Douglas Rappaport Quoted by Financial Advisor IQ on Pitfalls of Robo-Advisors

Douglas Rappaport, a partner in Akin Gump’s litigation practice, has been quoted in the Financial Advisor IQ article “Keep Your Robo Cool or It Might Land You in Hot Water,” regarding the potential liabilities financial advisers might face when they use robo-advisors to provide advice to their clients.

For some, as the article reports, robo-advisors can help cut costs, streamline asset allocation models or help engage with younger clients. But, as noted, there is also growing liability for those who use the robo-advisors incorrectly.

Rappaport said advisors need to do much more than simply conducting due diligence when buying a robo: “You can’t just leave it alone. It requires monitoring, and must be checked and retested in normal market conditions and under stress, especially if the robo’s job is not only to recommend asset allocation but also rebalance portfolios. If an algorithm isn’t choosing properly for technical reasons, then you will have a misallocation in the client’s portfolio.”

Rappaport compared the potential liability exposure of using robo-advisors to that of faulty algorithms in the electronic trading world, where bad or malicious programming has been known to crash markets, such as the so-called Flash Crashes of May 6, 2010, on the New York Stock Exchange and on the Singapore Exchange in October 2013.

“When it comes to the use of algorithms anywhere in the financial system, the abiding concern of regulators is a ghost in the machine. When you withdraw the human element it makes the process non-sentient,” said Rappaport. “We live in a world where computerization is seen as perfect and pristine, but that’s not always the case. While less emotion in investing may sound attractive and automation is certainly cheaper, the potential exposure an RIA leaves itself open to can increase significantly without the proper monitoring.”