SEC Proposes Rules on the Use of AI by Registered Investment Advisers and Broker-Dealers

Fenwick & West LLP

Fenwick & West LLP

In light of concerns associated with artificial intelligence (AI) and AI-adjacent technologies such as machine learning in the field of investment advisory, the Securities and Exchange Commission (SEC) proposed new rules on July 26, 2023 under the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 that, if enacted, would require broker-dealers and investment advisers to take steps to address conflicts of interest associated with their use of predictive data analytics and similar technologies.

The proposed rules would apply when a broker-dealer or a registered investment adviser (or its associated persons) uses or may reasonably foreseeably use “covered technology” in an investor interaction. According to the SEC, the proposed rules will likely apply to substantially all of the 15,402 registered investment advisers, as well as 74% of the broker-dealers in the United States.

Concerns Regarding Conflicts of Interest From Use of AI

The SEC is concerned that AI technologies—while offering benefits through market access, efficiency and returns—may allow regulated firms to optimize for their own interests in a manner, whether or not intentionally, that places their interests ahead of their clients’ interests. The SEC argues that the historic regulatory framework requiring broker-dealers and investment advisers to disclose, mitigate or eliminate conflicts is not durable to address AI and AI-adjacent technologies because these new technologies may (i) introduce novel and unidentified risks; (ii) evolve at rapid rates, exponentially scaling the potential for conflicts of interest; and (iii) create or transmit conflicts of interest, not only in investment advice but also in sales practices and investor interactions more generally. In its proposing release, the SEC states its belief that without specific oversight tailored to the risks involved in the use of AI and AI-adjacent technologies, there may be outcomes that financially benefit firms at the expense of investors.

Implications for Technology Companies

The proposed rules, while directed at broker-dealers and investment advisers, are likely to be of interest to technology companies offering AI and AI-adjacent technology services or tools. Broker-dealers and investment advisers that use such AI and AI-adjacent technology services or tools may seek to pass on the technological requirements and costs of complying with the rules to the companies selling the services or tools. Technology companies may also be asked to accept liability for breaches of the proposed rules, both on behalf of the companies themselves and on behalf of the broker-dealers and investment advisers. Accordingly, technology companies offering AI and AI-adjacent technology services or tools should be prepared to understand the rules, carefully evaluate the liability limitations and indemnity terms in their commercial agreements, adopt internal protocols and or development tools to address the technological requirements, and otherwise guard against harm associated with potential breaches.

Covered Uses of AI and Proposed Requirements

A conflict of interest under the proposed rules would exist when a firm uses a covered technology that takes into consideration an interest of the firm or its associated persons. The proposed conflicts rules would cover use of a covered technology by both a firm and associated persons of the firm and would address technologies that take into account both interests of the firm and the interests of its associated persons. The proposed rules would provide an exception for situations where covered technology is used in investor interactions solely for purposes of meeting legal or regulatory obligations, or providing clerical, ministerial or general administrative support.

As proposed, the rules define “covered technology” to include a technology that uses an analytical, technological or computational function, algorithm, model, correlation matrix or similar method or process that optimizes for, predicts, guides, forecasts or directs investment-related behaviors or outcomes in an investor interaction.

Building off existing legal standards, the SEC is proposing that the conflicts of interest issues created by covered technologies be eliminated or effects neutralized. The proposed rules would generally require the following of broker-dealers and investment advisers: 

  1. Eliminate, or neutralize the effect of, a conflict of interest that uses an AI or AI-adjacent technology that places or results in placing the firm’s or its associated person’s interest ahead of the interest of investors.
  2. Adopt, implement and, in the case of broker-dealers, maintain written policies and procedures reasonably designed to achieve compliance with the proposed conflicts rules.  
  3. Keep specific written books and records related to the requirements of the proposed rules to help facilitate the SEC’s examination and enforcement capabilities, including assessing compliance with the requirements of the proposed conflicts rules.

Firms would be permitted to employ tools that they believe would address these risks and that are specific to the particular technology they use, consistent with the proposal.


Members of the SEC as well as commentators have concerns that the proposed rules very broadly define AI or AI-adjacent technology, picking up any and all technology tools utilized by broker-dealers and investment advisers, even Excel spreadsheets as well as mathematical formulas used to price securities. We expect there to be a fair amount of formal comment to address these definitional issues.

The SEC considered and determined not to simply propose the traditional mitigation of disclosure of any conflict of interests as a way to address its concerns. Rather, under the proposed rules, a covered technology would be subject to review for conflicts of interest, both before and during deployment, which must be eliminated or neutralized. Commentators argue this will increase the cost of complying with the proposed rules and decrease the likelihood of firms using covered technologies. Dissenting commentators also voiced concerns that the proposed rules would end up prohibiting individuals from receiving benefits from these AI-technology tools.

The proposed rules are currently out for a public comment period, which will end on October 10, 2023, so as to allow interested parties and the general public time to address the areas where comment was specifically requested as well as make suggestions or raise other concerns or considerations. Following the public comment period, the SEC will reevaluate the proposed rules prior to adopting any final rules. Fenwick will continue to monitor these rules and rulemaking.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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