RIA Compliance Blog
Demonstrating its regulatory interest in the robo adviser industry, on December 21, 2018, the Securities and Exchange Commission issued an Order Instituting Administrative and Cease-and-Desist Proceedings against Wealthfront Advisers, LLC, a registered investment adviser which uses a software-based “robo adviser” platform in servicing its clients. The action is the second case against robo advisers filed on the same day. Wealthfront submitted an offer of settlement in light of the proceeding.
According to the SEC’s Order, Wealthfront utilizes a proprietary tax loss harvesting program (“TLH”) to help its clients garner tax benefits. These tax benefits would typically come through selling assets at a loss, which could potentially be used to reduce income or gains and create a lower tax liability. From October 2012 onward, Wealthfront has featured whitepapers on its website that provide information about the TLH strategy.
Between October 2012 and May 2016, Wealthfront’s TLH whitepaper explained that Wealthfront monitored client accounts in order to prevent transactions that could result in a “wash sale.” According to the SEC’s order, a wash sale happens when an investor sells a security at a loss and buys the same or a substantially similar security within a 30-day period after the sale. A wash sale results in the investor being unable to receive a tax benefit from realizing a loss. The SEC, however, found that in reality, Wealthfront’s TLH software was not set up so that it would review all client accounts to prevent wash sales. The SEC also found that as a result of this inadequate monitoring, about 31 percent of client accounts which used the TLH strategy incurred wash sales. As a result, clients failed to realize the tax benefits that Wealthfront advertised.
The SEC also alleged in its Order that Wealthfront violated the Investment Advisers Act’s Advertising Rule by publishing testimonials as well as other advertisements that did not include material information. Wealthfront published testimonials by retweeting Twitter posts from other Twitter users that contained favorable statements about Wealthfront. Wealthfront also allegedly retweeted posts made by persons who had an economic interest in Wealthfront, which created a conflict of interest that was not disclosed. When Wealthfront posted advertisements on Twitter, it also failed to consistently keep records of these advertisements.
The SEC also found that from about the middle of 2014 to the middle of 2015, Wealthfront participated in a program known as the Wealthfront Affiliate Program, where it would compensate bloggers to solicit clients to establish Wealthfront accounts. To solicit new clients, the bloggers would usually put a Wealthfront hyperlink in or close to a positive blog post about Wealthfront. The bloggers’ compensation would be determined based on the amount of assets a new client would invest in a Wealthfront account. According to the SEC, Wealthfront’s conduct pertaining to the Affiliate Program violated the Advisers Act because Wealthfront did not have a written solicitation agreement, did not make required disclosures to clients, and did not receive any written acknowledgments from clients confirming that they had received the required disclosures. The Advisers Act’s Cash Solicitation Rule, Rule 206(4)-3, obligates investment advisers who compensate third-party solicitors for client referrals to have a written solicitation agreement, to make specified disclosures to clients, and to receive written acknowledgments confirming that the solicited clients have received those disclosures. The SEC also found that during the time Wealthfront was participating in the Affiliate Program, it did not put into practice its written policies and procedures regarding solicitor agreements.
The SEC’s Order enjoined Wealthfront from further violations of the Advisers Act and imposed a civil money penalty of $250,000.
Parker MacIntyre provides legal and compliance services to investment advisers, broker-dealers, registered representatives, hedge funds, and issuers of securities, among others. Our regulatory practice group assists financial service providers with complex issues that arise in the course of their business, including compliance with federal and state laws and rules. Please visit our website for more information.