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Compliance March 8, 2024
Gensler Defends Predictive Analytics to Skeptical Audience
SEC Chairman Gary Gensler addressed the investment community’s concerns anxiety about regulation of predictive data analytics, including artificial intelligence, at IAA’s 2024 Compliance Conference.
Reported by Paul Mulholland
The Securities and Exchange Commission’s predictive analytics proposal, which would regulate predictive technology such as artificial intelligence, is associated with the “highest level of anxiety,” Karen Barr, the president and CEO of the Investment Adviser Association said on Friday at the IAA’s 2024 Investment Adviser Compliance Conference in Washington, D.C.
Barr told SEC Chairman Gary Gensler during a “fireside chat” at the conference that when she asked IAA members for their greatest concern about the SEC, “99.9% said the predictive analytics rule.” Gensler defended the merits of the proposal during the discussion.
The proposal, first published in July 2023, would require an adviser 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 covered technology refers to “a firm’s use of analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor,” according to the SEC.
On Friday, Gensler defended the proposal and explained that it is designed to make sure advisers do not use predictive technologies to place their interests ahead of their clients, saying, “Our fiduciary duty doesn’t square with that.” He explained that more and more advising is automated or done through robotic advising.
Gensler’s concern with artificial intelligence and predictive analytics lies primarily in advisers that put their “profits and revenues into their optimization function,” he said. That is, when an algorithm or robo-adviser is programmed, the extent to which they account for an adviser’s profitability is a potential conflict to the extent that it leads to different advice than an algorithm programmed solely to promote the client’s interest would.
Comparing the financial industry to health care, Gensler asked about a hospital that uses AI when analyzing images produced by CT scans and MRIs and asked attendees if they were “fine with your doctor optimizing for the profits of the hospital? Because I’m not.”
Barr responded by saying that, “if they were also optimizing for my health, then, ‘Yes,’” and that the use of technology is “about the outcome for the client.”
Neither Gensler nor Barr discussed instances in which it is impossible to optimize both profitability and the interests of a client, whether in finance or health care.
The IAA has called on the SEC to completely withdraw the proposal.
Barr also argued that “the proposal addresses all technologies more broadly” and is not limited to machine learning and AI. She added that “we feel this is already addressed by fiduciary duty” and that the SEC’s standing Regulation Best Interest rule would prevent an adviser from putting himself or herself ahead of a client in the first place. She said, “Everyone is in a business to make money,” but “their obligation today is to put their client’s interest first.”
In a press pool with reporters after the discussion, Gensler said, “We live in a world now where we’re inundated with prompts, behavioral prompts and nudges to do things, and [the SEC is focused on] ensuring that investment advisers and broker/dealers continue to put investors first and put their interests behind the investors’, and that those behavioral prompts, as well as recommendations and advice, don’t shift that.”
He added: “We literally have over 50 million Americans with separately managed accounts, many of which don’t have a human in the loop: They’re just robo-advising and so forth.” He added that he wanted to ensure that “the algorithms live with that stricture and have the appropriate guardrails.”
In past public appearances, Gensler has also cited the difficulty of adequately disclosing the way AI is used as a reason why elimination of related conflicts is necessary, because disclosure will not be enough to protect investors.
On Thursday, the outgoing director of the SEC’s Investment Management Division, William Birdthistle, noted at the same conference that the SEC was unlikely to abandon the predictive analytics proposal as requested by the IAA. Gensler’s appearance further solidified that stance.
