SEC Proposes New Rules to Address Conflicts of Interest in AI Usage by Brokerage Firms

The U.S. Securities and Exchange Commission (SEC) has proposed new rules to address potential conflicts of interest that may arise when investment advisers and broker-dealers use predictive data analytics and artificial intelligence (AI). Regardless of the technology used, the plan, which was presented on July 26, 2023, wants to stop businesses from putting their own interests ahead of investors’.

The proposed rules would require firms to analyze and identify any conflicts of interest that may emerge when using predictive data analytics to interact with investors. If such conflicts are found to place the firm’s interests ahead of investors’, the firms would need to eliminate or neutralize the effects of those conflicts. The rules would also mandate firms that use this technology for investor interactions to maintain books and records regarding their compliance with these matters.

The proposal comes in response to the increasing ability of predictive data analytics models to make individualized predictions about investors. This capability facilitates efficient, large-scale communication and can influence investors’ decisions. However, it also raises the possibility of conflicts of interest if advisers or brokers optimize to place their interests ahead of their investors’.

SEC Chairman Gary Gensler highlighted the transformative age we live in with regard to predictive data analytics and the use of AI. He noted that these advances open up significant opportunities across various sectors, including healthcare, science, and finance. However, he also stressed the potential risks, stating, “If a firm’s optimization function takes the interest of the firm into consideration as well as the interest of the investor, this can lead to conflicts of interest.”

The SEC has also adopted new rules requiring publicly traded companies to disclose hacking incidents within four days of determining their materiality to investors. The rule, first proposed in March 2022, is part of a broader SEC effort to strengthen the financial system against data theft, system failures, and cyber intrusions.

The proposed rules on AI usage have been met with dissent from Republican commissioners, who argue that existing disclosure requirements are sufficient and that the new proposal could stifle the use of new technologies. However, the SEC maintains that the complexity and opacity of these technologies necessitate a special rule.

Commissioner Hester Peirce, one of the dissenting voices, argued that the proposal seemed to suggest that investors, when confronted with these technologies, “just melt into puddles of incompetence and so disclosure doesn’t work for them.” However, William Birdthistle, the SEC’s director of investment management, countered that the proposal would not replace any disclosure requirements.

The U.S. Securities and Exchange Commission (SEC) has underscored the need for a unique regulatory approach to manage the use of highly scalable, intricate, and often non-transparent technologies in the financial sector. This statement comes in light of the SEC’s recent proposal to mitigate potential conflicts of interest arising from the use of artificial intelligence (AI) and predictive data analytics by investment advisers and broker-dealers.

The proposed rules are set to be published in the Federal Register, initiating a 60-day period for public commentary before a final decision is made. This process marks a significant milestone in the ongoing discourse surrounding the convergence of technology and financial regulation. It highlights the necessity to strike a balance between fostering innovation and safeguarding investor interests.

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