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SEC Proposes Regulations to Address Conflicts of Interest

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The Securities and Exchange Commission (SEC) has put forward new regulations that would require registered investment advisors and broker-dealers to tackle conflicts of interest that could arise from the use of artificial intelligence (AI), predictive analytics, and other forms of technology in wealth management.

The proposal, currently open for public comment, aims to address concerns that advisors and brokers may leverage sophisticated technology applications to influence clients in a way that favors financial firms over the best interests of their clients.

SEC Chairman Gary Gensler emphasized the importance of addressing conflicts of interest related to predictive analytics and similar techniques used by investment advisors and broker-dealers. He stated, “These rules would help protect investors from conflicts of interest and ensure that firms fulfill their obligations by prioritizing investors’ interests, regardless of the technology they employ.”

The proposal was approved by a 3-2 party-line vote, with dissent from two Republican commissioners. Republican Commissioner Hester Peirce voiced her opposition to the proposal, describing it as “hostile” towards technology and suggesting that it could discourage firms from adopting innovative tools that could benefit investors.

Under the new rule, firms would be required to identify any technology applications falling within the rule’s scope and evaluate whether they have the potential to create conflicts that prioritize the interests of firms or their representatives over those of clients.

To comply with the regulation, firms would need to take steps to “eliminate or neutralize” any identified conflicts, as mere disclosure would not be sufficient.

Firms Grapple with Technology and Investor Behavior

Firms operating in the financial industry will now face new compliance requirements as they navigate the use of technology. Gensler, a leading industry figure, has raised concerns about how technology can influence investor behavior and potentially create conflicts of interest. He specifically warns against digital engagement practices that could prompt investors to make decisions that are not in their best interest, such as trading actions that generate commissions.

The rapid advancement of predictive data analytics, artificial intelligence, machine learning, and other technologies has amplified the potential for these conflicts. As a result, firms must implement written policies and procedures to ensure compliance with the new rule. Additionally, their record-keeping operations must be updated to track and address conflicts that arise due to technology use.

One key point of contention surrounding the rule is its scope. While the rule specifically mentions predictive analytics, its definition of “covered technology” encompasses a wide range of analytical, technological, or computational functions. This definition has sparked concerns among dissenting commissioners like Peirce and Uyeda. They believe that the rule’s language is broad enough to include various technology applications used by advisors, even those commonly employed in financial planning or portfolio management.

Uyeda criticizes the proposal as overly extensive in its reach, suggesting that imposing additional regulations on fiduciary advisors and brokers under Regulation Best Interest may lead to a superficial adherence to compliance requirements. He goes on to argue that it could result in a burdensome amount of paperwork, especially when it comes to demonstrating that seemingly innocuous tools like desktop calculators do not present conflicts of interest.

The implications of this rule have prompted firms to reassess their technological practices and adapt accordingly. As they navigate this new landscape, it is crucial for firms to address potential conflicts of interest and ensure that investors’ best interests remain at the forefront of their operations.

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