FINRA Reports on Effective Practices for Digital Investment Advice
Ray Pellecchia (212) 858-4387
WASHINGTON — Financial services firms' offerings of digital investment advice need sound governance and supervision, including effective means of overseeing suitability of recommendations, conflicts of interest, customer risk profiles and portfolio rebalancing, according to a new report from the Financial Industry Regulatory Authority (FINRA). The report also outlines lessons for investors and says training and education are crucial for financial professionals who use digital investment advice tools.
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.
"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," said Richard Ketchum, Chairman and CEO 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."
The report outlines regulatory principles and effective practices in five key 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;
- 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.
FINRA, the Financial Industry Regulatory Authority, is the largest independent regulator for all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. FINRA touches virtually every aspect of the securities business – from registering and educating all industry participants to examining securities firms, writing rules, enforcing those rules and the federal securities laws, and informing and educating the investing public. In addition, FINRA provides surveillance and other regulatory services for equities and options markets, as well as trade reporting and other industry utilities. FINRA also administers the largest dispute resolution forum for investors and firms. For more information, please visit www.finra.org.