SEC Proposes New Rules to Address Conflicts of Interest with AI Tools
The U.S. Securities and Exchange Commission (SEC) has recently proposed new rules aimed at addressing potential conflicts of interest arising from the use of artificial intelligence (AI) tools and predictive data analytics (PDAs) by broker-dealers and registered investment advisers (RIAs). The proposed rules, if implemented, would require RIAs to identify and eliminate any conflicts of interest associated with the use of such technologies, while also introducing changes to recordkeeping requirements for both broker-dealers and RIAs.
The SEC acknowledges the benefits that AI, PDA, and similar technologies can bring in terms of market access, efficiency, and returns. However, the commission argues that the complexity and opacity of these technologies, coupled with their scalability and the potential for reaching a broad audience at a rapid pace, necessitate additional regulations to protect investors from conflicts of interest.
Under the proposed rule, RIAs would be obligated to eliminate or neutralize conflicts of interest rather than relying solely on prior disclosure and client consent. This represents a departure from the disclosure-based regulatory regime that traditionally governs the conduct of investment advisers.
To comply with the proposed rule, each RIA would be required to adopt written policies and procedures to evaluate their firms and identify any covered technologies that may give rise to conflicts of interest. The rule defines covered technology as any analytical, technological, or computational function that predicts, guides, or directs investment-related behaviors or outcomes. This includes AI, machine learning, neural networks, natural language processing, and other technologies that utilize historical or real-time data.
While the proposed rule primarily affects advisers and broker-dealers serving retail investors, private fund sponsors should also take note. Although few private fund sponsors currently employ the types of technologies covered by the proposed rule, the SEC believes that the risks of conflicts of interest associated with AI use will expand as firms’ adoption of AI grows. Private fund sponsors should pay attention to the potential growth of AI technologies in the future and the elimination or neutralization requirement proposed by the SEC.
If the proposed rules are adopted, all current RIAs would need to implement policies and procedures to assess the existence of covered technologies and mitigate any conflicts of interest they may pose. Investment advisers should already be aware of practices, including the use of AI or PDA applications, that present conflicts with their clients and investors.
Overall, the SEC’s proposal represents a significant step towards regulating the use of AI in the securities industry. It aligns with the commission’s broader efforts to address cybersecurity practices, restrictions on private funds, ESG standards, and other key areas of concern. As AI continues to have a profound impact on the financial sector, the proposed rules aim to protect investors from potential abuses while encouraging innovation and market efficiency.
In conclusion, the SEC’s proposed rules on conflicts of interest with AI tools highlight the commission’s commitment to safeguarding investors in an evolving technological landscape. By implementing these rules, the SEC aims to strike a balance between embracing the advantages of AI and ensuring investor protection. As the proposals undergo further review, stakeholders in the financial industry will be closely watching to see how these regulations may shape the future of AI adoption in the sector.
