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Regulatory

Looking ahead: 2023 and beyond

Looking into 2023, we expect that regulations will be shaped by factors including crypto, ESG, the SEC’s new marketing rule, and AI.

As we look further into 2023 and beyond, we can expect the regulation of broker-dealers and investment advisors to continue to evolve with the shifting business practices. Specifically, we expect that the regulations will be shaped by a number of factors, both past and present, including the increase of virtual currency activities within the traditional financial services ecosystem, continued focus on ESG, and the implementation of the SEC’s new marketing rule. Beyond those, we look at the potential for AI and ChatGPT to revolutionize certain aspects of broker-dealer and investment advisors and with it regulations will have to keep pace. 

New marketing rule: guidance and enforcement actions

While the SEC’s new marketing rule compliance period started in November 2022, we expect that we will continue to see guidance and potentially enforcement actions that clarify certain elements. Fortunately for industry participants, the SEC updated its frequently asked questions (FAQs) regarding the marketing rule in early January.1 While the FAQs are currently short and non-controversial, it sets a promising precedent and a basis on which the SEC can choose to expand.

We also recently saw the SEC’s Division of Examinations publish its 2023 examination priorities that highlight its focus on the new marketing rule in future examinations.2 Specifically, the SEC’s Division of Examinations noted its focus on whether investment advisors have adopted and implemented policies and procedures designed to comply with the new marketing rule. It doesn’t take much foresight to see coming fines in this area in 2023 and beyond. 

All things crypto

Earlier this year, the SEC proposed rules to enhance custodial protections of customer virtual assets managed by registered investment advisers.3 One point regarding the proposed regulation, underscored by SEC Chair Gary Gensler, is that it “covers a significant amount of crypto assets.”4 In order to comply with the proposed rule, an investment adviser with custody of client crypto assets would need to ensure such assets are maintained with a qualified custodian.

A great deal of crypto asset trading volume occurs on platforms that directly settle trades. As a result, it’s not uncommon for crypto trading platforms to require investors to pre-fund trades, and to transfer their crypto assets to such an exchange prior to the execution of any trade. Under the proposed rules, this practice would likely be barred for any exchanges not also qualified custodians (i.e., most crypto exchanges). Consequently, this proposal could effectively prevent many investment advisers from investing client funds in crypto assets. Pushback from the crypto industry is likely over the next year; however, it is likely that new regulations will be promulgated to the nascent virtual currency industry. 

While the Lummis-Gillibrand Responsible Financial Innovation Act has made little progress since introduced in the Senate in June 2022, the high-profile collapse of FTX and other prominent crypto scandals may foreshadow an increased appetite among legislators for comprehensive crypto legislation. Expect to see the Lummis-Gillibrand bill dusted off and revisited during 2023, or other comprehensive crypto legislation proposed; however, it is unlikely that any comprehensive crypto legislation is passed in the near-term. 

GPT3 investment advice and the like

In theory, the rise of GPT3 and other artificial intelligence-based language models are the logical next step for the “robo-adviser” space. But in some ways, AI language models are qualitatively different from what’s currently on offer. For one thing, GPT3 and similar language models can have trouble actually “understanding” their input or output in the conventional sense – they’re usually designed to produce textual outputs based on their massive bodies of training text, to provide likely follow-ups to a given prompt. As such, they can “mix-and-match” their training data to produce a probable response to a given query, but lack the ability to verify the truth or falsity of the result. The popular ChatGPT system, for instance, lacking any outside context for the words it uses, is known for its tendency to occasionally fabricate factual information, a phenomenon popularly referred to as “hallucinating.”

While the ability to “synthesize” large amounts of information is promising, the potential consequences for fabricated information provided to a client could keep GPT3 and similar language models away from mainstream robo-advisers for at least the next several years. Nevertheless, the rapid progress in the development of such systems suggests that it may not be long before personalized marketing copy, background briefs, or even investment advice are routinely the province of GPT3’s successors.

ESG

Environmental, social, and governance (ESG) factors are becoming increasingly important for investors, and regulators are responding by proposing new requirements to make ESG disclosures more consistent and comparable. In May of 2022, the SEC proposed a rule that would require the enhancement and standardization of climate-related disclosures. Later last year, the SEC proposed rules that would require asset managers to provide more information about their ESG-related investment products. Given the controversy surrounding the topic of ESG, it remains unclear whether either of these rules will be finalized in the near term.

Only time will tell how these projections do or don’t come to fruition. I look forward to being both right and wrong and continuing the discussion.

1. https://www.sec.gov/investment/marketing-faq

2. https://www.sec.gov/files/2023-exam-priorities.pdf

3. https://www.sec.gov/news/press-release/2023-30

4. https://www.sec.gov/news/statement/gensler-statement-custody-021523

The opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.  Fidelity and any other third parties are independent entities and not affiliated. Mentioning them does not suggest a recommendation or endorsement by Fidelity.

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Mark Roszak

Regulatory & Compliance Advisor to Saifr
Mark started his career in financial services regulatory roles in Washington DC, working both for the Financial Industry Regulatory Authority and as an Associate at K&L Gates. He then continued his career working with legal tech and fintech startups based out of San Francisco. Mark now runs 1121 Law, a boutique fintech law firm focusing on providing corporate and regulatory counseling to both capital allocators and operators.

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