This article is written by OKOOBO ESELE DOREEN of UNIVERSITY OF BENIN in 400 LEVEL during her internship with Ledroit India
Abstract.
As “software eats the world”, the law must adapt legal frameworks that were designed for traditional businesses to new, technology-based business models. In the financial services sector, the emergence of robo-advisors, online services that use algorithms to generate investment recommendations for clients, has raised questions regarding the regulation of digital advice. While these platforms offer efficiency and accessibility, they also create uncertainty regarding accountability when AI-driven decisions lead to significant portfolio losses.
This article examines the issue of liability arising from robo-advisory services and considers whether existing legal frameworks adequately address responsibility for financial harm caused by artificial intelligence.
At the heart of the discussion is whether liability should rest on the investment firm operating the robo-advisor, the software developers who designed the algorithm, the regulators who oversee financial markets, or even the investor who agreed to the platform’s terms and conditions.
Introduction.
Robo-advisors are automated digital platforms that provide clients with algorithm-based financial advice and investment management services. These platforms utilize advanced algorithms and data analytics to generate investment recommendations and construct diversified portfolios tailored to each client’s financial goals, risk tolerance, and time horizon. Robo-advisors typically offer a streamlined, cost-effective, and user-friendly approach to investment management, targeting a broad range of investors, including individuals, small businesses, and institutional investors.
In recent years, robo-advisory services have witnessed significant growth and adoption across the financial industry. The appeal of robo-advisors lies in their ability to democratize access to professional investment advice, offering a digital alternative to traditional human advisors. The ease of use, lower fees, and convenience of managing investments online have attracted a wide range of investors, particularly millennials and tech-savvy individuals seeking efficient and accessible investment solutions.
However, it’s pertinent that we understand how robo- advisor works.
Despite the benefits associated with robo-advisory services, their increasing reliance on artificial intelligence raises important legal concerns, particularly in situations where automated investment decisions result in significant financial losses. The absence of human judgment in many robo-advisory models complicates the determination of responsibility when a portfolio crashes.
How robo- advisor works
Robo-advisors operate through a structured and automated process designed to deliver investment advice with minimal human involvement. The process typically begins with user onboarding, where investors are required to complete an online questionnaire. This questionnaire collects relevant information such as the investor’s financial goals, income level, investment horizon, and risk tolerance. The data provided forms the basis upon which the robo-advisor tailors its investment recommendations.
Once the investor’s profile is established, the robo-advisor employs algorithms and artificial intelligence models to determine appropriate asset allocation. These algorithms are programmed to analyse market data, historical trends, and predefined investment strategies in order to construct a diversified portfolio that aligns with the investor’s risk profile. In many cases, portfolios are built using exchange-traded funds (ETFs) and other low-cost investment instruments to minimize risk and management costs.
Robo-advisors also provide continuous portfolio monitoring and automatic rebalancing. As market conditions change, the system periodically adjusts asset allocation to ensure that the portfolio remains consistent with the investor’s original risk preferences and objectives. Some platforms incorporate tax optimisation strategies, such as tax-loss harvesting, to enhance overall returns. Depending on the model adopted, certain robo-advisors may include limited human oversight, while others function as fully autonomous systems.
Features of robo- advisor
1: Portfolio management
Robo-advisors create optimal portfolios based on the investors’ preferences. Typically, portfolios are created based on some variant of the Modern Portfolio Theory, which focuses on the allocation of funds to stocks that are not perfectly positively correlated.
Robo-advisors usually allocate funds to risky assets and risk-free assets, and the weights are decided based on the investors’ goals and risk profile. Robo-advisors monitor and rebalance the portfolio as economic conditions change by adjusting the weights of risky and risk-free assets.
2: Tax-loss harvesting
Tax-loss harvesting involves the sale of securities at a loss in order to save on capital gains tax, typically done towards the end of the tax year. By selling a security at a loss, investors avoid paying taxes on that income.
At the same time, it is important to invest in a similar security in order to maintain the portfolio allocation and reap the rewards of an upturn in the markets. Robo-advisors automate the process, allowing users to benefit from tax-loss harvesting effortlessly.
Legal nature of Robo- advisory Relationships
The relationship between an investor and a robo-advisory platform is primarily contractual in nature. When an investor signs up to use a robo-advisor, they are required to agree to the platform’s terms and conditions, privacy policies, and risk disclosures. These documents collectively define the rights, obligations, and responsibilities of both parties and form the legal basis of the advisory relationship.
Under this contractual arrangement, the robo-advisor undertakes to provide investment advice or portfolio management services in accordance with the investor’s disclosed financial profile. In return, the investor consents to the use of automated systems and accepts the risks associated with investment decisions made by algorithms. Most robo-advisory contracts include disclaimers stating that investment outcomes are not guaranteed and that market risks are borne by the investor. However, such disclaimers do not automatically absolve the platform from legal responsibility, particularly where negligence or misrepresentation can be established.
In many jurisdictions, robo-advisors are classified as investment advisers or operate under the regulatory framework governing financial advisory services. This classification means that, despite the absence of human interaction, robo-advisory platforms may still owe duties of care and loyalty to their clients. The use of artificial intelligence does not eliminate the expectation that advice provided must be suitable, transparent, and in the best interest of the investor.
The legal nature of robo-advisory relationships therefore differs from traditional advisory relationships mainly in form rather than substance. While human judgment is replaced by automated decision-making, the service provided remains financial advice. As a result, the legal obligations attached to financial advisory services continue to apply, albeit with added complexity arising from the involvement of technology. Understanding this legal relationship is essential to determining liability when a robo-advisor’s decisions lead to financial loss.
Advantages of Robo-Advisors
1. Less expensive
Robo-advisors offer traditional investment management services at much lower fees than their human counterparts (financial advisors). The minimum amount required to use such types of software is also much lower than the minimum amount required by financial planners.
2: Easy to use and secure
Robo-advisors also add value by allowing investors to invest in many different asset classes conveniently through mobile phones or web applications. Furthermore, they provide full access to portfolio management tools, which offer more flexibility and security to users.
3:Consistency and reduced human bias. Robo-advisors operate based on predefined algorithms and data-driven models, which eliminates emotional decision-making that often affects human investors and advisors. By adhering strictly to investment strategies and risk profiles, robo-advisors provide more consistent and disciplined portfolio management.
4:Financial inclusion: robo-advisors support financial inclusion by lowering entry barriers to investment services. With minimal account requirements and simplified onboarding processes, they enable a broader segment of the population to participate in structured investment planning, contributing to wider participation in financial markets.
Although robo-advisors offer cheaper and faster investment management services than human advisors, they lack the subjectivity required to offer fully-personalized services.
Who Is Liable When a Robo-Advisor Causes Financial Loss?
Determining liability when a robo-advisor causes significant financial loss is complex due to the automated nature of the service and the involvement of multiple actors. Unlike traditional financial advisory services, where liability can often be traced to a human advisor, robo-advisory systems rely on algorithms, data inputs, and technological infrastructure. As a result, responsibility may be distributed among several parties depending on the circumstances surrounding the loss.
Liability of the Robo-Advisory Firm
The robo-advisory firm or financial institution operating the platform is generally the primary party that may be held liable when an AI financial advisor causes loss. This is because the firm offers the advisory service to the public and enters into a contractual relationship with investors. In many jurisdictions, robo-advisors are regulated as investment advisers and are therefore required to comply with standards of care, suitability, and disclosure.
Where financial loss results from negligent algorithm design, inadequate testing, failure to properly maintain or update the system, or misleading representations about the capabilities of the robo-advisor, the firm may be held liable for breach of duty or negligence. The fact that advice is generated by artificial intelligence does not exempt the firm from responsibility, as the deployment and control of the AI system remain within human and corporate oversight.
Liability of Software Developers and Algorithm Designers
Software developers and algorithm designers play a crucial role in creating robo-advisory systems. However, they generally do not have a direct contractual relationship with investors. As a result, investors are unlikely to successfully bring direct claims against developers for financial losses caused by robo-advisors.
Nevertheless, where losses arise from defects in the software or flaws in algorithmic design, the robo-advisory firm may seek indemnity or compensation from developers under contractual arrangements. This form of liability typically operates indirectly and does not replace the firm’s primary responsibility to investors.
Liability of Investors
In certain circumstances, liability may rest partly with the investor. Most robo-advisory platforms require users to accept detailed terms and conditions that emphasise the risks associated with investment and disclaim liability for losses resulting from market fluctuations. Where losses are caused by normal market volatility or by inaccurate information provided by the investor during onboarding, the investor may bear responsibility.
However, investor consent and risk acknowledgment do not absolve robo-advisory firms from liability in cases involving negligence, fraud, or regulatory violations. Disclaimers cannot override statutory duties owed to investors.
Can Artificial Intelligence Be Held Liable?
Under existing legal frameworks, artificial intelligence systems lack legal personality and therefore cannot be held liable in their own right. An AI system cannot be sued, punished, or compelled to provide compensation. Consequently, liability for harm caused by AI-generated decisions must be attributed to the human or corporate actors responsible for developing, deploying, and supervising the system.
This limitation highlights a significant challenge in applying traditional liability principles to AI-driven services and underscores the need for clearer legal rules addressing responsibility for autonomous decision-making technologies.
Regulatory Challenges and Gaps
The rapid adoption of robo-advisors has exposed gaps in existing financial and technological regulatory frameworks. Many regulatory systems were designed for human advisors and struggle to adequately address issues such as algorithmic opacity, lack of transparency, and automated decision-making. The difficulty of understanding how AI systems reach specific investment decisions further complicates the process of proving negligence or causation.
Additionally, robo-advisory services often operate across borders, raising jurisdictional challenges and complicating regulatory enforcement. These challenges suggest that existing laws may be insufficient to fully protect investors in AI-driven financial markets.
Recommendations and the Way Forward
To address liability concerns associated with robo-advisors, clearer regulatory guidelines are needed to define responsibility for AI-driven financial advice. Regulators should require greater transparency in algorithmic decision-making and impose minimum standards for testing, monitoring, and human oversight of robo-advisory systems.
Furthermore, shared liability frameworks may be considered to ensure that firms deploying AI systems remain accountable while encouraging responsible innovation. Strengthening disclosure obligations and investor education can also enhance trust and reduce the risks associated with automated financial advice.
Conclusion
Robo-advisors have improved access to investment services through automated and cost-effective financial advice. However, their reliance on artificial intelligence raises important legal questions regarding liability when investment decisions result in financial loss. Since AI systems lack legal personality, responsibility must be attributed to the human and corporate actors behind the technology, particularly robo-advisory firms. As the use of AI in financial services continues to grow, legal and regulatory frameworks must evolve to ensure accountability while maintaining adequate protection for investors. So, striking a balance between technological innovation and legal accountability remains essential to maintaining trust in AI-driven financial advisory services, while ensuring that investors are not left without remedies when losses occur.
