Unlock the Editor’s Digest for free
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 a global leader, known for its innovation and performance. However, it faces an unsettling predicament — a looming threat to its competitive edge and the interests of those it serves.
Over the past two years, the US Securities and Exchange Commission has inundated the industry with regulatory proposals and rulemakings that cast a shadow of uncertainty over its future.
The core of the SEC’s latest proposal revolves around addressing conflicts of interest in the use of “predictive data analytics” by investment advisers and broker-dealers. While on the surface, this appears to be about companies’ use of artificial intelligence-like technologies, in fact it proposes to rewrite the established fiduciary duty rules between clients and their investment advisers — and without sufficient consideration of the enormity of the rule’s negative impact.
Essentially, the SEC’s proposal requires groups, including investment advisers and broker-dealers, to “eliminate or neutralise” conflicts of interest arising from their use of technology that “optimises for, predicts, guides, forecasts, or directs investment-related behaviors or outcomes”.
Crucially, this includes decisions made with the assistance of technology to invest or trade on behalf of investors. This all-encompassing definition of what they term “covered technology” indiscriminately lumps together cutting-edge AI and rudimentary spreadsheets.
This creates huge uncertainty and places an unnecessary burden on investment companies using even the most common means of technology. Most investment management is done with the aid of technology of some kind. The proposed rules would force groups to evaluate, test and document every technology routinely used in everyday trading and client interactions, an impractical and operationally unfeasible expectation. Increased costs would cut investor returns.
The proposal’s broad interpretation of “conflict of interest” raises further concerns. Any technology that considers any interest of the investment adviser may be labelled as “conflicted”. This would probably render most technology as a conflict, obliging companies to prove otherwise.
A deeper look into the proposal reveals a clear lack of understanding of how the investment management industry crucially relies upon technology. From marketing and risk management to compliance with expanding SEC rules, technology plays a vital role in securing the best possible outcomes for investors.
Moreover, the rule appears to misunderstand the nature of how some of the most advanced technology, such as deep learning, works in practice by attempting to treat it as something that is fully deterministic and predictable in the manner it generates output. In this way, it would make the use of AI much more burdensome, if not impossible, from a compliance perspective, just at the time when all businesses are trying to find ways to harness this new 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 that it invokes to promulgate the rule compound the matter further. It is crucial to recognise that existing obligations already prioritise clients’ interests via the longstanding fiduciary duty that governs the client-adviser relationship. Therefore, this proposed rule attempts to address a gap that does not exist.
Sadly, this proposal appears to be part of a larger emerging pattern. Here, as well as in other areas, the SEC is seeking to rely on novel interpretations of existing statutory language to try to push through an agenda of profound and disruptive change in nearly all areas of US capital markets and, in most cases, without enough evidence of market failure. We struggle to see who the beneficiaries of this are. It is unlikely to be the investors whom the SEC claims it is trying to protect.
In nearly every speech SEC chair Gary Gensler gives, he mentions that the US has the largest, deepest and most liquid capital markets in the world. Given this strength, the urgency for unprecedented and rushed reforms is unwarranted. Balancing regulatory prudence with innovation is vital for safeguarding the future of the US investment management industry. The SEC’s current approach appears to tilt the scales in the wrong direction, endangering the industry’s competitive edge and investors’ best interests.
