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SEC Proposes Rule to Tackle AI-Driven Conflicts of Interest in Investment Firms

The U.S. Securities and Exchange Commission (SEC) has taken a significant step in addressing potential conflicts of interest arising from the use of artificial intelligence by investment firms. On Wednesday, the SEC voted 3-2 to propose a new rule aimed at “neutralizing” such conflicts and safeguarding investors’ interests.

SEC Chair Gary Gensler highlighted the rule’s purpose, stating that it would “help protect investors from conflicts of interest—and require that, regardless of the technology used, firms meet their obligations not to place their own interests ahead of investors’ interests.” He pointed out that if firms’ optimization functions prioritize their own interests alongside investors’, it could lead to conflicts at scale during interactions with their investor base.

The proposed rule comprises three key provisions. First, it requires firms to eliminate or neutralize conflicts associated with technologies that prioritize the firm’s interests over those of investors. Second, firms must establish written policies and procedures to ensure compliance when investors interact with covered technology. Lastly, firms will be obligated to maintain records related to any conflicts with the rules.

The proposal defines “covered technology” as any analytical, technological, or computational function, algorithm, model, correlation matrix, or similar method that optimizes, predicts, guides, forecasts, or influences investment-related behaviors or outcomes of an investor. The public has a 60-day window to provide comments and feedback on the proposal.

SEC Commissioner Jaime Lizarraga, who supported Gensler in voting for the proposal, emphasized the increasing reliance of investors on technology to interact with financial professionals and seek investment advice. Lizarraga highlighted the importance of adhering to laws that protect retail investors, ensuring broker-dealers and investment advisers address conflicts of interest and provide adequate fee and cost disclosures.

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The proposal received support from Democratic Commissioners Caroline Crenshaw and Gensler, as well as Commissioner Lizarraga. However, Commissioner Hester Peirce, along with fellow Republican Commissioner Mark Uyeda, dissented, raising concerns about the rule’s impact on technology adoption and investor benefits.

Peirce in particular expressed skepticism about the necessity of the rule, arguing that it could lead to a ban on certain technologies, depriving investors of potential benefits. Instead, she suggested issuing guidance or conducting discussions on specific topics like adaptive AI.

Ethan Corey, senior counsel at Eversheds Sutherland, remarked on the SEC’s evolving approach to conflicts of interest, stating that the agency now views disclosure as insufficient due to the complexity and opacity of AI technologies.

The proposal represents a departure from the SEC’s traditional regulatory approach, which allowed conflicts of interest as long as they were fully disclosed. The new regime focuses on neutralization or elimination of conflicts to ensure a higher level of investor protection.

While the proposal has stirred debate, it signals the SEC’s determination to grapple with the challenges posed by AI-driven technologies in the investment landscape. As the public engages with the SEC during the comment period, the industry awaits the final ruling that could shape the future of AI integration in investment practices.

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