New SEC Rules Proposed to Regulate Use of Predictive Data Analytics and AI Technologies
The Securities Exchange Commission (SEC) has proposed new rules that would regulate conflicts of interest associated with the use of predictive data analytics (PDA) and artificial intelligence (AI) technologies by broker-dealers and investment advisers. These technologies include machine learning, deep learning, neural networks, natural language processing, and generative pre-trained transformers (GPT), among others.
Under the proposed rules, these regulations would apply to “investor interactions,” which consist of engagements or communications between firms and certain investors. This includes broker-dealers’ retail customers and prospective customers, investment advisers’ clients and prospective clients, as well as investors and prospective investors in private funds managed by advisers.
Firms would be required to develop policies and procedures to identify and evaluate conflicts of interest resulting from their use of covered technologies. They would also need to determine if these conflicts place their interests ahead of investors and promptly eliminate or neutralize the effects of such conflicts.
The SEC’s proposal is notable because it focuses on theoretical or potential uses of PDA and AI technologies rather than current uses. It aims to shape the development of these technologies and how the industry uses them. The proposed rules would have a broader scope than the current Federal fiduciary duty framework and would require firms to go beyond disclosure and informed consent to address conflicts of interest.
The SEC believes that disclosure and consent are insufficient to address the complexity, opacity, scalability, and speed of PDA and AI technologies. It claims authority under the Dodd-Frank Wall Street Reform and Consumer Protection Act to prohibit or restrict certain sales practices, conflicts of interest, and compensation schemes that it deems contrary to the public interest and investor protection.
The proposed rules include key terms such as covered technology, which encompasses various analytical, technological, or computational functions that predict or guide investment-related behaviors or outcomes. A conflict of interest is defined as a firm’s use of a covered technology that takes into consideration its own interests. Investor interactions refer to engagements or communications with investors, excluding interactions for legal or regulatory obligations or general administrative support.
The proposed rules would have a significant impact on broker-dealers and investment advisers, as they would require firms to actively manage conflicts of interest related to their use of PDA and AI technologies. The SEC’s focus on potential uses of these technologies shows its intent to regulate the industry’s future development and usage. Firms will need to adapt their policies and procedures to comply with these proposed rules if they are adopted.
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