“ Collectively , these issues adversely impacted the value of [ tax-loss harvesting ] for over 25,000 client accounts , and as a result , clients lost approximately $ 4 million dollars in potential tax benefits ,” the SEC said in its administrative order announcing cease-anddesist proceedings and the $ 9 million civil penalty against Betterment , a registered investment advisor .

The agency said that at various times between March 2016 and April 2019 , Betterment failed to alert clients about changes in their advisory contracts and failed to maintain books and records . The robo-advisor also failed to adopt investment policies and procedures to avoid violating the Investment Advisers Act of 1940 , the agency said .

Betterment ’ s service , according to the complaint , was designed to scan for tax-loss-harvesting opportunities in client accounts . In January 2016 , the complaint says , Betterment started scanning on

The agency said that at various times between March 2016 and April 2019 , Betterment failed to alert clients about changes in their advisory contracts and failed to maintain books and records .

alternate days instead of every day , yet continued to say until April 2019 that it was scanning daily in some of its materials .

Also , “ at different times during the relevant period , Betterment had two computer coding errors that prevented [ the service ] from harvesting losses for certain impacted clients ,” the SEC claims .

“ Beginning in April 2016 , a coding error caused two Betterment client databases to not interface properly for certain accounts . The result was that for at least 150 accounts , [ tax-loss-harvesting ] was disabled although clients had enabled it .”

Betterment , a pioneer among robo-advisors , was registered with the SEC in 2009 and effectively launched in 2010 in the Chelsea neighborhood of Manhattan by Harvard and Columbia Business School grad Jon Stein , who wanted to provide automated , software-based portfolio management . In its Form ADV , updated May 1 ,

the firm said it had $ 36.6 billion in assets under management and more than a million accounts . The current CEO is Sarah Levy .

The company launched its tax-loss harvesting service in 2014 .

“ In order to take advantage of the service , clients must affirmatively enable [ tax-loss harvesting ] by selecting it through the online user interface ,” the SEC order says . This is “ an automated , algorithm-driven process whereby individual positions in client taxable accounts are scanned to identify unrealized investment losses . If , after meeting certain conditions , an ETF is identified where a client has an unrealized loss that could potentially be used to reduce their liability , it is sold and replaced with a closely correlated ETF with similar exposure .

“ In other words , [ tax-loss harvesting ] is designed to replace a security with another security to capture a potential tax benefit while maintaining a similar exposure and allocation in a client ’ s account . Since its introduction through January 2023 , over 275,000 client accounts have enabled [ the service ].”

— Eric Rasmussen

says Frank Corrado , managing director , principal at Robertson Stephens in Holmdel , N . J .

Nevertheless , tax-sensitive clients might explore philanthropic strategies to minimize estate and income taxes . Clients can also consider paying the capital gains tax on the tax return as if the assets did

not receive an adjustment in basis . “ They then file an amended tax return requesting a refund based on the assets receiving a step-up basis and providing full disclosure that this position was taken ,” Corrado says . “ If the step-up is denied , the taxpayer would not have made a substantial underpayment on the original return .”

How serious is this ruling ? “ It ’ s likely that taxpayers might litigate this issue in the future , so the matter may not be fully settled ,” Duffy says . “ In the interim , following the IRS ruling is likely the safest course of action .”

— Jeff Stimpson

JUNE 2023 | FINANCIAL ADVISOR MAGAZINE | 13