SEC's Proposed Rules on AI Use in Investment Advisory

Dan Nicholson

Artificial Intelligence (AI) has revolutionized the financial landscape, offering unprecedented insights and efficiencies. However, with these advancements comes the challenge of ensuring that the technology serves the best interests of investors and not just those of the firms employing them. The Securities and Exchange Commission (SEC) has taken a significant step in addressing these concerns.

The SEC's Proposal and Its Reach

On July 26, the SEC rolled out new rules concerning the application of AI by registered investment advisers and broker-dealers. The focus lies squarely on addressing the conflicts of interest inherent in the predictive data analytics and related technologies that these entities utilize.

These rules are designed to cover situations where a broker-dealer or registered investment adviser uses or anticipates the use of "covered technology" during an interaction with an investor. The SEC estimates that this would encompass a staggering majority of registered investment advisers—virtually all of them, in fact—as well as three-quarters of the broker-dealers in the U.S.

The Core Concerns

There's a palpable fear that these tools might be harnessed in ways that prioritize the interests of firms over those of their clients. The rapid evolution of these technologies, coupled with their potential to introduce unforeseen risks, adds layers of complexity to the issue.

Implications for Tech Enterprises

Though the rules target broker-dealers and investment advisers, they are poised to resonate through the technology sector. Companies specializing in AI and related technologies might find themselves bearing the brunt of compliance costs. They may also face potential liabilities for any breaches of the proposed rules, not just on their own behalf but on behalf of their broker-dealer and investment adviser clients.

Consequently, tech companies need to be proactive. Understanding the rules, scrutinizing liability clauses in their commercial contracts, and implementing robust protocols to meet the technical demands of compliance will be paramount.

Defining the "Covered Technology"

A focal point of the proposed rules is the definition of "covered technology." As it stands, this term is broadly interpreted to include any technology harnessing algorithms, models, or similar methodologies that influence investment-related decisions during an investor interaction.

The SEC's proposition is clear. Any conflicts arising from these technologies must either be eradicated or neutralized. To ensure adherence to this principle, broker-dealers and investment advisers would be mandated to:

  1. Address conflicts of interest stemming from the use of AI technologies that might prioritize the firm's interests over those of investors.
  2. Formulate and sustain written guidelines to assure compliance with the rules.
  3. Retain detailed written records pertinent to the rules, bolstering the SEC's ability to oversee and enforce them.

The proposed regulations do provide some flexibility, allowing firms to employ tools tailored to the specific technologies they utilize.

Points of Contention and the Path Ahead

There are reservations about the SEC's broad definition of AI and related technologies. Some argue that it could encompass even rudimentary tools used by broker-dealers and advisers. 

Another notable point of contention is the SEC's decision to forego the conventional approach of merely disclosing conflicts of interest. The proposal mandates a comprehensive review of covered technologies for potential conflicts prior to and during their deployment. Critics argue that this could escalate compliance costs and discourage firms from deploying AI tools.

The ball is now in the public's court, with a comment period extending until October 10, 2023. This window offers an opportunity for stakeholders to voice their perspectives, concerns, and recommendations. 



Dan Nicholson is the author of “Rigging the Game: How to Achieve Financial Certainty, Navigate Risk and Make Money on Your Own Terms,” deemed a best-seller by USA Today and The Wall Street Journal. In addition to founding the award-winning accounting and financial consulting firm Nth Degree CPAs, Dan has created and run multiple small businesses, including Certainty U and the Certified Certainty Advisor program.

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