Page 38 - Investment Advisor - September 2023

especially harsh rule for particular types dards for broker-dealer and investment reasonably foreseeably may use covered
of technology.” adviser use of novel or algorithmic-driv- technology in an investor interaction,”
en analytical tools, such as AI, machine according to a fact sheet released by
‘AddItIonAL LAYer oF reGuLAtIon’ learning, and generative language mod- the agency.
Attorneys at Eversheds Sutherland els,” the Eversheds attorneys said. Gensler has questioned when design
weighed in with their thoughts after the Attorneys at Morgan Lewis noted in elements and psychological nudges
SEC passed the plan by a 3-2 vote. They their own alert that the proposed rules “are associated with digital engagement
stated in an alert that while the SEC very broad in their application.” The defi- platforms “cross the line” and become
staff “was clear that they did not view nition of “covered technology,” the Morgan recommendations.
the rule proposal as ‘expanding’ Reg BI Lewis attorneys state, “would apply to “Today’s predictive data analytics
… the rule proposal certainly imposes many of the investor- and financial profes- models also provide an increasing ability
an additional layer of regulation beyond sional-facing tools currently in use.” This to make predictions about each of us as
Reg BI and the advisory fiduciary duty.” would include “even a simple financial individuals,” Gensler said. “This growing
For instance, the attorneys capability facilitates being able
wrote, “Reg BI begins with an “Today’s predictive data analytics to differentially communicate to
account or investment ‘recom- models also provide an increasing each of us — and do so efficiently
mendation,’ and non-recommen- at scale. How might we respond
dation communications are not ability to make predictions about to individualized communica-
subject to Reg BI’s heightened each of us as individuals. This tions or nudges? How might we
standard of care. Likewise, an respond to individualized product
adviser’s fiduciary duty applies growing capability facilitates offerings? How might we respond
with respect to an advisory rela- being able to differentially to individualized pricing? This
tionship with its clients.” includes means to optimize for,
The rule proposal “goes beyond communicate to each of us — and predict, guide, forecast, or direct
both of these concepts, and do so efficiently at scale.” investors’ investment decisions.”
imposes additional duties on any Amy Lynch, founder and pres-
‘investor interactions,’ where such —Gary Gensler ident of FrontLine Compliance,
interactions may not be covered told me in a recent email that
by Reg BI or an adviser’s fiduciary duties.” model in a spreadsheet,” the attorneys said. the SEC’s Conflicts of Interest and
While the SEC may not have explicitly The Morgan Lewis attorneys opined Predictive Analytics proposal “addresses
proposed to revisit or amend Reg BI or the that the rules, if adopted as proposed, a topic that is very close to Gensler’s past
fiduciary duty, it proposed rules that would “would impose broad and potentially role at MIT, so he has a personal interest
expand the scope of the type of “interac- burdensome conflict-of-interest require- in getting this one passed.”
tions” and activities that are now subject ments on broker-dealers and investment The meme stock frenzy of 2021, Lynch
to SEC requirements, the attorneys wrote. advisers that use even simple technolo- said, “initiated this rule and firms that uti-
The SEC “did use this rulemaking as gies to communicate with clients and lize machine learning, AI, algorithms, etc.,
an opportunity to create new standards fund investors or manage clients’ assets.” for their online applications or software
or requirements that would, if ultimate- The Morgan Lewis attorneys conclude used with customers will be affected” by
ly adopted, apply to AI, machine learn- that “given the resources that firms have the SEC’s proposal. Reg BI “kicks in regard-
ing and predictive data analytics,” the invested in designing, implementing, ing any kind of investment recommenda-
attorneys said. and testing systems to comply with Reg tion (buy, sell or hold),” Lynch explained.
The attorney agreed that the definition BI, the addition of duplicative require- Concerns raised by Peirce and others,
of a covered technology “is quite broad, ments under the PDA Rules would be Lynch continued, seem “to be around
and includes an ‘analytical, technologi- particularly disruptive and costly.” how to differentiate between a software
cal, or computational function, algorithm, Further, advisors “using interactive program that guides/nudges an inves-
model, correlation matrix, or similar analysis tools in connection with the tor to action, and when that action then
method or process that optimizes for, pre- new Marketing Rule could be required crosses the line into advice under Reg
dicts, guides, forecasts, or directs invest- to also comply with the proposed PDA BI. This will be the struggle that firms
ment-related behaviors or outcomes.’” Rules,” the Morgan Lewis attorneys said. will need to deal with and identify if this
Given this broad definition, and state- rule passes in its current form.”
ments by the SEC in the release propos- CrossInG tHe LIne
ing the rule, “it seems clear the SEC is The proposed rules would apply when Washington Bureau Chief Melanie Waddell can
seriously considering imposing new stan- a broker-dealer or an advisor “uses or be reached at [email protected].

36 Investment AdvIsor September 2023 | thinkAdvisor.com