult the Interface from time to time for
the most up-to‐date Advisory Agreement.26

Robo-advisor users who wish to allocate their assets themselves

generally may do so only among the assets made available by the robo-
advisor and only in accordance with the recommended plan.

Rather than characterize robo-advisors as providing personal

investment advice, it is more accurate to describe them providing online
tools for a client to use in determining the client’s own risk tolerance and
investment preferences and then enabling the client to subscribe to an
investment strategy based on asset allocation formulas recommended for
investors with similar preferences. In this regard, robo-advisors are
similar to mutual funds. 27

For the foregoing reasons, it would be a mistake for retail or

retirement investors to view robo-advisors as providing comprehensive
personal investment advice designed to meet their individual needs.

B. Robo-Advisors Do Not Minimize Investment Costs

Some robo-advisors advertise that they offer their services for

“free.” The DOL has touted robo-advisors as a benefit to retirement
investors for that reason. 28 The claim that robo-advisor services are “free”
or “low-cost,” however, is misleading if not completely false.

While some robo-advisors may not charge a fee to users, they do

not offer their services without compensation. The compensation they
receive ultimately is paid for by their customers in the form of higher fees
embedded in investment products and services. Robo-advisors receive
compensation from affiliated and non-affiliated broker-dealers,
________________________
26 Robo-advisor B customer agreement at 36.
27 As discussed infra, some robo-advisors may be operating as unregistered
investment companies.
28 See, e.g., “DOL Secretary Perez touts [robo-advisor] as paragon of low-

cost, fiduciary advice,” Investment News, June 19, 2015.

12
custodians, and clearing firms that handle their customer’s securities
transactions, and who similarly do not act without compensation. Robo-
advisor users typically bear the cost of brokerage, transaction, and other
transaction fees and expenses, whether directly or indirectly, and thus
contribute to the robo-advisor’s compensation. Accordingly, it is
misleading to say that robo-advisory services are “free” or even “low-
cost” to the user.

Robo-advisors disclose their compensation arrangements with

service providers in their customer agreements. Some robo-advisors
charge a single “all-inclusive” fee or “wrap fee” and the client may not
pay a separate charge for securities transactions. Nevertheless, the robo-
advisor may receive revenue sharing payments from products in which
clients are invested. A leading “low-cost” robo-advisor, for example,
discloses:

Client understands and agrees that [Robo-advisor], [Robo-

advisor] Securities, their affiliates, and their
representatives, consultants, or other agents in connection
with the performance of their respective services, shall be
entitled to and may share in the Fee or revenues derived
from the Program. 29

In addition, users who invest through a robo-advisor are charged

fees embedded in the investment products purchased for the user’s
account:

The only other fees Client will incur are the fees
embedded in the Products purchased on Client’s behalf. 30

Such embedded fees can be significant and include mutual fund

advisory fees, brokerage, and other fees and expenses. One robo-advisor
discloses:

[Robo-advisor] charges no advisory fees. [Robo-advisor]

affiliates do earn revenue from the underlying assets in
[Robo-advisor] accounts. This revenue comes from
managing [Robo-advisor] ETFs™ and providing services
relating to certain third-party ETFs that can be selected for
the portfolio, and from the cash feature on the accounts.
________________________
29 Robo-advisor B customer agreement at 27.
30 Robo-advisor B customer agreement at 27.

13
 Revenue may also be received from the market centers
where ETF trade orders are routed for execution. 31

All fees paid to [Robo-advisor] for investment advisory

services are separate and distinct from the fees and
expenses charged by Funds to their shareholders. These
fees and expenses are described in each Fund’s
prospectus. These fees are generally composed of a
management fee and other Fund expenses. 32

Moreover, robo-advisors typically reserve the right to charge or

change a fee at any time:

Client understands and agrees that [Robo-advisor] may

change the Fee or amend the Fee Schedule at any time by
giving 30 days prior written notice. 33

Moreover, robo-advisors do not appear to offer their services at less

cost than many mutual funds that are available online and provide simple
asset allocation tools that enable investors to invest directly without the
need for an intermediary.

Similarly, robo-advisors do not appear to be less costly to the

investor than ERISA 401(k) plans and similar plans that offer mutual fund
“C” shares with no fee at the account level.

It is unclear what benchmark the DOL is using, but its assumption

that retirement investors can obtain investment advice from a robo-
advisor for “free” or at “low cost” is not well-founded.

In any event, while fees can have a significant impact on

investment returns, it is well-established that the least cost investment is
not necessarily the best investment. The DOL itself has rejected the idea
that the least cost investment is required by ERISA or is necessarily in the
best interests of plan beneficiaries.

________________________
31 Robo-advisor A customer agreement.
32 Robo-advisor B customer agreement at 10.
33 Robo-advisor B customer agreement at 27.

14
 C. Robo-Advisors Are Not Free from Conflicts of Interest

Robo-advisors are affected with a number of conflicts of interest

that enable them to engage in self-dealing transactions. Among other
things, as noted, in providing services to customers, robo-advisors use
affiliated brokers, custodians, clearing firms or other firms from which
they receive compensation. They also use their own investment products.

To effect securities transactions for users, robo-advisors typically

use an affiliated broker-dealer or a broker of their choice, which may not
always obtain a favorable price for the user. As one leading robo-advisor
discloses:

All brokerage transactions for securities in [the] Program

accounts will be routed to [Robo-advisor’s brokerage
affiliate] for execution, which may not always obtain as
favorable a price as another broker-dealer.34

Another robo-advisor agreement similarly discloses that the client

may not obtain rates as low as it might otherwise get if the robo-advisor
selected a non-affiliated broker:

All transactions shall be executed by Broker [which may

be an affiliate] as the custodian of the Account. Client
represents and warrants that Client is satisfied with the
terms and conditions relating to all services to be
provided by Broker. [Robo-advisor] shall not have any
responsibility for obtaining for the Account the best prices
or any particular commission rates. Client recognizes that
Client may not obtain rates as low as it might otherwise
obtain if [Robo-advisor] had discretion to select broker-
dealers other than Broker. 35

The customer agreement also discloses that the robo-advisor

engages in agency cross-trades that have resulting conflicts of interest. The
client is required to consent to such conflicts:

Client agrees that [Robo-advisor], or any person

controlling, controlled by or under common control with
[Robo-advisor], may act as broker for both Client and for
________________________
34 Robo-advisor A customer agreement at 5.
35 Robo-advisor C customer agreement at 6.

15
 another person on the other side of any transaction
involving funds or Securities in the Account (“Agency
Cross Transaction”). Client recognizes that [Robo-advisor]
or its affiliates may receive commissions, and have a
potentially conflicting division of loyalties and
responsibilities regarding, both parties to such Agency
Cross Transactions…. 36

Robo-advisors may have an interest or position in securities that

are recommended to clients:

[Robo-advisor] or individuals associated with [Robo-

advisor] may buy or sell securities identical to or different
than those recommended to clients for their personal
accounts. In addition, any related person(s) may have an
interest or position in certain securities which may also be
recommended to a client. 37

Robo-advisors may require customers to consent to allow the robo-

advisor to engage in principal transactions with itself in connection with
the sale or purchase of securities for the client’s account:

Client expressly authorizes [Robo-advisor] Securities with

[Robo-advisor’s] cooperation to arrange “agency cross”
transactions (i.e., transactions for which [Robo-advisor]
Securities or an affiliate acts as a broker for both parties in
a transaction) and transactions between Client and [Robo-
advisor’s] own account, which may result in conflicting
loyalties. 38

Another robo-advisor agreement discloses similar conflicts of

interest in the handling of client orders:

Order Handling. [Robo-advisor] Securities may, but is not

required to, aggregate orders for the sale or purchase of
securities for the Account with orders for the same
security for other [Robo-advisor] Securities customers,
including its employees and their related persons, and for
[Robo-advisor’s] own account with [Robo-advisor]
________________________
36 Robo-advisor C customer agreement at 6.
37 Robo-advisor B customer agreement at 9.
38 Robo-advisor B customer agreement at 64.

16
 Securities. In such cases, each Account will be charged or
credited with the average price per unit.

Client expressly authorizes [Robo-advisor] and [Robo-

advisor] Securities to arrange “agency cross” transactions
(i.e., transactions for which [Robo-advisor] Securities or an
affiliate acts as a broker for both parties in a transaction)
and transactions between Client’s Account and [Robo-
advisor’s] own account with [Robo-advisor] Securities.
These types of transactions may result in conflicting
loyalties. In instances of agency cross transactions and
transactions with [Robo-advisor’s] account no mark down,
mark up, or other compensation will be charged. 39

Robo-advisors may receive payments for order flow in exchange

for routing trades to a clearing firm. For example, one robo-advisor
agreement discloses:

[Robo-advisor] routes your trades to our brokerage

partner, Apex Clearing, for execution. In exchange for
routing trades, we may receive monetary rebates that
offset our commission cost. 40

Apex or [Robo-advisor] may receive compensation or

other consideration for the placing of orders with market
centers for execution. The amount of the compensation
depends on the agreement reached with each venue.
The source and nature of compensation relating to the
undersigned’s transactions will be furnished upon written
request. 41

[Robo-advisor] Securities reserves the right to receive

remuneration (generally in the form of per-share cash
payments or through profit sharing arrangements) for
directing orders in securities to particular broker-dealers
and market centers for execution. Client understand that
this remuneration, known as “payment for order flow,” is
considered compensation to [Robo-advisor] Securities and

________________________
39 Robo-advisor B customer agreement at 26.
40 Robo-advisor C customer agreement at 16.
41 Robo-advisor C customer agreement at 20.

17
 the source and amount of any compensation received by
[Robo-advisor] Securities in connection with Client’s
transaction will be disclosed on written request. 42

One leading robo-advisor uses deposits of an affiliated bank for the

cash sweep allocation of its investment program. The robo-advisor
discloses that this arrangement creates a conflict of interest:

[Robo-advisor] Bank (“Robo Bank”) earns income on the

Sweep Allocation for each investment strategy. The higher
the Sweep Allocation and the lower the interest rate paid
the more Robo Bank earns, thereby creating a potential
conflict of interest for [Robo-advisor]. The cash allocation
can affect both the risk profile and performance of a
portfolio.43

To mitigate the conflict, the robo-advisor, states that its investment

strategies are constructed “pursuant to modern portfolio theory and
behavioral factors seeking an optimal return goal for a portfolio based on
the level of risk an investor is willing to take.” 44 It is unclear, however,
how this “mitigation” relates to the actual conflict.

As noted above, the SEC/FINRA Joint Alert cautions investors that

robo-advisors may be programmed to consider only limited investment
options, such as only investments offered by an affiliated firm. A review
of robo advisory programs indicates that this warning is justified and that
robo-advisors are structured to invest in products sponsored by affiliates
or from which they and/or their affiliates receive fees. One leading robo-
advisor discloses:

Eligible ETFs include [affiliated] ETFs™, which are

managed by [investment manager], which is an affiliate of
[Robo-advisor]. [Robo-advisor’s] ETFs pay fees to [another
affiliate, which] has discretion to allocate any portion,
from none up to 100%, of an investment strategy into
[Robo-advisor] ETFs….**** Each ETF, including a [Robo-
advisor] ETF, pays investment advisory, administrative,
distribution, transfer agent, custodial, legal, audit, and

________________________
42 Robo-advisor B customer agreement at 67.
43 Robo-advisor A at 1.
44 Robo-advisor A at 1.

18
other customary fees and expenses, as set forth in the ETF
prospectus. An ETF pays these fees and expenses, which
ultimately are borne by its shareholders. Therefore, [Robo-
advisor affiliate] will earn fees from [Robo-advisor] ETFs
that are held in [] Program accounts.

[Robo-advisor] has established the [Robo-advisor] ETF

OneSource™ program (“ETF OneSource”) under which
ETFs can be traded without a commission on buy and sell
transactions. [Robo-advisor] Program accounts may
include ETFs that participate in ETF OneSource. [Robo-
advisor] receives payments from the third-party ETF
sponsors or their affiliates participating in ETF OneSource
for recordkeeping, shareholder services and other
administrative services that [Robo-advisor] provides to
participating ETFs. In addition, [Robo-advisor] promotes
the ETF OneSource program to its customers, and a
portion of the fees paid to [Robo-advisor] offsets some or
all of [Robo-advisor’s] costs of promoting and
administering ETF OneSource. [Robo-advisor] does not
receive payment to promote any particular ETF to its
customers.

ETF sponsors or their affiliates pay a fixed program fee to

[Robo-advisor] each year for each ETF participating in
ETF OneSource. The program fees vary, but can range up
to $250,000 per year for each participating ETF. ETF
sponsors or their affiliates also pay [Robo-advisor] an
asset-based fee based on a percentage of total ETF assets
purchased by [Robo-advisor] customers after the ETF was
added to ETF OneSource. The amount of the asset-based
fee can range up to 0.20% annually. [Robo-advisor]
ETFs™ do not pay any program or asset-based fees to
participate in ETF OneSource.

Assets in [Robo-advisor] Program accounts are included

in the calculation of the asset-based fee to be paid to
[Robo-advisor] by an ETF sponsor or its affiliates. [Robo-
advisor] may exclude other assets or other types of

19
 transactions from the asset-based fee paid by an ETF
sponsor or its affiliates. 45

Robo-advisors that provide discretionary investment management

services generally use only the products they select, which typically
include mainly proprietary products or mutual funds and ETFs with
which they have revenue sharing agreements. For example, one robo-
advisor customer agreement provides:

Client understands that the Products available for

inclusion in the Account are to be determined by [Robo-
advisor] and that [Robo-advisor] may change the Products
available for inclusion in the Account without notice to
Client. 46

Client may direct [Robo-advisor] by means outside of the

Interface to allocate assets in the Account in a manner
determined by Client and other than as determined by
[Robo-advisor]; provided however, that the Products
available under such alternative asset allocation shall be
limited to the Products determined by [Robo-advisor]. 47

Robo-advisor agreements may impose requirements or restrictions

that limit users’ access to their funds. For example, one robo-advisor
agreement reserves the right to impose a waiting period of longer than
five days during which a user might not have access to his or her funds
for trading or withdrawal:

Client understands and agrees that the deposit and

withdrawal of funds to or from the Account will be
conducted exclusively in cash via [sic]. Client understands
and agrees that ACH transactions are subject to
processing delays which may last up to five Business Days
or longer and funds transferred may not be credited to the
Account or otherwise available to Client during
processing. [Robo-advisor]and [Robo-advisor]Securities,
in their sole discretion, may impose a longer waiting

________________________
45 Robo-advisor A at 1 and 4.
46 Robo-advisor B customer agreement at 24.
47 Robo-advisor B customer agreement at 25.

20
 period during which funds may not be available for
trading or withdrawal. 48

The agreement does not indicate what circumstances would

warrant the robo-advisor, in its sole discretion, imposing an indeterminate
longer waiting period during which the customer could not access his or
her funds.

All of these conflicts of interest are not necessarily prohibited under

federal securities law to the extent they are disclosed by the robo-advisor
and the user consents by accepting the customer agreement. But they do
indicate that robo-advisors are not free from conflicts of interest, contrary
to the DOL’s assertions otherwise.

D. Robo-Advisors Do Not Meet a High Standard of Care

Robo-advisors do not meet the high fiduciary standard of care that

normally governs the provision of investment management services by a
registered investment adviser or ERISA fiduciary.

The prevailing standard of care is that described in the Uniform

Prudent Investor Act (“UPIA”). The UPIA requires a trustee to “invest
and manage trust assets as a prudent investor would, by considering the
purposes, terms, distribution requirements, and other circumstances of the
trust” and to “exercise reasonable care, skill, and caution” in doing so. 49

Among the factors the UPIA requires a trustee to consider when

investing and managing trust assets are:

• general economic conditions;

• the possible effect of inflation or deflation;

• the expected tax consequences of investment

decisions or strategies;

________________________
48 Robo-advisor B customer agreement at 28.
49 Uniform Prudent Investor Act § 2. The UPIA was approved for enactment
in all the states by the National Conference of Commissioners on Uniform State
Laws in 1994. Nearly all of the states have adopted the UPIA or a variation
thereof.

21
 • the role that each investment or course of action
plays within the overall trust portfolio, which
may include financial assets, interests in closely
held enterprises, tangible and intangible
personal property, and real property;

• the expected total return from income and the

appreciation of capital;

• other resources of the beneficiaries;

• needs for liquidity, regularity of income, and

preservation or appreciation of capital; and

• an asset’s special relationship or special value, if

any, to the purposes of the trust or to one or
more of the beneficiaries.

None of the leading robo-advisor advisory services evaluate an

investor’s total financial circumstances in light of all these factors, and
none of them meets the fiduciary standard of care set forth in the UPIA.

The UPIA states that “investment and management decisions

respecting individual assets must be evaluated not in isolation but in the
context of the trust portfolio as a whole and as a part of an overall
investment strategy having risk and return objectives reasonably suited to
the trust.” (emphasis added) Robo-advisors do just the opposite—they
make isolated investment and management decisions that do not take into
consideration the investor’s portfolio as a whole. They generally disclaim
that they offer an overall investment strategy for the investor. For
example, a leading robo-advisor’s agreement provides:

Client understands and agrees that [Robo-advisor’s]

investment plan will not be based on assets that Client
may have outside of the Account or Client’s preferences
that [Robo-advisor] does not explicitly request via the
Interface after Client logs into the Website, unless [Robo-
advisor] specifically requests such information via the
Interface after Client logs into the Website and Client
provides the requested information via the Interface.
Client understands and agrees that [Robo-advisor’s] only
obligation is to manage the Account in accordance with
the IPS [investment policy statement], and that Client has

22
 not engaged [Robo-advisor] to provide any individual
financial planning services beyond what is provided via
the Interface. 50

In addition, none of the leading robo-advisors appears to comply

with the UPIA requirement that a trustee “make a reasonable effort to
verify facts relevant to the investment and management of trust assets.” A
robo-advisor typically does not make any effort to verify such facts but
relies solely on information provided by the client and requires the client
to certify that the information provided to the robo-advisor is correct.

The UPIA requires a fiduciary to monitor investments to ensure

that they continue to be in the best interests of the account. The Supreme
Court has held that the fiduciary duty of an ERISA fiduciary similarly
includes the duty to monitor investments for fiduciary accounts on an
ongoing basis. 51 Robo-advisors, however, do not monitor the
appropriateness of investments for individual client accounts. They may
adjust their asset allocations and rebalance customer accounts, but they do
not monitor whether the client’s account investments are in the best
interests of the client on an ongoing basis.

One robo-advisor customer agreement emphasizes that it is the

client’s responsibility to monitor his or her own accounts and that robo-
advisor personnel will conduct only limited, non-periodic reviews of
customer accounts:

[Robo-advisor’s] investment tools are intended for clients

to utilize to review their account and better understand
their holdings and performance. [Robo-advisor’s]
personnel conduct only limited, non-periodic individual
reviews of client accounts when triggered by certain
investment activity and account settings. 52

E. Robo-Advisors Do Not Act in the Client’s Best Interest

Robo-advisors are not structured to act in the client’s best interest.

As one agreement states, the client—not the robo-advisor—is responsible
for determining that investments are in the client’s best interests:

________________________
50 Robo-advisor B customer agreement at 24.
51 Tibble v. Edison Int’l, 135 S. Ct. 1823 (2015).
52 Robo-advisor B customer agreement at 10.

23
 Client is responsible for determining that investments are
in the best interests of Client’s financial needs. 53

The customer agreement further provides:

In deciding to engage [Robo-advisor] and open the

Account, Client represents that Client has determined that
the Program is appropriate for Client, taking into account all
factors that Client believes are relevant…. 54

Nowhere in the agreement does the robo-advisor obligate itself to

act in the customer’s best interest.

Robo-advisors appear to aim to minimize their fiduciary duty to

clients. Their agreements are designed to limit their fiduciary duty. One
robo-advisor agreement expressly disclaims that it has any relationship
with the client other than as an independent contractor:

[Robo-advisor] is and will hereafter act as an independent

contractor and not as an employee of Client, and nothing
in this Agreement may be interpreted or construed to
create any employment, partnership, joint venture or other
relationship between [Robo-advisor] and Client. 55

Another robo-advisor agreement all but disclaims any fiduciary

duty to the client:

Client understands and agrees that Client is responsible

for any trades placed in the Account and for all Losses
arising from or related to the Account. Except for
negligence or malfeasance or violation of applicable law,
Client agrees that [Robo-advisor] and [Robo-advisor]
Securities and their respective officers and employees
shall not be liable hereunder for any action performed or
omitted to be performed or for any errors of judgment in
managing the Account. Federal and state securities laws
impose liabilities under certain circumstances on persons
who act in good faith and therefore nothing herein shall in
any way constitute a waiver or limitation of any rights
________________________
53 Robo-advisor B customer agreement at 26.
54 Robo-advisor B customer agreement at 33 (emphasis added).
55 Robo-advisor C customer agreement at 7.

24
 which Client may have under federal or state securities
laws. In addition, it is possible that Client or [Robo-
advisor] itself may experience computer equipment
failure, loss of internet access, viruses, or other events that
may impair access to [Robo-advisor’s] software based
financial advisory service. [Robo-advisor] and its
representatives are not responsible to any Client for losses
unless caused by [Robo-advisor] breaching its fiduciary
duty. 56

Another robo-advisor agreement actually requires the client to

agree to indemnify the robo-advisor and its officers, directors, employees,
shareholders, and affiliates for “all claims, losses, damages, liabilities, and
expenses” that arise by reason of any act or omission of the client, broker,
agent, or other third party selected by the robo-advisor:

Client…shall indemnify and defend [Robo-advisor] and

[Robo-advisor’s] directors, officers, shareholders,
employees and affiliates and hold them harmless from
and against any and all claims, losses, damages, liabilities
and expenses, as they are incurred, by reason of any act or
omission of Client or Broker or any custodian, broker,
agent or other third party selected by [Robo-advisor] in a
commercially reasonable manner or selected by Client,
except such as arise from [Robo-advisor’s] breach of
fiduciary duty to Client. 57

Another robo-advisor agreement similarly limits its liability:

Client shall indemnify and hold harmless [Robo-advisor]

Securities, its directors, employees, agents, and affiliates
from and against any and all Losses, claims, or financial
obligations that may arise from any act or omission of
[Robo-advisor] with respect to the Account. 58

While a fiduciary generally is not responsible for losses in a client’s

account that are beyond its control, the extent to which robo-advisors seek

________________________
56 Robo-advisor B customer agreement at 32.
57 Robo-advisor C customer agreement at 6.
58 Robo-advisor B customer agreement at 59.

25
to limit their liability suggests that they do not perceive themselves as
under a fiduciary duty to act in the client’s best interest.

The leading robo-advisor agreements provide for mandatory

arbitration of disputes and require investors to waive their right to a
court-ordered remedy:

The parties waive their rights to seek remedies in court,

including any right to a jury trial.59

All parties to this Advisory Agreement are giving up the

right to sue each other in court, including the right to a
trial by jury, except as provided by the rules of the
arbitration forum in which a claim is filed…Arbitration
awards are generally final and binding; a party’s ability to
have a court reverse or modify an arbitration award is
very limited…The ability of the parties to obtain
documents, witness statements and other discovery is
generally more limited in arbitration than in court
proceedings…The arbitrators do not have to explain the
reason(s) for their award unless, in an eligible case, a joint
request for an explained decision has been submitted by
all parties to the panel at least 20 days prior to the first
scheduled hearing date…The panel of arbitrators will
typically include a minority of arbitrators who were or are
affiliated with the securities industry…. 60

Based on the foregoing, it cannot be said that robo-advisors act in

the best interest of the client but rather leave it to the client to act in his or
her own best interest.

F. Robo-Advisors Exclude ERISA Accounts

Robo-advisors avoid fiduciary status under ERISA by not offering

their services to retirement accounts that are subject to ERISA. One
leading robo-advisor’s customer agreement explicitly states that ERISA
accounts are “not eligible” to use its services:

Business entities, government entities and accounts that

are subject to the Employee Retirement Income Security
________________________
59 Robo-advisor C customer agreement at 7.
60 Robo-advisor B customer agreement at 37.

26
 Act of 1974 (“ERISA”), as amended, are not eligible for the
SIP Program. 61

Another leading robo-advisor’s agreement similarly provides:

Client represents and warrants to [Robo-advisor] and

agrees with [Robo-advisor] as follows: …As of the
Effective Date, and at all times during the term of this
Agreement, none of the Account’s assets are or will be
assets of “employee benefit plans” within the meaning of
the Federal Employee Retirement Income Security Act of
1974, as amended.

Robo-advisors may allow customers with individual retirement

accounts (IRAs) to use their services, but generally avoid ERISA accounts.
By refusing to serve ERISA accounts, they thereby avoid ERISA’s strict
fiduciary duties.

Accordingly, robo-advisor services do not appear to be available to

retirement investors for their 401(k) plans, which are subject to ERISA,
notwithstanding the DOL’s encouragement of their use by such investors.

G. Robo-Advisors Do Not Meet DOL’s Proposed “Best Interest

Contract”

The DOL has proposed a new definition of “fiduciary” for

purposes of ERISA under which investment advisers will be deemed to
have “fiduciary” status under ERISA. 62 In connection with the proposed
rule, the DOL also proposed an exemption to allow such fiduciaries to
receive compensation that otherwise would be prohibited under ERISA if
the fiduciary enters into a “best interest” contract with each retirement
investor.63 Under the contract, the adviser must:

• contractually acknowledge its fiduciary status,

• commit to adhere to basic standards of

impartial conduct,

________________________
61 Robo-advisor A customer agreement at 1.
62 DOL, “Definition of the Term “Fiduciary”; Conflict of Interest Rule –
Retirement Investment Advice,” 80 Federal Register 21927-21960 (April 20, 2015).
63 80 Federal Register 21960 (April 20, 2015).

27
 • warrant that it has adopted policies and
procedures reasonably designed to mitigate any
harmful impact of conflicts of interest,

• disclose basic information on its conflicts of

interest and the cost of its advice,

• commit to fundamental obligations of fair

dealing and fiduciary conduct,

• commit to give advice that is in the customer’s

best interest,

• commit to avoid misleading statements, and

• agree to receive no more than reasonable

compensation. 64

As proposed, the DOL’s best interest contract exemption does not

apply to compensation received by a robo-advisor. The DOL in its Federal
Register notice stated that such an exemption—and its stringent
requirements—is not necessary because the marketplace for robo-advice is
evolving in ways that “both appear to avoid conflicts of interest that
would violate the prohibited transaction rules, and minimize cost.”
Indeed, the DOL’s position seems to be that, because robo-advisors give
investment advice without any personal interaction or advice from an
individual adviser, they are not even ERISA fiduciaries. Furthermore, the
DOL seems to say, there is no need to regulate them as fiduciaries under
ERISA since they avoid conflicts of interest and minimize cost.

The DOL provides no basis for its assumption that robo-advisors

are free from conflicts of interest or minimize costs. As this paper has
shown, the leading robo-advisors do not meet these standards. Among
other things, the robo-advisors do not acknowledge their fiduciary status
and indeed some seek to contract it away. They do not commit to give
advice that is in the customer’s best interest, and are not structured to do
so. They do not agree to receive no more than reasonable compensation.
Accordingly, despite being touted by the DOL as providing beneficial
“low-cost” investment advisory services to retirement investors, the
leading robo-advisors do not meet the DOL’s proposed fiduciary
standards.
________________________
64 Id.

28
 Moreover, the DOL seems surprisingly unconcerned about the
minimal level of fiduciary responsibility assumed by robo-advisors. Robo-
advisors are not structured to comply with the prudent investor standard
of care or to act in the client’s best interest. Rather, they rely on the client
to act in his or her own best interest.

The DOL’s endorsement of robo-advisors seems especially

misplaced in light of the fact, as shown above, that the leading robo-
advisors are structured to exclude ERISA retirement accounts for
eligibility for their services.

H. Robo-Advisors May Be Unregistered Investment Companies

Robo-advisors may be acting as unregistered investment

companies in violation of the Investment Company Act of 1940 and SEC
regulations thereunder. The SEC has taken the position that investment
advisory services that are provided on a discretionary basis to a large
number of advisory clients having relatively small amounts to invest may
be deemed “investment companies” unless they comply with a
nonexclusive “safe harbor” under SEC Rule 3a-4 under the Investment
Company Act. 65
________________________
65 See Status of Investment Advisory Programs under the Investment
Company Act, 62 Federal Register 15098 (March 31, 1997) (final rule); 60 Federal
Register 39574 (Aug. 2, 1995) (proposed rule). The SEC said: “Under wrap fee
and other investment advisory programs, a client's account typically is managed
on a discretionary basis in accordance with pre-selected investment objectives.
Clients with similar investment objectives often receive the same investment
advice and may hold the same or substantially the same securities in their
accounts. In light of this similarity of management, some of these investment
advisory programs meet the definition of investment company under the
Investment Company Act, and can be deemed to be issuing securities for
purposes of the Securities Act of 1933 ("Securities Act"). Section 3(a)(1) of the
Investment Company Act defines the term investment company generally to
include any "issuer" which is engaged primarily in the business of investing,
reinvesting, or trading in securities. The definition of issuer includes any
organized group of persons, whether or not incorporated, that issues or proposes
to issue any security. An investment advisory program could be considered to be
an issuer because the client accounts in the program, taken together, could be
considered to be an organized group of persons. Investors in the program could
be viewed as purchasing securities in the form of investment contracts. If an
investment advisory program is deemed to be an "issuer," it also would be
deemed to be an investment company because it is engaged in the business of
investing, reinvesting, or trading in securities.” 60 Federal Register 39574.

29
 To be eligible for the safe harbor, an investment advisory program
must be organized and operated in accordance with certain requirements.
Among these are that “each client’s account in the program is managed on
the basis of the client’s financial situation and investment objectives and in
accordance with any reasonable restrictions imposed by the client on the
management of the account” and “the sponsor and personnel of the
manager of the client’s account who are knowledgeable about the account
and its management are reasonably available to the client for
consultation.” 66

It may be questioned whether robo-advisors meet these

requirements to the extent they do not manage client accounts on the basis
of each client’s financial situation and clients do not have reasonable
access to personnel who are available to consult with the client. As
discussed above, robo-advisor questionnaires do not necessarily elicit all
of the relevant information about each client’s financial situation. Thus,
the robo-advisor may not be managing the client’s account on the basis of
the client’s financial situation but rather on the basis of responses to the
questionnaire, and the advisor’s assumptions based thereon, which might
not be accurate. Moreover, robo-advisors are designed to provide
investment advice based on asset allocation formulas and strategies that
result in the same investment recommendations to investors with broadly
similar investment goals and thus may not be based on each client’s
individual financial situation.

Finally, to the extent robo-advisors limit communication with their

clients to an Internet interface, clients may not be able to consult with the
sponsor or personnel of the manager of the client’s account who are
knowledgeable about the account. Indeed, the reason robo-advisors are
called “robo” is because they are designed to operate with no individual
account manager or human personnel contact.

IV. CONCLUSION
The DOL has touted robo-advisors as investment alternatives for
retirement investors based on ill-founded assumptions that robo-advisors
are free or “low-cost” and seek to minimize conflicts of interest. This
paper has examined several of the leading robo-advisors and shown that
the DOL’s assumptions are incorrect or misleading.

________________________
66 SEC Rule 3a-4; 17 C.F.R. 270.3a-4.

30
 Based on a review of robo-advisor customer agreements, this paper
has shown that robo-advisors are not free from conflicts of interest and do
not minimize investment costs to the extent the DOL assumes. Moreover,
robo-advisors do not provide personal investment advice, do not meet a
high standard of care for fiduciary investing, and do not act in the client’s
best interest. The robo-advisor agreements reviewed herein would not
meet the DOL’s proposed “best interest” contract exemption that requires
investment advisers to acknowledge their fiduciary status, commit to give
only advice that is in the customer’s best interest, and agree to receive no
more than reasonable compensation.

The SEC and FINRA have issued cautionary advice to investors

regarding robo-advisors. Their concerns appear justified, based on the
robo-advisor customer agreements reviewed herein.

31