A SHOT ACROSS THE BOW OF ROBO-ADVISERS

The Massachusetts Securities Division – one of the most active and sophisticated in the nation – recently issued a Policy Statement “to provide its state-registered investment advisers who establish concurrent or sub-advisory relationships with third-party robo-advisers with guidelines on how to best comply with the Massachusetts Uniform Securities act and meet the fiduciary duties owed to their clients.” That may be the longest sentence I have ever written.

So let’s start with the basics: what is a robo-adviser? Generally speaking, a robo-adviser is an online wealth management service that provides automated algorithm-based portfolio advice. Of course, a traditional adviser may also utilize software based data but they typically employ that data in the context of more personalized advice and wealth management or retirement planning. A few examples of robo-advisers in the marketplace today are Covestor, Market Riders, Asset Builder and Flex Score.

The problem, at least as I see it, is robo-advisers dressed up as fiduciaries. Some, and in particular one ubiquitous SEC registered RIA, actually promotes itself as a premium fiduciary with unparalleled individualized portfolio construction. In my opinion, it is not. Not even close. Unfortunately, the SEC has failed to take action against such cynical charades, but the Massachusetts Securities Division is doing what it can do within its jurisdictional constraints.

According to the new Massachusetts policy, any investment adviser registered pursuant to the Massachusetts Uniform Securities act must:

• Must clearly identify any third-party robo-advisers with which it contracts; must use phraseology that clearly indicates that the third party is a robo-adviser or otherwise utilizes algorithms or equivalent methods in the course of providing automated portfolio management services; and must detail the services provided by each third-party robo-adivser;
• If applicable, must inform clients that investment advisory services could be obtained directly from the third-party robo-adviser;
• Must detail the ways in which it provides value to the client for its fees, in light of the fiduciary duty it owes to the client;
• Must detail the services that it cannot provide to the client, in light of the fiduciary duty it owes to the client;
• If applicable, must clarify that the third-party robo-adviser may limit the investment products available to the client (such as exchange-traded funds, for example); and
• Must use unique, distinguishable, and plain-English language to describe its and the third-party robo-adviser’s services, whether drafted by the state-registered investment adviser or by a compliance consultant.

If you want to review the flesh on these bones, click here. Now, if only the SEC, California, Missouri, Florida and… would follow Lantagne’s lead.

District Court Retroactively Applies Dodd-Frank Ban on Pre-dispute Arbitration in SOX Whistleblower Claims

The U.S. District Court for the District of Massachusetts applied the Dodd-Frank Act (“the Act” or “Dodd-Frank”) prohibition on pre-dispute arbitration agreements under the Sarbanes-Oxley (“SOX”) whistleblower protection retroactively. In a March 1 ruling, in Pezza v. Investors Capital, et al, Judge Douglas P. Woodlock, reasoned that retroactive application was appropriate due to the lack of clear Congressional intent to restrict the temporal scope and procedural nature of Section 922.

Section 922 of the Act, among other things, confers jurisdiction on the courts, rather than to a Financial Industry Regulatory Authority (FINRA) arbitration panel, by voiding arbitration provisions in employment agreements that purport to force an employee to arbitrate, rather than litigate disputes arising under Section 806 of SOX.

The suit arose from a claim of wrongful retaliation (in violation of SOX) against the plaintiff after he raised concerns about the defendant’s misconduct in connection with securities transactions. (The plaintiff had previously filed the requisite complaints with the Department of Labor.) The defendants, Investors Capital Corp., Investors Capital Holdings, Inc., and Timothy Murphy, argued that the plaintiff was required to submit his dispute to arbitration, not the courts, pursuant to a pre-dispute arbitration provision in his employment agreement. However, while the defendant’s motion to compel arbitration was under advisement, Congress enacted Dodd-Frank, which included the prohibition on pre-dispute arbitration agreements for whistleblower claims brought under SOX.

In determining whether to apply Section 922 retroactively, the court used the framework setup by the Supreme Court in Fernandez-Vargas v. Gonzales, which essentially instructs a court to first look to whether there is any Congressional intent allowing for retroactive application. If there is no clear indication by Congress, the court then must look to whether retroactive application would result in a disfavored consequence affecting a substantive right. If the court answers in the negative, retroactive application is appropriate.

Here, Section 922 did not include any express provisions or clear statements of Congressional intent regarding retroactivity. Further, after applying the standard rules of statutory construction, the court found nothing that indicated Congress intended for the provision to apply to existing arbitration agreements. The court also found it insufficient that Congress vested the authority to limit future pre-dispute arbitration provisions with the new Bureau of Consumer Financial Protection and the CFTC. Thus the court determined that the result regarding retroactivity under Fernandez-Vargas was inconclusive.

However, under Landgraf v. USI Film Prods, the Supreme Court recognized that jurisdictional statutes may be applied retroactively absent specific legislative authorization without raising retroactivity issues. As a result, the District Court construed Section 922 to be a jurisdictional statute and relied on the holding from Landgraf instead of the retroactivity test under Fernandez-Vargas. Accordingly, the court denied the defendants’ motion to compel arbitration and concluded that Section 922 should be applied retroactively to combat bad conduct arising prior to the enactment of Dodd-Frank.