Executive Summary
In July 2023, the U.S. Securities and Exchange Commission published a proposed rule that, if adopted as proposed, will have significant impacts for investment advisers and broker-dealers interacting with investors through covered technology.
The proposed rule defines “covered technology” as an analytical, technological, or computational function, algorithm, model, correlation matrix, or similar method or process that optimizes for, predicts, guides, forecasts, or directs investment-related behaviors or outcomes. The proposed definition is designed to capture predictive data analytics (PDA)-like technologies, such as AI, machine learning, or deep learning algorithms, neural networks, NLP, or large language models (including generative pre-trained transformers), as well as other technologies that make use of historical or real-time data, lookup tables, or correlation matrices among others.
A conflict of interest exists when an investment adviser uses a covered technology that takes into consideration an interest of the investment adviser, or a natural person who is a person associated with the investment adviser.
An investor means any prospective or current client of an investment adviser or any prospective or current investor in a pooled investment vehicle advised by the investment adviser. An investor interaction means engaging or communicating with an investor, including by exercising discretion with respect to an investor’s account; providing information to an investor; or soliciting an investor.
The proposal would require investment advisers to:
- assess the use, or potential use, of "covered technology" in investor interactions for conflicts of interest. If such conflicts prioritize the firm’s or its associated person’s interests, they must be eliminated or neutralized;
- adopt and implement written policies and procedures reasonably designed to achieve compliance with the proposed rules. These policies should cover the evaluation of "covered technology" use, disclose material features of any "covered technology" used in any investor interaction and associated conflicts, address situations where conflicts may favor the firm or associated person, outline steps to mitigate these conflicts, and undergo annual reviews for adequacy and effectiveness; and
- maintain, make and retain certain books and records related to the requirements of the proposed rules.
If you would like to read more about the requirements under this proposal, you can access our August 11, 2023 summary of the proposal.
Please contact James Delaney or Nick Pernas with any questions regarding this proposal.
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James Delaney
Managing Director, Asset Management Regulation
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Nick Pernas
US Policy & Regulation Analyst
Practical Implications
If these changes are adopted as proposed, they will present the following practical implications for registered investment advisers:
An investment adviser will need to:
- evaluate any use, or reasonably foreseeable potential use, of a covered technology by the investment adviser, or a natural person who is a person associated with the investment adviser, in any investor interaction to identify any conflict of interest associated with that use or potential use (including by testing each such covered technology prior to its implementation or material modification, and periodically thereafter, to determine whether the use of such covered technology is associated with a conflict of interest);
- determine if any conflict of interest identified places or results in placing the interest of the investment adviser, or a natural person who is a person associated with the investment adviser, ahead of the interests of investors; and
- eliminate, or neutralize the effect of, any conflict of interest promptly after the investment adviser determines, or reasonably should have determined, that the conflict of interest placed the interests of the investment adviser, or a natural person who is a person associated with the investment adviser, ahead of the interests of investors.
An investment adviser must adopt and implement written policies and procedures, including:
- a written description of the process for evaluating any use or reasonably foreseeable potential use of a covered technology in any investor interaction and a written description of any material features of, including any conflicts of interest associated with the use of, any covered technology used in any investor interaction prior to such covered technology’s implementation or material modification, which must be updated periodically;
- a written description of the process for determining whether any conflict of interest identified results in an investor interaction that places the interest of the investment adviser or a natural person who is a person associated with the investment adviser ahead of the interests of investors;
- a written description of the process for determining how to eliminate, or neutralize the effect of, any conflicts of interest determined to result in an investor interaction that places the interest of the investment adviser or natural person who is a person associated with the investment adviser ahead of the interests of investors; and
- a review and written documentation of that review, no less frequently than annually, of the adequacy of the policies and procedures and the effectiveness of their implementation as well as a review of the written descriptions.
An investment adviser must maintain books and records, including:
- Written documentation of the evaluation, including:
- a list or other record of all covered technologies used in investor interactions by the investment adviser, including:
- the date on which each covered technology is first implemented, and each date on which any covered technology is materially modified; and
- the investment adviser’s evaluation of the intended as compared to the actual use and outcome of each covered technology in investor interactions.
- documentation describing any testing of the covered technology, including:
- the date on which testing was completed;
- the methods used to conduct the testing;
- any actual or reasonably foreseeable potential conflicts of interest identified as a result of the testing;
- a description of any changes or modifications to the covered technology made as a result of the testing and the reason for those changes; and
- any restrictions placed on the investment adviser’s use of the covered technology as a result of the testing.
- a list or other record of all covered technologies used in investor interactions by the investment adviser, including:
- Written documentation of each determination made, including the rationale for such determination.
- Written documentation of each elimination or neutralization made.
- The written policies and procedures, including any written description and the date on which the policies and procedures were last reviewed.
- A record of any disclosures provided to each investor regarding the investment adviser’s use of covered technologies, including, if applicable, the date such disclosure was provided or updated.
- A record of each instance in which a covered technology was altered, overridden, or disabled, the reason for such action, and the date thereof, including a record of all instances where an investor requested that a covered technology be altered or restricted in any manner.
Timeline
AIMA has categorized this proposal as Medium Priority/High Impact and it is therefore represented in lavender/purple in the AIMA Regulatory Horizon Scan gantt chart.
Re-Proposal Expected | Spring 2025 | **New** |
Further joint trades comment letter filed | July 9, 2024 | **New** |
Comment deadline | October 10, 2023 | |
AIMA response to proposal filed | October 10, 2023 | |
Joint trades request to withdraw proposal submitted | September 12, 2023 | |
Joint trades request for extension submitted | August 15, 2023 | |
AIMA summary for members published | August 11, 2023 | |
Proposal published by SEC | July 26, 2023 |