The Securities and Exchange Commission (SEC) finds the increased use of predictive data analytics by broker-dealers and investment advisers to be of “significant interest,” SEC Assistant Chief Accountant Nicolina McCarthy said during a session on emerging issues at the Foundation for Accounting Education’s Alternative Investment Fund Conference on Nov. 2.

In discussing the SEC’s proposed rule, Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-dealers and Investment Advisers, McCarthy referred to SEC Chair Gary Gensler’s July 17 speech at the National Press Club, in which he said that generative artificial intelligence (AI)  is the “most transformative technology of our time, on par with the internet and mass production of automobiles.” He also noted that AI already is being used for numerous applications in finance, such as call centers, account openings, and compliance programs, and has changed the fields of robo-advising and brokerage apps.

She said that Gensler, in his speech, “provided a lot of actual real-world examples of exactly how AI is making its mark, and more specifically in the financial sector how AI is raising a number of challenges and questions. He alluded to both the transformative benefits, as well as the potential conflicts arising from the use of AI and predictive analytics, and indicated that he has directed staff to make recommendations on potential rulemaking on these matters. ” The proposed rule, issued on July 26, would address certain conflicts of interest associated with the use of predictive data analytics by broker dealers and investment advisers.

She explained that the proposed rule is meant to protect the interest of investors and to ensure that companies do not put their interests ahead of those of the investors.

McCarthy cited an SEC fact sheet, which provides that “the proposal 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 advisers) or achieve compliance with (in the case of broker-dealers) the proposed rules; and

● Recordkeeping related to the proposed conflicts rules.”

She explained why all of this is so important to investment advisers, saying, “Within the proposal, it discusses that investment advisers registered or required to be registered under Section 203 of the Investment Advisers Act of 1940 would have to apply this rule when they use or reasonably foreseeably using covered technology in an investor interaction. This would include engagement or communication with an investor.”

“This proposal has already generated a lot of feedback and conversation within the industry, and with the comment period now closed, the SEC staff are working to accumulate feedback and are speaking with various industry participants and stakeholders to find a path forward,” she said, encouraging interested attendees to familiarize themselves with the comment letters and meetings pertaining to the proposal on the SEC’s website.

McCarthy also mentioned the SEC’s recent adoption of new rules and rule amendments designed to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market.

McCarthy outlined the SEC’s examination priorities for 2024, which includes a continued focus on advisers to private funds. She noted that, according to that document, “examining for advisers’ adherence to their duty of care and duty of loyalty obligations remain a priority for the SEC’s Division of Examinations.”

She also highlighting one particular enforcement action, in which five advisory firms were charged with custody rule violations.

The firms were charged with failing to do one or more of: having audits performed, delivering audited financials to investors in a timely manner, and ensuring that a qualified custodian maintained client assets, according to the SEC. Two of the firms failed to file amended Forms ADV promptly to reflect that they had received audited financial statements, and one of the firms did not properly describe the status of its financial statement audits for multiple years when filing its Form ADV.

In the course of her 50-minute presentation, McCarthy also provided an overview of the SEC’s structure, reminded the attendees of the new rule on Documentation of Registered Investment Adviser Compliance, and discussed recent amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds.

“The amendments to Form PF will enhance FSOC’s [the Treasury Department’s Financial Stability Oversight Council] ability to monitor systemic risk,” the SEC’s fact sheet said. “