As the number of robo-advisors explodes, the Securities and Exchange Commission has honed its examinations on interactive digital investment advisors, including those that offer discretionary advice, uncovering a wide swath of deficiencies at almost all firms in the nation.

The SEC said it sent a deficiency letter to “nearly all” of the advisors examined, with examiners’ observations most often centering on compliance programs, portfolio programs, robo-advisors’ fiduciary duty to provide advice in each client’s best interest and marketing and performance advertising, the agency said in a risk alert released in early November.

“When robo-advisors fail to comply with their regulatory obligations … investors may experience poor outcomes,” the SEC said. That can include digital advice offerings that don’t “appropriately capture a client’s risk tolerance [and] it could result in advice to invest in securities that are not aligned with the client’s best interest. Similarly, if a robo-advisor is programmed to act on conflicts of interest that raise the costs or decrease the quality of the services provided, the client may be harmed as a result of the advisor’s putting its own interests ahead of its client,” the SEC said in the alert.

Examiners gave particular attention to whether or not robo-advisors were upholding their fiduciary duty to provide clear and adequate disclosure regarding the nature of the advisors’ services and performance history and act in their clients’ best interests.

In fact, the SEC found that robo-advisors either lacked written policies and procedures that would allow the firms to develop a reasonable belief that the investment advice being provided to clients was in each client’s best interest or adopted policies and procedures that were inadequate or not followed.

Some firms relied on just a few data points to formulate investment advice, examiners found. “This raised the concern that the questions did not elicit sufficient information to allow the advisor to conclude that its initial and ongoing advice were suitable and appropriate for that client based on the client’s financial situation and investment objectives.”

Moreover, many advisors failed to periodically evaluate or update whether or not accounts are still being managed based on clients’ needs. Robos also failed to inquire about any changes in investors’ financial situations or investment objectives, the SEC found.

Exams also uncovered the fact that more than 50% of robo-advisors had advertisement-related deficiencies, including misleading statements and “vague and unsubstantiated claims that could cause an untrue or misleading implication or inference” about what advisory services would be provided, what are the available investment options, what are the performance expectations and what are the costs incurred, the agency said.

Robo-advisors’ advertising and marketing on their websites in particular also found that firms:

• Misrepresented Securities Investor Protection Corp. (SIPC) protections by implying that client accounts would be protected from market declines;
• Used press logos such as those of ABC, CNN or Forbes, without providing links or disclosure that would explain their relevance; and
• Referred to, or provided links to, positive third-party commentary, without disclosing conflict of interest such as advisor compensation.

Robo-advisors’ websites implied that investor accounts would be safeguarded against market declines, while the SIPC only protects the custody function of a broker-dealer in the event of the firm’s failure and is limited to $500,000, the SEC said.

And some robo-advisors offered inadequate disclosures about the human element of their services, such as whether they cost extra and involved assigned financial professionals, according to the regulator.

“In response to the staff’s observations, some advisors elected to amend disclosures and marketing materials, modify or eliminate performance advertisements, revise compliance policies and procedures, improve data protection practices, and/or change other practices,” the SEC said.