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Regulatory

Q4 2023 regulatory roundup: three things worth talking about

Here are the regulatory actions that caught my eye at the end of 2023: US executive order on AI, SEC proposed PDA rule, and FINRA's focus on Reg BI.

As the regulatory landscape constantly evolves and adapts to modern technologies, such as artificial intelligence (AI), it’s important to stay informed on where policies stand to help determine how they may impact your firm and your work. I regularly review information from financial services regulators, and here are my findings from the U.S. government, the SEC, and FINRA that caught my attention at the end of 2023.

US government AI Executive Order

In October of 2023, President Joseph Biden issued the Executive Order on the Safe, Secure, and Trustworthy Development and Use of Artificial Intelligence to protect citizens from the irresponsible use of AI. This order seeks to prevent fraud, discrimination, bias, and misinformation that could potentially threaten the safety and security of the United States. There are eight guiding principles to accomplish this effort.

  1. AI must be safe and secure.
  2. AI must promote responsible innovation.
  3. Development would require a commitment to American workers.
  4. Consistent AI policy should help advance equity and civil rights.
  5. Interests of Americans who interact with AI products must be protected.
  6. Privacy and civil liberties must be protected.
  7. Adhere to risk management methods and governance.
  8. Federal government should lead progress (economic, societal, technological).

There is a lot to unpack here; but with the order will come more specific legislation geared toward the risks referenced above. One example of implementation might be around the use of large language models (LLMs). LLMs are becoming widely adopted in professional and personal landscapes and are often being used similarly to a spell-check. One way to mitigate risk in their use is to require a watermark for AI-generated content to help protect against IP infringement and be clear what content was created by AI. This is just one example of how this Order might be implemented.

The National Institute of Standards and Technology, the Secretary of Energy, the Secretary of Homeland Security, and heads of other relevant agencies will establish guidelines and best practices with the aim of promoting consensus and industry standards for developing safe and secure AI systems. More will follow this order with bespoke laws geared to different industries’ use of AI and the financial arena is likely to be one of the orders’ primary targets. This will likely be on the current administration’s radar as well as the next administration’s, so I’ll keep my eye out for further updates.

For more on the Order, read Jasmin Sethi’s blog.

Predictive data analytics feedback

Another thing that caught my eye and is worthy of note was the SEC’s proposed Conflicts of Interest Associated with the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers rule. It was proposed in July 2023 with public comments due in October 2023. The goal of the proposed rule is to neutralize the effects of certain conflicts of interest associated with broker-dealers’ or investment advisors’ interactions with investors using technology to predict, guide, or forecast investment-related behaviors or outcomes.

If this rule becomes law as proposed, firms will need to create and maintain certain records to support the proposed conflicts rule. I recently spoke about this topic at the Practicing Legal Institute in New York in November and know that firms are very concerned about how to comply with the current proposal “as is.” The current wide definition of “covered technology” is so vast that it could conceivably include anything from a retirement tool calculator to an excel spreadsheet. Some asset managers and financial firms could be in scope for hundreds of tools/predictive data outputs with this proposed rule. I’ll be keeping an eye out for the SEC’s next steps.

For more on this proposed rule, read Mark Roszak’s blog.

FINRA focus on best interest continues

In December of 2023, FINRA issued a Notice discussing guidance provided by the SEC regarding its Regulation Best Interest rule (RegBI)(3). FINRA's Notice helps members comply with RegBI by highlighting three highly relevant SEC bulletins and calling attention to other available resources. The most pertinent SEC bulletins are:  

  • SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Account Recommendations for Retail Investors; 
  • SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Conflicts of Interest; and 
  • SEC Staff Bulletin: Standards of Conduct for Broker-Dealers and Investment Advisers Care Obligations.

To recap, Reg BI requires a member firm to act in the best interest of its retail customers without placing the financial or other interest of the member, or any associated person, ahead of the interest of the customer when making a financial recommendation. The rule requires compliance with four obligations clearly laid out in the guide care, disclosure, conflicts, and compliance:

  • Disclosure Obligation: provide certain required disclosure before or at the time of the recommendation, about the recommendation and the relationship between you and your retail customer;
  • Care Obligation: exercise reasonable diligence, care, and skill in making the recommendation;
  • Conflict of Interest Obligation: establish, maintain, and enforce written policies and procedures reasonably designed to address conflicts of interest; and
  • Compliance Obligation: establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest.

The main premise of Reg BI is to help ensure that if you are acting as a fiduciary under the law, as a broker-dealer or investment advisor, you are making suitable recommendations to your client. The SEC staff believes that you must obtain and evaluate sufficient information about a retail investor to be able to form a reasonable basis to believe your recommendations are in the retail investor’s best interest.

This seems like a reasonable request to protect the investor against misrepresentation and/or promoting products that are not in their best interest. Complying with Reg BI for some firms can be challenging in terms of ensuring all back-up, supporting documentation is record-kept for each decision within each client’s portfolio. If a client has several positions that the advisor is recommending, it could be challenging to document and support each detail and decision for both the advisor and firm. We’ll see how firms do in 2024 and if FINRA’s Notice helps.

In summary, 2023 closed as expected with the protection of investors continuing to be at the forefront. I noticed increasing pressure on firms to comply with more detailed regulations in the AI space, conflicts of interest, and Reg BI. So, looking to 2024 we hopefully will see more clarity and enforcement around these looming regulations. Obviously, we cannot predict what regulators will do next, but I hope these notes help you face today’s compliance challenges more confidently.

 

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.

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Allison Lagosh

Head of Compliance
Allison currently serves as the Compliance Advisor and Director for Saifr within Fidelity Labs. She previously was a management consultant focusing on data validation and conversions, disclosure design, and regulatory expertise for the Saifr team. Allison has extensive experience in the financial services industry with various legal, compliance, risk, and marketing compliance positions. Most recently, she was a Vice President for State Street Global Marketing, where she led the Risk Management and Controls Governance Program and advised on Marketing workflow tool management. Allison also worked at various senior compliance and marketing manager positions at Columbia Threadneedle, MFS, and Fidelity Investments.

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