Artificial intelligence (AI) is getting better and better, faster and faster, so regulatory authorities are taking proactive steps to ensure the protection of investors' interests. On July 26, 2023, the U.S. Securities and Exchange Commission (SEC) unveiled an innovative proposal designed to address potential conflicts of interest that may arise from the use of AI and predictive data analytics within brokerage and investment advisory firms.
At the core of the SEC's proposal lies the objective of mitigating conflicts of interest that could emerge due to the adoption of AI and predictive data analytics by broker-dealers and investment advisers. SEC Chair Gary Gensler emphasized the significance of the proposal, stating, “When providing advice or recommendations, firms have a duty to eliminate or address conflicts of interest and must not prioritize their interests over those of investors. I believe that, if adopted, these rules will safeguard investors from conflicts of interest and will require firms to uphold their obligations irrespective of the technology they employ.”
The proposal mandates that brokerage and investment advisory firms take proactive measures to assess and mitigate conflicts of interest associated with their use of AI and predictive data analytics. This entails a comprehensive evaluation to ascertain whether the firm's interests could potentially supersede those of investors due to the deployment of this technology. If such conflicts are identified, the firms are obligated to rectify or neutralize them.
While the SEC's proposed rule aims to establish a regulatory framework for safeguarding investor interests, investment advisory firms can embrace best practices to not only comply with the forthcoming regulations but also enhance their operational transparency and ethical standards. It is worth noting that, while currently a proposal, the growing prominence of AI in the financial sector suggests that AI-related regulations will likely come into effect in some form, making these best practices invaluable.
The SEC recently conducted an examination aimed at identifying gaps in the compliance programs of investment advisory firms in relation to their use of AI. The following best practices were gleaned from this examination, offering a roadmap for investment advisory firms utilizing AI:
The SEC's proposed rule signifies a significant stride in aligning technological advancements with investor protection. As investment advisory firms continue to embrace AI and predictive data analytics, it is essential that they adhere to the proposed guidelines and implement best practices that prioritize investor interests. By embracing transparency and ethical practices, RIA firms can navigate the ever-evolving AI landscape in finance while safeguarding the trust and well-being of their clients.