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Regulation and Compliance > Federal Regulation > SEC

SEC Floats New Rules on Digital Nudges, Robos

By Melanie Waddell

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What You Need to Know

  • Broker-dealers and advisors would be required to take steps to address conflicts of interest associated with AI and predictive data analytics tools.
  • IAA's general counsel says the group is 'deeply concerned' about the proposed rules.
  • Another SEC plan seeks to modernize when advisors providing advisory services over the internet can register with the SEC.

On Wednesday, the Securities and Exchange Commission approved proposed rules to tighten the use of artificial intelligence by investment advisors and broker-dealers by targeting “conflicts of interest” associated with the firms’ use of predictive data analytics as it relates to certain investor interactions, as well as new registration rules for so-called internet advisors.

Under the SEC’s plan, broker-dealers and advisors would be required “to take certain steps to address conflicts of interest associated with their use of predictive data analytics and similar technologies to interact with investors to prevent firms from placing their interests ahead of investors’ interests,” the agency said.

The proposed rules would apply when a broker-dealer or an advisor “uses or reasonably foreseeably may use covered technology in an investor interaction,” according to a fact sheet released by the agency.

SEC Chairman Gary Gensler has questioned when design elements and psychological nudges associated with digital engagement platforms (DEPs) “cross the line” and become recommendations.

On Wednesday, Gensler said that “today’s predictive data analytics models also provide an increasing ability to make predictions about each of us as individuals. This growing capability facilitates being able to differentially communicate to each of us — and do so efficiently at scale. How might we respond to individualized communications or nudges? How might we respond to individualized product offerings? How might we respond to individualized pricing? This includes means to optimize for, predict, guide, forecast, or direct investors’ investment decisions.”

Gensler added that while such tools have the potential to offer “greater financial inclusion and enhanced user experience,” they also create the potential for conflicts to arise in which advisors or brokers “are optimizing to place their interests ahead of their investors’ interests.”

The SEC’s plan, which will be out for public comment, would require:

  • A firm to eliminate or neutralize the effect of conflicts of interest associated with the firm’s use of covered technologies in investor interactions that place the firm’s or its associated person’s interest ahead of investors’ interests
  • A firm that has any investor interaction using covered technology to have written policies and procedures reasonably designed to prevent violations of (in the case of investment advisors) or achieve compliance with (in the case of broker-dealers) the proposed rules
  • Recordkeeping related to the proposed rules

‘Deeply Concerned’

The plan is already drawing criticism.

Gail Bernstein, general counsel for the Investment Adviser Association in Washington, told ThinkAdvisor on Wednesday in an email that, based on a preliminary review and statements made by some of the commissioners at the open meeting, IAA “is deeply concerned about the proposed rules around advisors’ use of technology.”

The plan, according to Bernstein, “continues a troubling pattern in the commission’s approach to rulemaking in the investment advisor space. The proposal again appears not to identify and support with data the need for a new regulation, seeming to dismiss existing regulatory obligations that already govern the conduct the proposal is trying to address.”

Further, Bernstein continued, “it also doesn’t seem to seriously consider operational difficulties or accurately describe the likely costs advisors will bear, particularly smaller advisors. These operational difficulties and costs will be on top of the many other new requirements coming at advisors at an unprecedented speed and scale.”

The proposal “is also another example of the commission’s moving away from the principles-based regulatory framework for advisors — which includes their overarching fiduciary duty — towards more prescriptive and rigid requirements that will likely result in advisors’ judgments being second-guessed in hindsight,” Bernstein added.

‘Internet’ Advisors

The SEC’s plan regarding when investment advisors providing advisory services over the internet can register with the SEC “would modernize the Internet Advisers Exemption in two ways,” Gensler explained.

First, the SEC’s plan would require advisors seeking to rely on the Internet Advisers Exemption “to have at all times an operational, interactive website through which the advisor provides digital investment advisory services on an ongoing basis to more than one client,” Gensler explained.

“That means, if the proposal is adopted, firms that rely on the Internet Advisers Exemption — thus being regulated by the SEC rather than state securities regulators — would actually need to advise clients through the internet and do so from the moment the firms rely on this exception. The website cannot be used as a prop, akin to how a man behind the curtain used props to pretend to be the Wizard of Oz,” Gensler said.

Second, the proposal would require advisors seeking to rely on the Internet Advisers Exemption to provide advice to clients “exclusively through this operational, interactive website,” Gensler continued. “Currently, the rule allows advisors to qualify as internet advisors while, for instance, also serving a small number of investors in person, over the phone or by other means.”

These changes, Gensler stated, “would better reflect what it means in 2023 truly to provide an exclusively internet-based service.”

The plan requires that internet advisors “have an operational, interactive website at the time of registration,” William Birdthistle, director of the SEC’s Division of Investment Management, said during the open meeting.

Photo: Shutterstock

Melanie Waddell

@Think_MelanieW

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