RoboAdvisor Dilemma – How Do Feds Regulate an Algorithm?


We at FintekNews have kicked this dilemma around from time to time. Who (and how) regulates the ‘robots’? With robo-advisors (actually automated financial advice websites) popping up like weeds in the garden, new regulatory issues are being analyzed. Sure ‘robos’ bring lower costs and potentially higher quality (?) financial advice, BUT how to regulate the algorithms in the robot’s head? This is very intriguing and really opens things up for debate. Hmmmm, when coupled with artificial intelligence will robots have ethics? Morals? Will robots need robot lawyers who speak algorithm?
(Bill Taylor/CEO)

“Imagine you have just been given a modest amount of extra money that you would like to invest. If hiring a financial advisor is out of your price range, you could consider turning to a “robo-advisor” for help. Robo-advisors—or automated financial advice websites—are on the rise. Two leading investment management firms, BlackRock and Vanguard, have already instituted robo-advisor websites that work in conjunction with human advisors.

Although robo-advisors present the possibility of lower-cost, and potentially higher-quality, financial advice, they can also create a new set of challenges for the state and federal agencies that regulate the financial services industry. In a recent paper, two scholars consider the ways in which robo-advisors differ from human advisors and discuss the obstacles these differences present to regulators as they design regulatory schemes for robo-advisors.

Some of the problems that plague the financial services industry in its current, human-based form are likely to persist in dealings with robo-advisors. For example, financial advisors’ advice may be biased toward a certain client action that earns them a larger commission. Tom Baker of the University of Pennsylvania Law School and Benedict G. C. Dellaert of Erasmus University Rotterdam argue that the public should not assume robo-advisors would not be subject to the same misalignment of incentives, particularly when the robo-advisors are designed or purchased by financial intermediaries with the same incentives as human advisors.

Still, the authors contend that robo-advisors are different from human advisors in significant ways. New features differentiate robo-advisors from human advisors and present new regulatory challenges, such as the algorithms and processes that are the foundation of robo-advisors, the data required for robo-advisors to be effective, and the choice architecture that robo-advisors use to form their advice.

By Baker and Dellaert’s estimate, most or all robo-advisors run on algorithms that aim to match certain product attributes with certain client attributes. For example, a robo-advisor handling a retirement savings portfolio might recommend investments in different kinds of funds as the consumer ages. Baker and Dellaert argue that regulators must fully assess the competence of these algorithms…”