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(Article from Registered Funds Regulatory Update, January 2024)

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The SEC’s Division of Examinations recently launched a sweep exam of investment advisers specifically requesting information on AI-related topics, including AI-related marketing documents, algorithmic models used to manage client portfolios, third-party providers, and compliance training, according to letters obtained within the industry. The sweep exam also requested information related to back-up plans for system failures, reports on AI-related regulatory or legal issues, and disclosures and marketing pieces specifically referencing AI. An SEC spokesperson said examinations are not made public and would not confirm or deny that a sweep exam is taking place.

The SEC recently announced its Fall 2023 Regulatory Agenda that includes a focus on regulated firms’ use of AI. Additionally, the SEC in July proposed rules related to broker-dealer and investment adviser conflicts around the use of predictive data analytics, including AI, which would require firms to identify any conflicts of interest that result in broker-dealers’ or investment advisers’ interactions with investors that place the firm’s interests ahead of investor interests and eliminate or neutralize the effects of those conflicts. SEC Chair Gary Gensler has frequently publicly commented on the emerging risks resulting from the financial industry’s growing adoption of AI and warned on several occasions that the use of AI creates financial instability and could cause an economic crisis without intervention.