United States: We’re Not in Kansas Anymore: The SEC Proposes Rules for the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers

By: Richard Kerr and Matthew Rogers

On July 26, 2023, the Securities and Exchange Commission (“SEC”) proposed new rules (“Proposal”) intended to address certain conflicts of interests associated with the use of “Covered Technology” (defined below) by broker-dealers and investment advisers (“firms”) in investor interactions. If adopted as proposed, firms will be required to (i) identify conflicts of interests when using Covered Technology in interactions with investors, and (ii) adopt policies and procedures to eliminate or neutralize those conflicts of interests.

“Covered Technology” is broadly defined in the Proposal to include the use of analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor. Such Covered Technology is commonly referred to as “artificial intelligence.”

The new rules would apply when a firm makes use of Covered Technology in connection with 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, and would require, among other things, the firm to:

  • eliminate or neutralize the effect of conflicts of interest associated with the use of covered technologies in investor interactions that place the firm’s or its associated person’s interest ahead of investors’ interests;
  • adopt written policies and procedures reasonably designed to prevent violations of (in the case of advisers), and achieve compliance with (in the case of broker-dealers) the proposed rules when making use Covered Technology in investor interactions; and
  • maintain related books and records.

Policies and procedures adopted by each firm will be required to contain a written description of processes for both evaluating any use of Covered Technology in any investor interaction, and for determining how to eliminate or neutralize the effect of any conflicts of interest so that the interaction does not place the interest of the firm or an associated person ahead of the interest of the investor.

Comments on the Proposal should be submitted within 60 days after the Proposal is published in the Federal Register.

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