As Lord Denning once said; "If we never do anything which has not been done before, we shall never get anywhere. The law will stand still while the rest of the world goes on, and that will be bad for both".
On May 5, 2021, The Securities and Exchange Commission (SEC) published its "Proposed New Rules on Robo-Advisory Services1 (the "Rules"), which signifies the progression of certain aspects of the Nigerian legal framework on financial advisory services. In recent times, the extension of technology to money management in the form of "Fully Automated Robo-Advisers,"2 presents an option to an investor willing to take advantage of automated digital investment advisory technology for discretionary online algorithmic-based financial advice.
This newsletter examines in summary, some key provisions of the Rules and what they mean for the financial business community.
Scope: The Rules seek to apply to all capital market operators as well as individuals or corporate bodies, interested in providing "Digital (Robo) Advisory Services". The Rules also require that all interested individuals and companies shall be subject to registration by the SEC. This is in line with international best practices on investor protection. For example, in the U.S., Robo-Advisers must register with the U.S. Securities and Exchange Commission just like human advisers and are subject to the same securities laws and regulations as traditional broker-dealers.3
Definitions: The Rules offer three (3) definitions, and in essence categorisations of Robo-Advisory services. These are – "Fully Automated Robo-Advisers," ("Robo-Advisers with no human adviser interaction in the advisory process.") "Digital Advisory Services" ("the provision of advice on investment products using automate, algorithm-based tools which are client-facing, with little or no human adviser interaction...") and "Robo-Adviser" ("a person who provides digital advisory services"). Although Robo-Advisory technology exists, there are varying degrees of human interface and influence on the functionalities of this novel technology. This appears to be the rationale for SEC's decision to seek to hold humans accountable in the deployment of algorithm/artificial intelligence-based financial advisory services.
Additional Regulatory Requirements: The Rules mandate strict compliance by Robo-Advisers to all 'business conduct requirements' in the Investment and Securities Act 20074. Robo-Advisers are also instructed to carry out due diligence5 on all third-party providers to assess risks associated with such outsourcing arrangements.6 In addition, Robo-Advisers are to adhere strictly to client's orders7 and Robo-Advisers intending to perform portfolio management functions are required to comply strictly with the rules and regulations governing Fund/Portfolio Management Functions.8
Rebalancing of Client Investment Asset Allocation: The procedure for digital advisory services which involves requesting a set of information regarding the risk appetite and preferred portfolio of the investor, is described under the Rules. Upon providing the requested data, the Robo-Adviser provides the best investment option, which is algorithm-based. The client may accept or reject the advice. Where the client, however, chooses to act on the previously rejected advice, the Rules refer to this as "Rebalancing". The Rules mandate Robo-Advisers to seek the express consent of an investor when presented with a revised portfolio after rejecting a previously recommended one. 9
Monitoring and Testing of the Client-Facing Tool: Robo Advisers are required under Section of the Rules to ensure the establishment of policies, procedures, and controls for regular monitoring and testing of algorithms to ensure optimum performance. Advisory services are to be suspended where an error or bias within an algorithm is detected and compliance checks on the quality of advice provided by the client-facing tool are to be carried out regularly. The frequency of such compliance checks, however, should be commensurate with the size and complexity of the Robo-Adviser's operations.
Developing the Client-Facing Tool: Robo Advisers are required to ensure that the technology utilized is programmed to carry out tasks to a premium standard. This includes the collection of information, analyses, and recommendations given by algorithm-driven advisor tools. Robo-Advisers are mandated to identify inconsistent responses from clients, identify and eliminate clients who are unsuitable for investing10 and also ensure that algorithms can detect bias, assign risk profiles correctly and consistently, and produce the intended asset allocation and investment recommendation.
Monitoring and Testing of the Client-Facing Tool: Robo Advisers are required under Section 7 of the Rules to ensure the establishment of policies, procedures, and controls for regular monitoring and testing of algorithms to ensure optimum performance. Advisory services are to be suspended where an error or bias within an algorithm is detected and compliance checks on the quality of advice provided by the client-facing tool are to be carried out regularly. The frequency of such compliance checks, however, should be commensurate with the size and complexity of the Robo-Adviser's operations.
Information on Algorithms: Another innovative inclusion in the Rules is the requirement for Robo-Advisers to disclose in writing, to their clients, all assumptions, limitations, and risks associated with the algorithms, circumstances where Robo-Advisers may override algorithms or halt services, and material adjustments to the algorithms.
Robo-Advisers have the potential to offer investors speedy and cost-effective access to investment advisory services. However, the fiduciary nature of this role demands prompt oversight. The provisions highlighted above, reveal that investor protection is at the heart of the Rules. Whilst implementing rules against an algorithm may seem impossible, ensuring that persons behind such algorithms are responsible for ensuring their efficient operation can be achieved. Therefore, the proposed monitoring of these innovations and future implementation of safeguards is a necessary step for the protection of investors in Nigeria.
1. SEC NIGERIA, 'Proposed New Rules and Sundry Amendments To The Rules And Regulations Of The Commission' (2021) < https://sec.gov.ng/proposed-new-rules-and-sundry-amendments-to-the-rules-and-regulations-of-the-commission/> Accessed 19 May 2021
2. Section 1 of the proposed Robo-Advisory Rule defines this to mean Robo Advisers with no human intervention
3. CFA Institute, 'Robo-Advisors' (2021)< https://www.cfainstitute.org/en/advocacy/issues/automated-advisors> Accessed 19 May 2021
4. Section 3 (i) of the Proposed New Rules on Robo-Advisor Services
5. Section 3 (iii) of the proposed New Rules on Robo-Advisor Services
6. Section 3 (ii) of the proposed Robo-Advisory Rule provides that third-party providers to whom development and maintenance of client-facing tools have been outsourced to by a Robo Advisor are required not to be registered by the commission.1. https://www.companybug.com/what-is-share-capital/
7. Section 27(2) of the Companies and Allied Matters Act, 1990.
8. Section 27(2) of the Companies and Allied Matters Act, 2020.
9. Paragraph 13 of the Companies Regulations, 2021
10. Section 130 of the Companies and Allied Matters Act, 2020.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.