On February 10, 2022, the U.S. Securities and Exchange Commission (SEC) issued a settlement order with a firm providing digital investment advice that claimed to operate in compliance with Islamic Shari’ah law (the Robo-Adviser). The SEC’s titling of its own press release, “SEC Charges Robo-Adviser with Misleading Clients,” highlights the SEC’s continued focus on both robo-advisers since the Division of Examination’s November 2021 Risk Alert and the accuracy of fund and adviser communications around investment services based on norms, such as Sharia’ah law, and other environmental, social, and governance (ESG) factors since the Division’s April 2021 Risk Alert.
In addition to running its robo-advisory business in a Shari’ah-compliant manner, the Robo-Adviser manages a Shari’ah-compliant exchange-traded fund (ETF). However, the SEC alleged that the Robo-Adviser’s activities discussed in the settlement order involved violations of the anti-fraud and other provisions of the Investment Advisers Act of 1940 (Advisers Act).
- False or Misleading Advertisements: The settlement order finds that marketing materials disseminated by the Robo-Adviser prior to the launch of its ETF stated that the firm managed proprietary Shari’ah-compliant funds when it did not. Such statements violated Section 206(4) of the Advisers Act and Rule 206(4)-1(a) thereunder, which prohibit advisers from using marketing materials that contain any untrue statement of material fact or are otherwise false or misleading.
- Failure to Rebalance Accounts: The order finds that, like other robo-advisers, the Robo-Adviser promised current and prospective clients in SEC disclosures and marketing materials that it would monitor and periodically rebalance their accounts, when it in fact failed to do so and had no established rebalancing policy in effect, either verbally or in writing. These shortcomings violated Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder, which require advisers to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder.
- Failure to Disclose Conflicts of Interest: The order finds that once it launched the Shari’ah-related ETF, the Robo-Adviser utilized existing clients’ assets as seed money for the ETF without disclosing the related conflicts of interest, including the Robo-Adviser’s financial interest in the ETF, the additional fees charged at the ETF level that the Robo-Adviser would receive, and the client assets that were being used to seed the ETF, making the ETF more attractive to other potential investors. As a result, the SEC found that the Robo-Adviser’s clients were not given the opportunity to provide informed consent to or reject these conflicts of interest.
- Lack of Applicable Policies and Procedures for Key Element of Marketed Shari’ah Service: The SEC’s settlement order also finds that the Robo-Adviser marketed its adherence to Shari’ah-compliant investing by advertising the importance of its income purification process and its annual purification reporting service. Despite these representations, the order finds, the Robo-Adviser lacked written policies and procedures addressing how it would ensure Shari’ah compliance on an ongoing basis, how it would calculate and report the purification of impure income, and how it would obtain reasonable support for its Shari’ah-related marketing claims.
Noting the Robo-Adviser’s remedial efforts, the SEC imposed a $300,000 civil penalty and required that the Robo-Adviser work with a compliance consultant to correct its Advisers Act compliance program.