Could digital advice tools place licensees at risk of class action?

Digital advice tools are on the rise but licensees will need to ensure they still meet adviser obligations or potentially risk a class action if clients lose money from their usage.

Unlike robo-advice, digital advice delivers personal advice and combines customer facts with both regulatory inputs and assumptions where gaps exist, then uses algorithms to produce single issue personal advice outcomes that comply with the Best Interests Duty and related obligations. 

Firms such as AMP, Colonial First State and Iress have all launched digital advice tools recently, while they are popular with superannuation funds such as Rest and UniSuper as a cheaper, easier way to provide advice to their members. 

The Delivering Better Financial Outcomes legislation also includes a section around exploring new advice channels to encourage innovation and new models for advice delivery, which could include its provision via a digital format. 

However, two law partners have warned licensees to think carefully about their future usage before integrating or developing a digital tool across their practices. This includes ensuring they have adequate resources to provide the advice, having tailored risk management systems and the right compensation and insurance arrangements. 

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Due to the deliberate commoditisation of digital tools as a method to deliver personal advice to thousands of users, the duties of best interest and appropriate advice that apply to human advisers would also apply to digital ones.

Speaking to Money Management, King & Wood Mallesons partner Nathan Hodge and his colleague, partner Amanda Engels, said: “Two adviser obligations that are potentially relevant are the adviser’s duty of best interests and the adviser’s duty to provide appropriate advice. In the context of a digital tool, it is the licensee responsible for the digital tool who must ensure that that digital tool satisfies these duties because it is effectively the adviser in this context.”

As preventative measures, they suggested ensuring the tool can access sufficient information, implementing upfront warnings around the type of advice provided and details of the types of circumstances that the tool could work with, as well as “off-ramps” for users to exit the process and seek professional advice if their circumstances require it.

The challenge for licensees and digital tool developers is to ensure the tool is still appealing and usable to users while abiding by these compliance measures. 

However, with thousands of users relying on the advice provided by the product, any issues with the underlying algorithm of the tool could see significant volumes of individuals all encountering the same mistake. In the worst-case scenario, the licensee could be vulnerable to a class action if the clients can demonstrate they have suffered a loss from the usage of the digital tool.

“It is possible that class actions may arise in response to poor advice given by digital tools. This is because there are statutory mechanisms for users of digital advice tools who suffer loss due to a breach of various obligations, like adviser obligations, to recover that loss,” the pair told Money Management.  

“Where a licensee breaches one of these duties, resulting in the digital tool giving poor or incorrect financial advice, the Corporations Act grants the client statutory rights to damages or compensation order. 

“To date, there have been some, but only a small number of class actions commenced where damages have been sought in relation to a breach of the best interest obligation (although none involving digital tools). Separately, there have been multiple class actions where claimants have sought compensation orders, but these less typically relate to breaches of the adviser obligations.

“The key to a claim in these circumstances is for the client to show that they suffered loss as a result of the breach of adviser obligations – in effect, that they relied on the advice provided.”

Digital tools need to be checked and updated on an ongoing basis to ensure the advice remains appropriate for the clients, as well as be in regular contact with the technology team running the tool so changes are enacted quickly.

The broad nature of a digital advice tool’s usage also highlights the need for sufficient compensation arrangements, as current arrangements at a firm may be insufficient given the likely growth in client numbers and potential for widespread losses. Losses arising for different clients as a result of one flawed algorithm may also be treated as a single claim by a PI insurer. 

However, licensees would also have own potential grounds for legal action, Hodge and Engels said, and could possibly make their own claim against the tool’s developer. 

“If the licensee relied on a third party to provide the tool to them, the licensee may have a cross claim against that third party depending on factors like the root cause of the breach and the terms of the contract between licensee and third party.”

ASIC guidance on digital advice 

According to ASIC, licensees using digital advice must have at least one responsible manager who meets the minimum training and competence standards that apply to advisers. While most advice firms will already hold an AFSL, start-up fintech firms must also become an authorised representative or get their own AFSL.

As well as the usual AFSL questions, those pursuing a digital path may be asked by the regulator about the technology and algorithms to provide the advice, the level of human review undertaken on the advice generated, any outsourcing of functions, whether their PI insurance is adequate and their procedures to monitor algorithms.

“We expect digital advice licensees to have at least one person who has a general understanding of the technology and algorithms used to provide digital advice. We do not expect all digital advice licensees to understand the specific computer coding of an algorithm – however, we expect your understanding to include having people within the business who understand the rationale, risks and rules behind the algorithms underpinning the digital advice.

“Failure to have at least one person with the skills and experience needed to understand the technology and algorithms underpinning the digital advice increases the risk that clients are exposed to poor quality advice or that there are issues with your systems.”

They should also have technology to maintain client records and data integrity, protect confidential and other information, meet current and anticipated future operational needs, including in relation to system capacity, and comply with all obligations under the law.

In the instance of a problem with the algorithm, ASIC said no advice should be provided until the problem is rectified, clients have been contacted, and reportable situation notification needs to be lodged. 

"Where errors within an algorithm are detected, and that error is likely to result in client loss and/or a breach of the Corporations Act, digital advice licensees should take immediate steps to rectify the problems. Advice should
not be provided to clients until the defect is rectified.

"Suspension of an algorithm alone is unlikely to be sufficient to rectify the problems.

"You should also take additional steps to review the advice provided to clients where this advice may have been defective. We expect you to remediate clients who have suffered loss as a result of defective advice being provided."