SEC takes on AI use by investment advisers and broker-dealers

The US Securities and Exchange Commission (SEC) is holding an open meeting this Wednesday to consider whether to propose new and amended rules under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 relating to “conflicts of interest associated with broker-dealers’ and investment advisers’ use of predictive data analytics in connection with certain investor interactions.” This rulemaking, which appears (in part) to be based on an earlier request for comment on digital engagement practices, could very well be one of Chair Gensler’s most significant initiatives for broker-dealers and investment advisers in a crowded field of SEC proposals. For now, all we have is the SEC’s agenda item announcing Wednesday’s open meeting. But that’s enough to get us thinking about Wednesday’s meeting and what may lie ahead.

Here are five things the Eversheds Sutherland team will be on the lookout for during Wednesday’s open meeting.

1. Conflicts or Beyond? The SEC’s announced agenda for its meeting indicates that the rule will be focused on conflicts. Will more be in the mix? There is an established framework already in place for addressing broker-dealer and adviser conflicts, and anything the SEC wants to say about conflicts can be handled in a risk alert. Earlier in the year, Chair Gensler hinted that the SEC may tackle AI via rulemaking or other avenues. It now seems that Chair Gensler has settled on rulemaking. What’s really going on? Will the proposed rulemaking seek to establish comprehensive guardrails regarding the use of artificial intelligence (AI) by broker-dealers and advisers that go beyond conflict disclosures?
    
2. Is AI Broadly in Scope? The open meeting agenda indicates that the proposed rulemaking will address conflicts in the use of “predictive data analytics” by broker-dealers and investment advisers. Has the SEC set its sights on predictive data analytics, or will its focus be broader, capturing the use of AI and machine learning by firms? The SEC’s prior request for comment on digital engagement practices (DEPs) contained many related issues and asked for comments broadly, so will the SEC include all of those issues within the scope of “predictive data analytics”?
    
3. New Duties for Advisers and Broker-Dealers? Will the SEC use this rulemaking as an opportunity to re-visit Regulation Best Interest and an investment adviser’s fiduciary duty? Will the SEC use this as an opportunity to create new standards or stretch existing standards of care for broker-dealers and advisers (Regulation BI and fiduciary duties) to the use of AI and machine learning activities and predictive data applications by investment advisers and broker-dealers? What type of AI-driven communications or digital prompts, when used by financial professionals, will now be subject to best interest and/or fiduciary standards?
    
4. Changing Landscape for the Scope of Recommendations and Advice? What will the SEC say about what constitutes a broker-dealer recommendation and the provision of investment advice? These concepts seem to be the doors through which the SEC may seek to regulate AI and machine learning. In seeking information and comment in August 2021 regarding the use of DEPs by broker-dealers and investment advisers, the SEC asked various questions, including:

• Do broker-dealers/advisers consider the observable impacts of DEPs when determining if they are making “recommendations” or providing investment advice? How does the fact that a DEP might impact the behavior of a statistically significant number of retail investors affect this determination? 
• What additions or modifications to existing regulations or new regulations or guidance might be warranted to address investor protection concerns identified in connection with the use by broker-dealers and investment advisers of DEPs.

We will be reviewing the SEC’s proposal to see how the agency addresses these questions.

5. Coordination? The Executive Branch and certain members of Congress have strongly indicated their interest in developing a federal-level approach to AI. Given the size and importance of the financial services industry, will the SEC indicate in its proposal a desire to coordinate with other agencies so that the financial services industry is not subject to standards more onerous than those imposed on AI developers and others, by other agencies? 

More questions right now than answers. Our team at Eversheds Sutherland will be actively digesting the SEC’s proposal once it is released to the public. We will plan to follow up with our quick reactions and answers to these questions in a separate legal alert after the proposal is released. Stay tuned. 

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If you have any questions about this Legal Alert, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.