It was never a question of if, but rather, when the Securities and Exchange Commission would launch its first charges against robo-advisors and what those charges would be. Following then-SEC Chairperson, Mary Jo White’s keynote address at the SEC-Rock Center on Corporate Governance in 2016, regulators have been carefully monitoring robo-advisors’ compliance with the Investment Advisers Act of 1940 (“Advisers Act”). In two recent Orders, the SEC found Wealthfront Advisers made false statements about its tax-loss harvesting program (“TLH”), and found Hedgeable made false performance comparisons about its investment performance. Both robo-advisors were also found to be in violation of the Advisers Act for their marketing use on social media platforms.
False Statement in Whitepaper Description
Wealthfront designed its TLH program to incentivize clients to sell certain assets at a loss to create tax benefits. On its website, Wealthfront provided whitepapers outlining the TLH program. However, from October 2012 through mid-May 2016, Wealthfront falsely stated in the TLH whitepaper that it monitored all client accounts to avoid any transactions that might trigger a wash sale, which prevents the tax benefit of the TLH program. (A wash sale occurs when an investor sells a security at a loss but within 30 days of the sale, buys the same or substantially identical security.) The SEC found Wealthfront did not in fact monitor all of its client accounts to prevent a wash sale prior to mid-May 2016. In fact, at least 31 percent of accounts enrolled in the TLH program experienced a wash sale. Ultimately, the failure to monitor for and prevent wash sales led to slightly lower returns: The average Wealthfront client received fewer tax losses, obtaining overall 5.6 percent in annual harvesting yield versus 5.8 percent. Despite the relatively minor impact on customers, the SEC fined the robo-advisor $250,000 for, among other things, violating Section 206(2) of the Advisers Act, which prohibits transactions or business practices that operate as a fraud or deceit upon clients or prospective clients.
Misleading Advertising and Marketing Materials
A second robo-advisor, Hedgeable, was sanctioned for its misleading marketing through the use of its “Robo Index” created to compare the performance of Hedgeable, to other unaffiliated robo-advisors. Hedgeable’s misrepresentations were egregious. Featured on its website, the index incorrectly illustrated Hedgeable’s returns by failing to account for over 96 percent of Hedgeable’s clients in its calculations. Hedgeable failed to use actual performance data and various other risk factors when depicting the average returns for the comparison robo-advisors, thereby providing incorrect return projections for its competition robo-advisors.
The SEC also found Hedgeable’s online fact sheets to be misleading. The annual benchmark returns were not updated for certain years, leading clients to believe the model portfolio outperformed its benchmark greater than what actually occurred. Hedgeable also incorrectly calculated certain benchmark and portfolio returns for several ETFs in violation of Section 206(2) and Section 206(4) of the Adviser Act.
Compliance of Social Media Usage
Under Section 206(4) of the Advisers Act, it is “unlawful for any investment adviser…to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative.” The SEC has made clear that these requirements are applicable to robo-advisors. Publishing, circulating, or distributing any advertisement that directly or indirectly provides a testimonial concerning the investment adviser that “contains any untrue statement of a material fact or which is otherwise false or misleading” is a violation of Rule 206(4)-1.
In addition to its findings with respect to Wealthfront’s TLH whitepapers, the SEC also found Wealthfront, willfully violated Section 206(4) of the Advisers Act and Rules 206(4)-1 by selectively republishing (“retweeting”) certain posts by other Twitter users that constituted positive testimonials about Wealthfront’s services. In some cases, Wealthfront knew or should have known that the Twitter users providing positive reviews had an economic interest in promoting Wealthfront, and Wealthfront failed to disclose the conflict of interest in violation of Rule 206(4)-3. These charges come as no surprise, following the SEC’s sanctions in July 2018 against two investment advisers and three investment adviser representatives for similar violations of Section 206(4) for soliciting, and publishing client testimonials on its various websites including Yelp and Facebook.
Similarly, the SEC found Hedgeable was in violation of Section 206(4) and the rules thereunder, for marketing false and misleading information on its “Robo-Index” through social media as well as its website.
Further, neither robo-advisor adopted and designed written policies and procedures with a scope that included certain social media usage in its compliance review of marketing materials and communications as required by Rule 206(4)-7.
Ultimately, the SEC charged both robo-advisors with violations of the Advisers Act and required them to pay a fine. In addition, Wealthfront is required to notify its advisory clients of the Order and provide a copy of the Order to clients by January 20, 2019. While, these Orders were not unique issues to robo-advisors, they serve as a reminder that the Advisers Act and its rules apply to robo-advisors. In fact, these Orders indicate that since robo-advisors are only available on electronic platforms, they may be more susceptible to misleading online marketing and social media ploys. Robo-advisors, therefore, should examine their compliance and supervision policies to ensure truthful and accurate data is being provided to clients, as well as ensuring social media platforms are being adequately monitored.
McGuireWoods’ experienced broker-dealer/investment adviser team will continue to monitor and report on important regulatory compliance updates. For more information, contact the authors of this article or any member of the team.
 See Financial Industry Regulatory Authority (FINRA) Report on Digital Investment Advice https://www.finra.org/sites/default/files/digital-investment-advice-report.pdf (2016). For state registered advisers, see, Massachusetts Securities Division Policy Statements: State-Registered Investment Advisers’ Use of Third-Party Robo-Advisers( http://www.sec.state.ma.us/sct/sctpdf/Policy-Statement-State-Registered-Investment-Advisers-Use-of-Third-Party-Robo-Advisers.pdf) and Robo-Advisers and State Investment Adviser Registration (April 1, 2016) (http://www.sec.state.ma.us/sct/sctpdf/Policy-Statement–Robo-Advisers-and-State-Investment-Adviser-Registration.pdf).
 Hedgeable was not also required to send its Order to advisory clients, which is most likely because the firm, as noted in the Order, is winding down its business and no longer meets the requirements to be an SEC registered adviser. Furthermore, Hedgeable is paying a significantly reduced penalty, as compared to Wealthfront, and has a payment plan, both factors indicative of reduced assets.