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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief executive of the Alternative Investment Management Association
The US investment management industry is globally recognized for its innovation and exceptional performance, making it a leading force in the global market. Despite its achievements, the industry is facing a concerning challenge, one that jeopardizes its competitive edge and the interests of its stakeholders.
Within the past two years, the US Securities and Exchange Commission (SEC) has inundated the industry with numerous regulatory proposals and rulemakings, casting a cloud of uncertainty over its future.
The latest proposal from the SEC revolves around addressing conflicts of interest stemming from the use of “predictive data analytics” by investment advisers and broker-dealers. While this may seem focused on the utilization of artificial intelligence-like technologies, it actually aims to rewrite the established rules of fiduciary duty between clients and their investment advisers. Unfortunately, the negative impact of this rule has not been adequately considered.
This proposal by the SEC requires various groups, including investment advisers and broker-dealers, to eliminate or neutralize conflicts of interest arising from their use of technology that optimizes, predicts, guides, forecasts, or directs investment-related behaviors or outcomes. This broad definition encompasses both cutting-edge artificial intelligence and basic spreadsheets.
As a result, this creates vast uncertainty and imposes unnecessary burdens on investment companies that rely on technology in their everyday operations. The proposed rules would force these groups to evaluate, test, and document every technology used in trading and client interactions, which is impractical and operationally unfeasible. These increased costs would ultimately hinder investor returns.
The proposal’s interpretation of “conflict of interest” raises further concerns. Any technology that considers the interests of the investment adviser may be deemed “conflicted.” Consequently, most technologies would be labeled as conflicts, placing the burden of proof on companies to demonstrate otherwise.
A deeper analysis reveals a clear lack of understanding from the SEC regarding the crucial role technology plays in the investment management industry. Technology is integral to marketing, risk management, compliance with SEC rules, and securing optimal outcomes for investors.
Moreover, the rule demonstrates a misunderstanding of advanced technologies like deep learning, treating them as fully predictable and deterministic. This approach makes the use of artificial intelligence more burdensome, if not impossible, from a compliance perspective, at a time when businesses seek to harness this emerging technology.
While we support appropriate regulatory frameworks that protect investors, this particular proposal is inadequately justified and fundamentally flawed. Concerns about the SEC’s statutory authority compound the issue further. It is important to recognize that existing obligations already prioritize clients’ interests through the longstanding fiduciary duty that governs the client-adviser relationship. Therefore, this proposed rule attempts to address a nonexistent gap.
Unfortunately, it seems that this proposal is part of a larger trend. The SEC is attempting to rely on novel interpretations of existing statutory language to drive profound and disruptive changes in numerous areas of US capital markets without sufficient evidence of market failure. It remains unclear who will truly benefit from these changes, but it is unlikely to be the investors whom the SEC claims to protect.
In his speeches, SEC Chair Gary Gensler often highlights the US capital markets’ strength and prominence. Given this strength, there is no urgent need for rushed reforms. Balancing regulatory prudence with innovation is crucial for protecting the future of the US investment management industry. The SEC’s current approach appears to lean in the wrong direction, endangering the industry’s competitive edge and the best interests of investors.
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