Robo-advisor Betterment is setting aside $9 million to compensate clients for tax savings that regulators say it promised but failed to produce in their investment portfolios.
The Securities and Exchange Commission, which oversees advisory services like Betterment, said Tuesday that it had
"Robo-advisers have the same obligations as all investment advisers to ensure they are transparent about services they provide and upfront about any material changes to those services or issues that may negatively affect clients," Antonia Apps, director of the SEC's New York regional office,
According to the SEC, Betterment let its clients opt into a system that promised to scan their portfolios every day for harvesting opportunities. Investments that had declined in value would be automatically sold and the money would then be reinvested in assets carrying similar risks.
Despite the promise of daily attention, Betterment began in January 2016 to scan its accounts only on alternating days, according to the SEC. The change, the regulator said, was due to "constraints related to overall trading volume." The alternating-day system lasted until April 2019, when daily scans were resumed. The SEC reckons the lack of daily monitoring cost 25,000 client accounts $1.9 million in tax benefits.
Regulators also alleged two coding errors cost roughly 700 Betterment client accounts an additional $1 million in tax benefits. The errors prevented Betterment's algorithms from running tax loss harvesting scans for some clients who had signed up for them.
After discovering the initial error in January 2019, Betterment agreed to pay $28,600 to compensate clients for missed tax benefits from the previous year. But the coding had in fact been causing problems since April 2016.
Betterment,
"For the segment of customers who potentially incurred financial impact by missing possible tax loss harvests, the median payout is expected to be less than $100 per customer," Betterment said.
David Goldstone, the manager of research at Condor Capital Wealth Management, which publishes the quarterly
But entrusting a function to a computer rather than to people can increase the risk that programming deficiencies and malfunctions will go undetected.
"So robo-advisors clearly need to have robust systems in place to identify errors," Goldstone said.
Regulators also accused Betterment of overpromising its ability to help some clients avoid tax complications that can arise from the IRS's "wash sale rule." This rule bars investors from claiming a tax loss on securities they sell and then repurchase within 30 days. The goal is to prevent investors from realizing a loss on assets they had no intention of actually selling.
Betterment's robo-advisor system avoided the wash sale rule by making sure that any money obtained from a stock sale was reinvested in different securities. The trouble arose for clients who didn't confine themselves to a single portfolio strategy. When investors put their money into multiple strategies — some of them managed by third-party companies — Betterment's algorithm sometimes adopted a more conservative harvesting strategy, according to the SEC. The SEC estimates that cost 3,200 client accounts about $1 million.
Betterment customers usually end up putting their money into exchange traded funds. These typically low-cost funds hedge against risk by investing in a wide variety of stocks, bonds or other securities. Some ETFs, for instance, will put money into every company listed on the S&P 500 or other indexes.
Most of the SEC's other accusations against Betterment involved alleged failures to inform customers of the true nature of its policies and to live up to the fiduciaries duties imposed by the Investment Advisers Act of 1940. Under that federal law, advisors are required to always put their clients' first and to eliminate all but the most unavoidable conflicts of interest.
In one instance cited by the SEC, the firm modified its website to state: "Betterment makes no guarantees regarding the frequency and/or timing of tax loss harvests, and neither Betterment nor Betterment Securities shall be liable for any losses arising out of the failure to harvest a particular loss at a particular time." Betterment, according to the SEC, violated its fiduciary duties when it did not inform customers of the change.
Betterment is among the many tech companies that have cut jobs in the past year in response to tightening economic conditions. In February, the
Betterment's $9 million payment will be set aside into a separate fund and eventually paid out to affected customers once the SEC approves a distribution plan. According to the settlement terms, the amount cannot be lowered if Betterment is ever ordered to pay a separate penalty in a civil case brought by customers.
