On July 26, 2023, the SEC issued proposed rules under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to address conflicts of interest that the SEC believes are associated with the use by broker-dealers and investment advisers of predictive data analytics (PDA) and PDA-like technologies, such as artificial intelligence (AI), in investor interactions. The proposed rules seek to prevent firms from using these technologies to influence investor behavior to the investor’s detriment and the benefit of the firm.
Key elements of the proposal are summarized below.
- Scope. The proposed rules would apply to all broker-dealers and investment advisers registered, or required to be registered, with the SEC, and would apply only when a firm uses a covered technology in an investor interaction. For broker-dealers, an “investor” would include prospective and current retail investors that are natural persons (or their legal representatives); for investment advisers, an “investor” would include prospective and current clients and prospective and current investors in a pooled investment vehicle advised by the firm. An “investor interaction” would encompass a firm’s engagement or communication with an investor, including by exercising discretion with respect to an investor’s account, providing information to an investor or soliciting an investor.
- Covered Technology and Uses. “Covered technology” under the proposed rules would include a firm’s use of analytical, technological or computational functions; algorithms, models, correlation matrices; or similar methods or processes that optimize for, predict, guide, forecast or direct an investor’s investment-related behaviors or outcomes. This definition is designed to cover a broad range of technologies, such as AI, machine learning, deep learning, neural networks, natural language processing (NLP) and large language models (including generative pre-trained transformers (GPT)), as well as other technologies that make use of historical or real-time data, lookup tables or correlation matrices. In addition, the proposed rules are intended to capture different use cases for these technologies, including their use in providing investment advice or recommendations and their use in digital engagement practices intended to influence investment-related behaviors or outcomes from investors, such as behavioral prompts, differential marketing, gamification features and other practices. A firm’s use of a covered technology would also encompass both direct uses (i.e., an investor directly interfacing with the technology) and indirect uses (i.e., a firm using a technology and communicating the information obtained with that technology to an investor).
Covered technology would not include: (1) technologies designed solely to inform investors (e.g., a website describing the investor’s account balance and past performance); (2) technologies used to make predictions not related to affecting an investment-related behavior or outcome (e.g., whether an investor would be approved for a credit card issued by an affiliate); and (3) technologies used to assist with basic customer service support (e.g., a chatbot used only for this function).
- Requirements. Firms subject to the proposed rules would be required to (1) evaluate any use or reasonably foreseeable potential use of a covered technology in any investor interaction to identify any conflicts of interest; (2) determine whether any identified conflict of interest would place the interest of the firm or its associated persons ahead of the interests of investors; and (3) eliminate, or neutralize the effect of, those conflicts of interests promptly after the firm determines, or reasonably should have determined, that the conflict of interest would place the interest of the firm or its associated persons ahead of the interests of investors.
For purposes of requirement (1) above, a conflict of interest would exist when a firm uses a covered technology that takes into consideration an interest of the firm or its associated persons. In its evaluation of a covered technology, a firm would also be required to test the technology prior to implementation or material modification, and periodically thereafter, to identify any conflicts of interest. For purposes of requirement (3) above, conflicts of interest that exist solely because a firm seeks to open a new investor account would be excluded. Under the proposed rules, a firm also would be required to adopt, implement and (for broker-dealers) maintain written policies and procedures reasonably designed (for broker-dealers) to achieve compliance with and (for investment advisers) to prevent violations of the proposed rules. Firms would also be subject to certain recordkeeping and retention requirements related to the proposed rules.
Comments on the proposal are due by October 10, 2023.