Digital Investment Advice Tools

For most advisors, the days of manually pairing a client with specific investments are gone.  More common today is the use of Investment Advice Tools (IATs”), or electronic programs that use algorithms to help with client profiling, asset allocation, portfolio execution, trade execution, rebalancing and so on.  Some IATs, for example, allow an advisor to complete – or hopefully have the client complete – a survey of personal questions, which answers are then converted into an investment profile which is then matched up with a pre-packaged portfolio of securities.  

While IATs can make an advisor’s job easier, they are fraught with both regulatory and civil risks.  FINRA issued last month a report designed to address some of those risks and offer advisors guidance and advice.  A close and careful review of that report is recommended, but here is a very brief summary:

  1. Understand the Technology.  According to FINRA, and I suspect the SEC too, just making use of IATs will get you in trouble.  You and your staff need to have at least a basic understanding of the methodology embedded in the algorithms.  FINRA specifically suggests you understand the program’s data inputs and assumptions, and then test the outputs for consistency with your needs and expectations.  In short, you need to understand what the IAT is doing for you and ensure that its recommendations are accurate and result in suitable recommendations.  Manually inspect and test a number of client accounts is what I recommend.
  2. Conduct Ongoing Reviews.  Clients change and markets change.   As a result your assessment and testing of the IATs being used must be ongoing.  A blind and trusting reliance on the same program repeatedly and over time is just plain bad practice which will eventually get you into trouble.
  3. Develop Compliance Procedures.  In an audit situation, or in a client dispute, one thing that will almost always happen is an assessment of your compliance procedures.  Do you have them?  What are they?  Are they designed properly?  Have they been tested?  Are you following them?  These questions, and more, apply equally to IATs.  What protocols are in place for using IATs?  Testing outputs?  Recording exception reports?  Do the prepackaged proposals create conflicts of interest for you?   Starting soon as a result of new DOL fiduciary rules, you will also need to test and ensure the proposals are in the client’s best interests.
  4. Training.  As with just about anything we do in this industry, training is crucial.   That one IT person in your firm might understand IATs is a dangerous practice.  Make sure everyone and anyone with access to IATs are fully educated and compliant.  

Written by Daniel D. Hill