How is the robot advisor Betterment harvesting your investment losses?
“Any one may so arrange his affairs that his taxes shall be as low as possible,” said Learned Hand; “he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” But what about the reverse? If you are an investment adviser with a fiduciary duty to your clients, do you have an obligation to minimize their taxes? You do have a duty to be loyal and diligent and do a good job for them; you try to maximize their risk-adjusted return, and generally speaking reducing taxes increases returns more reliably than does, like, having a lot of investment skill. “I will buy stocks that go up, so my clients have high returns”: hard to do. “I will sell stocks that have gone down and rotate into similar stocks to generate losses to shield my clients’ capital gains”: pretty straightforward as these things go.
On the other hand, if you fail to minimize your clients’ taxes, it would be a little weird for a government regulator to come in and punish you. It’s not clear that government regulators have, you know, an interest in encouraging tax minimization? But here is a US Securities and Exchange Commission enforcement action fining Betterment LLC $9 million for not fulfilling its fiduciary duty to minimize its customers’ taxes. Well, technically the fine is for advertising that it did a better job of minimizing taxes than it actually did:
The SEC’s order finds that, from 2016 to 2019, Betterment, in communicating with clients, misstated or omitted several material facts concerning [tax loss harvesting], a service that scans clients’ accounts for opportunities to reduce their tax burden. According to the order, at different times, Betterment failed to disclose a change in the software related to its scanning frequency, failed to disclose a programming constraint affecting certain clients, and had two computer coding errors that prevented TLH from harvesting losses for some clients. Collectively, these issues adversely impacted more than 25,000 client accounts, resulting in those clients losing approximately $4 million in potential tax benefits.
For instance, for a while Betterment told clients that it scanned their portfolios every day for tax-loss-harvesting opportunities, but in fact it was only scanning them every other day. Eventually it fixed this problem and went back to scanning them every day, but in the meantime “approximately 25,000 clients lost approximately $1.9 million in potential tax benefits as a result of the undisclosed change in scanning frequency.” The US government got $1.9 million more in revenue because Betterment was not checking every client’s portfolio every day to minimize taxes. Which was bad I guess.
Before, a ProPublica investigation into tax-loss harvesting that big banks like Goldman Sachs Group Inc. do on behalf of their ultra-high-net-worth clients. ProPublica confronted Goldman with its findings and Goldman basically said, oh, right, a few of these trades were probably too aggressive, but for the most part (in ProPublica’s words) “the bank will continue its broader practice of finding similar stocks that achieve the same effect.” “It would be irresponsible not to,” I wrote: Goldman is a fiduciary, its customers are paying it for tax optimization, so it does the best job it can do of optimizing their taxes. One could object, on public-spiritedness grounds, but that really is the job. And if you don’t do it diligently, you will get in trouble.