determining whether those conflicts place their own (or their
associated persons') interests ahead of investors' interests.
    Because firms' use of covered technology is likely to be
continuously changing, firms generally should consider how they will
proactively

address reasonably foreseeable uses (which would include potential
misuses) of the covered technology. Firms should identify future and
evolving conflicts when evaluating their potential use of covered
technology to make sure that they have eliminated, or neutralized the
effect of, all conflicts they should have determined place their
interests ahead of investors' interests, including as their use of
technology evolves. One way to address potential misuses of a
technology could be to limit access to particular technology to
personnel who have been trained on the technology and how to use it in
compliance with the proposed conflicts rules. This could prevent the
technology from being used in investor interactions that place the
firm's interests ahead of investors' interests.
    The proposed requirement is also designed to be consistent with a
firm's applicable standard of conduct. Investment advisers, as
fiduciaries, are prohibited from subordinating their clients' interests
to their own (i.e., they may not place their interests ahead of their
clients' interests).\185\ In addition, investment advisers must
eliminate or at least expose through full and fair disclosure all
conflicts of interest which might incline an investment adviser--
consciously or unconsciously--to render advice which was not
disinterested.\186\ Where an adviser uses covered technology in an
investor interaction, compliance with the proposed conflicts rules'
requirement that conflicts of interest be eliminated or their effect
neutralized could also help the adviser satisfy its fiduciary duty.
Likewise, in satisfying its fiduciary duty, an adviser may also satisfy
the proposed conflicts rules' requirement to eliminate, or neutralize
the effect of, certain conflicts of interest. However, due to our
concerns that scalability could rapidly exacerbate the magnitude and
potential effect of conflicts,\187\ an adviser would not satisfy the
proposed conflicts rules' requirement to eliminate, or neutralize the
effect of, certain conflicts solely by providing disclosure to
investors. As the Commission has previously stated, in cases where an
investment adviser cannot fully and fairly disclose a conflict of
interest to a client such that the client can provide informed consent,
the adviser must take other steps such that full and fair disclosure
and informed consent to the adviser's other business practices are
possible.\188\ Moreover, as the Commission has previously stated,
investment advisers must act in the best interests of their clients at
all times and must not subordinate their clients' interests to their
own.\189\ The standard in the proposed conflicts rules is thus
consistent with that over-arching fiduciary obligation.
---------------------------------------------------------------------------

    \185\ See Fiduciary Interpretation, supra note 8, at section II.
    \186\ See Fiduciary Interpretation, supra note 8, at n.57 and
accompanying text.
    \187\ See supra section I.A. for a discussion about scalability
concerns.
    \188\ See Fiduciary Interpretation, supra note 8, at text
following n.67.
    \189\ See generally id.
---------------------------------------------------------------------------

    Similarly, when making recommendations, broker-dealers must act in
the best interest of a retail customer at the time the recommendation
is made, without placing the firm's financial or other interest ahead
of the retail customer's interests. This would include, under Reg BI's
Conflict of Interest Obligation, a requirement to establish, maintain,
and enforce written policies and procedures reasonably designed to,
among other things, identify and at a minimum disclose, or eliminate,
all conflicts of interest associated with a recommendation; identify
and mitigate (i.e., modify practices to reduce) conflicts of interest
at the associated person level; prevent any limitations placed on the
securities or investment strategies involving securities that may be
recommended to a retail customer and associated conflicts of interest
from causing the broker-dealer, or a natural person who is an
associated person of the broker-dealer, to make recommendations that
place the interest of the broker-dealer or such natural person ahead of
the interest of the retail customer; and eliminate sales contests,
sales quotas, bonuses, and non-cash compensation that are based on the
sales of specific securities or specific types of securities within a
limited period of time.\190\ Accordingly, where a broker-dealer uses
covered technology to make a recommendation, compliance with the
proposed conflicts rules' requirement that conflicts of interest be
eliminated or their effect neutralized could also help a broker-dealer
comply with similar aspects of Reg BI's Conflict of Interest
Obligation.
---------------------------------------------------------------------------

    \190\ See Exchange Act rule 151-1(a)(2)(iii).
---------------------------------------------------------------------------

    For example, if a broker-dealer uses covered technology to make a
recommendation to a retail customer, and the broker-dealer eliminates,
or neutralizes the effect of, any firm- and associated person-level
conflicts of interest under the proposed conflicts rule, it could help
address compliance with certain aspects of Reg BI's Conflict of
Interest Obligation. Conversely, compliance with Reg BI's Conflict of
Interest Obligation could help a broker-dealer comply with the proposed
conflicts rules' requirement to eliminate, or neutralize the effect of,
certain conflicts of interest. However, because the proposed conflicts
rules apply more broadly to the use of covered technology in investor
interactions as noted earlier,\191\ and not just to recommendations,
broker-dealers would be subject to both the proposed conflicts rules'
requirements and, separately when making a recommendation, Reg BI,
depending on the facts and circumstances of the investor interaction
and the use of the covered technology.\192\
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    \191\ See supra note 80.
    \192\ Moreover, while compliance with the proposed rule's
requirements could help address compliance with Reg BI's Conflict of
Interest Obligation, a broker-dealer that makes a recommendation to
retail customers would still be subject to Reg BI's other component
obligations.
---------------------------------------------------------------------------

    Depending on the facts and circumstances, the proposed requirement
may apply in addition to existing requirements for addressing conflicts
of interest. While existing requirements often address conflicts of
interest through disclosure, certain obligations require more than
disclosure to adequately address conflicts. For instance, under both
the fiduciary standard and Reg BI, disclosure of conflicts alone does
not necessarily satisfy the applicable standard of conduct. As noted
above, under these standards, certain conflicts should (and in some
cases, must) be addressed through elimination or mitigation.\193\
Similarly, when a firm uses covered technology in an investor
interaction involving a conflict of interest, scalability can make
disclosure of the conflict unachievable in many circumstances such that
disclosure alone would be insufficient to adequately address the
conflicts of interest. This is because a conflict can replicate to a
much greater magnitude and at a much greater speed than would be
possible to address through timely disclosure.
---------------------------------------------------------------------------

    \193\ See, e.g., Fiduciary Interpretation, supra note 8, at
nn.67-70 (discussing informed consent); Reg BI Adopting Release,
supra note 8, at text accompanying nn.17-19 (discussing the Conflict
of Interest Obligation's requirement for broker-dealers to identify
and disclose, eliminate or mitigate conflicts associated with
recommendations to retail customers).
---------------------------------------------------------------------------

    We recognize that many investor interactions could have the sole
goal of encouraging investors to open a new account, and that firms may
use covered technologies for this purpose. The proposed conflicts rules
would not require conflicts of interest that exist

solely due to a firm seeking to open a new investor account to be
eliminated or their effect neutralized. Even though opening an account
would likely be in the interest of the firm, the proposed conflicts
rules are not designed to limit firms' abilities to attract clients and
customers. However, as noted above, incentivizing specific types of
activity (such as margin or options trading privileges, as opposed to
opening a general account, or investing in a particular type of
investment, as opposed to just opening an account to invest) that is
particularly profitable to a firm (and is not always in investors'
interest), is intentionally addressed by the proposed conflicts rules.
    We request comment on all aspects of the proposed conflicts rules'
elimination or neutralization requirement, including the following
items:
    52. Considering that the proposed conflicts rules' elimination or
neutralization evaluation requirement may overlap with existing
regulatory requirements for broker-dealers and investment advisers,
would firms' compliance with those other regulatory requirements
contribute to compliance with the proposed conflicts rules, and vice
versa? If so, in what ways?
    53. Are our concerns correct that scalability could rapidly
exacerbate the magnitude and potential effect of the conflict in a way
that could make full and fair disclosure and informed consent
unachievable? Are there some conflicts that are more appropriately
addressed by disclosure than others? Does this depend on the kind of
investor interaction or kind of technology? For example, is scalability
more problematic when an investor directly uses a covered technology
than when an associated person communicates recommendations or advice
that the associated person has generated using covered technology?
    54. The elimination or neutralization requirement would also
require firms to eliminate, or neutralize the effect of, conflicts of
interest associated with use or potential use of a covered technology
by an associated person of a firm. What challenges, if any, would firms
face due to this aspect of the proposed conflicts rules? Should we make
any changes as a result? Instead of or in addition to covering
conflicts of interest associated with associated persons' use of
covered technologies, should we prescribe any additional requirements,
such as additional diligence or policies and procedures, relating to
conflicts of interest associated with associated persons? In addition
to natural persons, should the elimination or neutralization
requirement apply in the context of entities controlling, controlled
by, or under common control with firms?
    55. Should firms be required to eliminate, or neutralize the effect
of, conflicts of interest that place the firm's interests ahead of
investors' interests as required under the proposed rules? Instead,
should the elimination or neutralization obligation (or the
requirements of sections (b)(1) or (b)(2) of the proposed conflicts
rules) be limited to investor interactions involving, as applicable,
investment advice or recommendations by a firm or its associated
persons (or by a covered technology employed by a firm or its
associated persons)? Should that obligation or requirements be limited
to investor interactions directly with covered technologies? What other
ways could we address the risks that conflicts of interest associated
with firms' use of covered technologies will result in investor
interactions that place the firm's interest ahead of the investor
interest?
    56. Is the requirement to eliminate, or neutralize the effect of,
certain conflicts of interest sufficiently clear? Should we provide any
additional guidance on what we mean by ``neutralize the effect of''? If
so, how? Instead of, or in addition to, elimination and neutralization,
should the proposed conflicts rules require mitigation of some or all
of the effects of conflicts of interest determined to place a firm's
interests ahead of investors' interests under section (b)(2) of the
proposed conflicts rules? If so, which conflicts? Is there additional
guidance we should provide, or changes we should make to the text of
the proposed conflicts rules, to clarify the distinction between
elimination or neutralization, on the one hand, and mitigation, on the
other hand?
    57. Are there particular methods that firms currently use to
eliminate, or neutralize the effect of, conflicts of interest in
investor interactions using covered technology? Should we indicate that
certain methods (including limiting access to the technology, providing
policies and procedures for ``safe'' use of the technology, limiting
the data the technology considers, providing ``counterweights,'' or
training the algorithm to ignore certain information) are methods we
believe are generally appropriate to eliminate, or neutralize the
effect of, conflicts of interest under the proposed conflicts rules or
that certain methods are not appropriate for compliance with the
proposed conflicts rules? If we were to provide additional guidance,
how should we ensure that the proposed conflicts rules' requirement to
eliminate, or neutralize the effect of, conflicts is sufficiently
general that it would continue to apply to future technologies or
future conflicts we may not currently anticipate as such technologies
develop? Is using a ``counter-signal'' to train a learning model a
useful way to eliminate, or neutralize the effect of, conflicts
associated with the model? In addition to the testing requirement in
section (b)(1) of the proposed conflicts rules, should we also require
that firms that are eliminating, or neutralizing the effect of,
conflicts of interest test the covered technology after such
elimination or neutralization to determine whether it was successful?
    58. Is our understanding correct that the proposed conflicts rules,
including the proposed elimination or neutralization requirement, are
consistent with the applicable standards of conduct? To what extent
will firms be able to utilize existing methods of addressing conflicts
of interest and existing policies and procedures in order to comply
with the proposed conflicts rules? For example, do firms expect to
utilize their existing methods of addressing conflicts of interest
under Reg BI or the fiduciary standard, as applicable, in order to
comply with the proposed conflicts rules?
    59. The proposed investment adviser conflict prohibition would only
apply to investment advisers registered or required to be registered
under section 203 of the Advisers Act, meaning certain firms, including
exempt reporting advisers and state-registered advisers, would not be
covered. Should the prohibition be expanded to cover these entities? If
the investment adviser conflict prohibition is widened to capture these
entities, should the policies and procedures requirement in paragraph
(c) of the proposed conflicts rules be similarly widened? Would certain
types of advisers, such as those that primarily provide advice through
an interactive website, be disproportionately affected by this
proposal? Would any such advisers seek to restructure their operations
to avoid this result? We are separately proposing updates to the
internet adviser exemption, 17 CFR 275.203A-2. Should we modify any
aspect of the proposed conflicts rules in order to coordinate with the
proposed updates to the internet adviser exemption? \194\
---------------------------------------------------------------------------

    \194\ See Exemption for Certain Investment Advisers Operating
Through the internet, Investment Advisers Act Release No. 6354 (July
26, 2023).
---------------------------------------------------------------------------

    60. How do firms currently ensure their use of what the proposal
would define as covered technologies complies

with applicable existing rules and regulations or other legal
obligations, including standards of conduct? Do firms using ``black
box'' algorithms currently rely on disclosure instead of or in addition
to affirmative design steps to address the actual and potential
conflicts of interest associated with such algorithms? If so, what
disclosure do firms provide and what form of informed consent do
investors provide regarding firms' use of such algorithms? How do firms
comply with the applicable standard of conduct, including the duty to
act in the investor's best interest, particularly where they have been
unable to determine whether their interests are being placed ahead of
their investors?
    61. Is the exclusion for the use of covered technologies in
investor interactions that have the sole goal of encouraging investors
to open a new account sufficiently clear? Should this exclusion be
narrowed or broadened, and, if so, how? For example, should we provide
that the exclusion is only available if a firm does not differentially
market to investors in order to guide them to open a particular type of
account that is especially profitable for the firm, such as an options
or margin account?
3. Policies and Procedures Requirement
    The proposed investment adviser conflicts rule would require every
investment adviser that is subject to paragraph (b) of the rule and
uses covered technology in any investor interaction to adopt and
implement written policies and procedures reasonably designed to
prevent violations of paragraph (b) of that rule.\195\ Likewise, the
proposed broker-dealer conflicts rule would require every broker-dealer
that is subject to paragraph (b) of that rule and that uses covered
technology in any investor interaction to adopt, implement, and
maintain written policies and procedures reasonably designed to achieve
compliance with paragraph (b) of that rule.\196\ For all firms, these
policies and procedures would need to include: (i) a written
description of the process for evaluating any use or reasonably
foreseeable potential use of a covered technology in any investor
interaction pursuant to paragraph (b)(1) of the proposed conflicts
rules 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; \197\ (ii) a written description of the process
for determining whether any conflict of interest identified pursuant to
paragraph (b)(1) of the proposed conflicts rules results in an investor
interaction that places the interest of the firm or its associated
persons ahead of the interests of the investor; \198\ (iii) a written
description of the process for determining how to eliminate, or
neutralize the effect of, any conflicts of interest determined pursuant
to paragraph (b)(2) of the proposed conflicts rules to result in the
interest of the investment adviser, broker-dealer, or the firm's
associated persons being placed ahead of the interests of the investor;
\199\ and (iv) a review and written documentation of that review, no
less frequently than annually, of the adequacy of the policies and
procedures and written descriptions established pursuant to this
policies and procedures requirement and the effectiveness of their
implementation. Although it is possible that some firms that use
covered technology in investor interactions may not identify any
conflicts of interest in carrying out the requirements of paragraph
(b)(1) of the proposed conflicts rules, such firms would still be
required to adopt, implement, and, in the case of broker-dealers,
maintain these written policies and procedures, so as to be prepared to
address any instance where such a conflict of interest is later
identified by the firm in the course of its ongoing operations.
---------------------------------------------------------------------------

    \195\ See proposed rule 211(h)(2)-4(c)(3). See also discussion
of proposed conflicts rules at paragraphs (b)(1) through (3) supra
section II.A.2. As noted above, the definition of ``investor
interaction'' ``does not apply to interactions solely for purposes
of meeting legal or regulatory obligations or providing clerical,
ministerial, or general administrative support.'' See proposed
conflicts rules at paragraph (a) and discussion supra section
II.A.1.b.
    \196\ See proposed rule 15l-2(c). Under the Commission's rules,
investment advisers historically have been required to ``adopt and
implement'' policies and procedures that are ``reasonably designed
to prevent violation'' of the Advisers Act or rules adopted
thereunder, while broker-dealers have been required to ``establish,
maintain, and enforce'' policies and procedures that are
``reasonably designed to achieve compliance with'' the particular
rule. Compare 17 CFR 206(4)-7(a) (investment advisers required to
``adopt and implement written policies and procedures reasonably
designed to prevent violation'') with 17 CFR 240.15l-1(a)(2)(iv)
(broker dealers required to ``establish[ ], maintain[ ], and
enforce[ ] written policies and procedures reasonably designed to
achieve compliance with''). In order to assist firms with compliance
with the proposed conflicts rules' policies and procedures
requirements, we have used language that is consistent with these
respective rules. Accordingly, the wording of the proposed policies
and procedures requirements varies between investment advisers and
broker-dealers. We do not believe, however, that there is a
substantive difference between how firms would need to comply with
each proposed rule. See, e.g., Reg BI Adopting Release, supra note
8, at text accompanying n.810 (discussing policies and procedures
requirements for investment advisers and broker-dealers without
noting any difference despite the differing language).
    \197\ Proposed conflicts rules at (c)(1).
    \198\ Proposed conflicts rules at (c)(2).
    \199\ Proposed conflicts rules at (c)(3).
---------------------------------------------------------------------------

    These proposed policies and procedures requirements are designed to
help ensure that a firm understands how its covered technologies work
when engaging in any investor interaction using covered technologies,
the conflicts of interest those covered technologies present, and the
potential effects of those conflicts on investors.\200\ Further, these
proposed requirements are designed to help ensure that firms will not
place their own interests ahead of the interests of investors where
such conflicts of interest are associated with the firm's use of
covered technology. A firm's failure to adopt and implement (and, in
the case of broker-dealers, maintain) these policies and procedures
would constitute a violation of the proposed conflicts rules
independent of any other securities law violation. As a result, the
proposed conflicts rules would address the failure of a firm to
adequately describe how a covered technology works and the actual or
potential conflicts the technology's use could create with the
interests of investors before any such conflicts cause actual harm to
investors.
---------------------------------------------------------------------------

    \200\ The policies and procedures requirements complement the
elimination and neutralization requirement, and are intended to
encourage development of risk-based best practices by firms, rather
than to impose a one-size-fits-all solution. Cf. Chamber of Commerce
AI Report, supra note 144, at 89 (discussing necessity of firms
deploying certain technologies ``having sufficient understanding of
the system to provide effective human oversight'').
---------------------------------------------------------------------------

    We are proposing minimum standards for the written descriptions and
annual review that a firm's policies and procedures would need to
include. However, the proposed conflicts rules would provide firms with
flexibility to determine the specific means by which they address each
element, and the degree of prescriptiveness the firm includes in their
policies and procedures. To satisfy the proposed conflicts rules'
requirement to have policies and procedures including the specified
written descriptions and annual review, firms generally should take
into consideration the nature of their operations, and account for the
covered technologies in use or to be used. Further, in satisfying the
proposed conflicts rules, a firm should account for any use or
reasonably foreseeable potential use of a covered technology that does
or could result in conflicts of

interest in light of the firm's particular operations. For example,
under the proposed conflicts rules, the level of detail firms would
need to include when producing a written description of any material
features of any covered technology used in any investor interaction,
and the conflicts of interest associated with the use of that
technology, will generally be less for those firms that either engage
in a very limited use of covered technology, or that only use covered
technologies that are relatively simple.
    On the other hand, for a firm that makes extensive use of more
complex covered technology, such as machine learning technologies that
function automatically without direct interaction with firm personnel,
or a firm whose conflicts of interest are more complex or extensive,
the policies and procedures would need to be substantially more robust.
This could include consideration of all aspects of the covered
technologies the firm uses, including the data used to train the
technologies, ``explainability'' requirements, specific training for
technical staff, and maintaining (and regularly reviewing) logs
sufficient to identify any risks the firm's use of a covered technology
presents of non-compliance with the proposed conflicts rules.
    In addition to the requirements outlined in paragraphs (c)(1)-(4)
of the proposed conflicts rules, firms designing policies and
procedures reasonably designed to achieve compliance with paragraph (b)
of the proposed conflicts rules generally should consider including
other elements, as appropriate, such as: (i) compliance review and
monitoring systems and controls; (ii) procedures that clearly designate
responsibility to appropriate personnel for supervision of functions
and persons; (iii) processes to escalate identified instances of
noncompliance to appropriate personnel for remediation; and (iv)
training of relevant personnel on the policies and procedures, as well
as the forms of covered technology used by the firm.
    We request comment on all aspects of the scope of the proposed
conflicts rules' policies and procedures requirement, including the
following items:
    62. Does the proposed conflicts rules' policies and procedures
requirement complement, overlap with, or duplicate the existing
regulatory framework for broker-dealers and investment advisers? If so,
in what ways? Specifically, would firms' compliance with those other
regulatory requirements contribute to compliance with the proposed
conflicts rules, and vice versa?
    63. Are all aspects of these proposed policies and procedures
requirements, as well as the particular written descriptions and review
to be required by a firm's policies and procedures, necessary and
appropriate for achieving compliance with paragraph (b) of the proposed
conflicts rules? If not, what elements should be added, deleted, or
modified to better ensure firms' compliance with paragraph (b) of the
proposed conflicts rules?
    64. Several aspects of the proposed conflicts rules address
conflicts of interest associated with use or potential use of a covered
technology by an associated person of a firm; should any aspect of the
proposed policies and procedures requirement be changed as a result?
For example, instead of, or in addition to, maintaining an explicit
reference to a firm's associated persons in paragraph (b) of the
proposed conflicts rules, should we prescribe any additional
requirements, such as additional diligence or policies and procedures,
relating to conflicts of interest of firms' associated persons?
    65. Is the scope of firms covered by the proposed policies and
procedures requirement appropriate in light of the requirements of
paragraph (b) of this proposed rule? Should the proposed rule be
modified to only require these policies and procedures of those firms
that have identified at least one conflict of interest in their
evaluation of any covered technology that is used or that it is
reasonably foreseeable that the firm could potentially use in any
investor interaction?
    66. Should the proposed rule require that senior firm personnel
and/or specific technology subject-matter experts participate in the
process of adopting and implementing these policies and procedures? If
so, which parties, and what should be their required scope of
responsibilities? Further, should any senior firm personnel and/or
specific technology subject-matter experts be required to certify that
such policies and procedures that the firm adopts and implements are in
compliance with the requirements of this paragraph (c) of the proposed
conflicts rules? Would there be costs associated with such
participation or certification? If so, what are they? When designing
their policies and procedures, should firms be required to include some
or all of the following: (i) compliance review and monitoring systems
and controls; (ii) procedures that clearly designate responsibility to
appropriate personnel for supervision of functions and persons; (iii)
processes to escalate identified instances of noncompliance to
appropriate personnel for remediation; and (iv) training of relevant
personnel on the policies and procedures, as well as the forms of
covered technology used by the firm?
a. Written Description of Evaluation Process To Identify Conflicts of
Interest and Written Description of Material Features
    Under the proposed policies and procedures requirement, firms would
need to adopt and implement (and, in the case of broker-dealers,
maintain) written policies and procedures reasonably designed to
achieve compliance with paragraph (b) that include a written
description of the process for evaluating any use or reasonably
foreseeable potential use of a covered technology in any investor
interaction pursuant to paragraph (b)(1), and a written description of
the material features of, including any conflicts of interest
associated with the use of, any covered technology used in any investor
interaction.\201\
---------------------------------------------------------------------------

    \201\ Proposed conflicts rules at (c)(1).
---------------------------------------------------------------------------

    The proposed requirement to include a written description of the
process for evaluating any use or reasonably foreseeable potential use
of a covered technology in any investor interaction within the firm's
written policies and procedures is designed to help ensure the firms
establish and follow a defined process for evaluating any use or
reasonably foreseeable potential use of a covered technology in any
investor interaction and consequently identifying any conflict of
interest associated with that use or potential use, as required by
paragraph (b)(1). Although the scope of any individual evaluation may
depend on a variety of factors, including the specific covered
technology in question, the manner in which that covered technology
would interact with investors, and how the technology may be used, this
process generally should be designed to provide firms with a consistent
approach to satisfying the requirements of paragraph (b)(1) of the
proposed conflicts rules. This written description would assist firms
in performing the vital initial step of identifying all relevant
conflicts of interest, which is necessary to ultimately complying with
the proposed conflicts rules' requirement to eliminate, or neutralize
the effect of, those conflicts of interest that place or result in
placing the interest of the firm or its associated persons ahead of the
interests of the investor. In addition to assisting the firm's internal
staff, this

written description of the process that firms will use would assist the
Commission's examinations staff in assessing the firm's compliance with
the entirety of the proposed conflicts rules.
    This written description must articulate a process for the firm to
use in evaluating any use or reasonably foreseeable potential use of a
covered technology by the firm or its associated persons in any
investor interaction to identify any conflict of interest associated
with that use or potential use. Further, this process must address how
the firm will conduct the required testing of 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. Although we
recognize that this process must be flexible enough to account for
different types of covered technologies and investor interactions that
those technologies might be used in, the firm's written description
generally should be specific enough to ensure the consistent
identification of any associated conflicts of interest. The process
described by the firm generally should detail those steps it will take
in conducting this evaluation, as well as the means it will use in
identifying each relevant conflict of interest.
    To further promote compliance with the evaluation and
identification required under paragraph (b)(1), a firm's policies and
procedures would be required to include a written description of the
material features of any covered technology used in any investor
interaction, including any conflicts of interest associated with the
use of the covered technology, and would need to be prepared prior to
its implementation or material modification, and updated periodically.
As discussed above, we are concerned that some firms currently lack a
holistic understanding of the covered technologies they employ, and
that this could result in investor interactions that are based on
unknown conflicts of interest that are harmful to the investor.\202\
These concerns are heightened when firm personnel who are responsible
for ensuring the covered technology complies with applicable laws and
regulations, including SRO rules, do not fully understand how the
covered technology would work in interactions with investors, and,
thus, the risks the covered technology might present to those
investors.
---------------------------------------------------------------------------

    \202\ See supra section I.B (background discussion on conflicts
of interest).
---------------------------------------------------------------------------

    The proposed written description element is designed to address
these risks in a manner that helps ensure that the firm has identified
and developed an understanding of those conflicts of interest that
might impact the firm's investor interactions through the use of
covered technology. The material features of a covered technology
generally would include how the technology works, including how it
optimizes for, predicts, guides, forecasts, or directs investment-
related behaviors or outcomes, in a manner that would enable the
appropriate personnel at a firm to understand the potential conflicts
of interest associated with the technology. Further, firms generally
should include within this written description detail on when and how
the firm intends to use, or could reasonably foresee using, the covered
technology in investor interactions.
    To the extent that the outcomes of the technology are difficult or
impossible to explain (e.g., in the case of a ``black box''), the
description of how any associated conflicts arise would be critical to
informing the application of the firm's elimination or neutralization
procedures. As discussed above, the Commission is aware that some more
complex covered technologies lack explainability as to how they
function in practice, and how they reach their conclusions.\203\ The
proposed conflicts rules would apply equally to these covered
technologies, and firms would only be able to continue using them where
all requirements of the proposed conflicts rules are met, including the
requirements of paragraph (c). As discussed above, as a practical
matter, it would be impossible for firms to use such covered
technologies and meet the requirements of paragraph (b) of the proposed
conflicts rules where they are unable to identify all conflicts of
interest associated with the use of such covered technology.\204\ For
similar reasons, if a firm is incapable of preparing this written
description of all such conflicts of interest associated with the use
of the covered technology in any investor interaction as a result of
the lack of explainability of the analytical, technological, or
computational function, algorithm, model, correlation matrix, or
similar method or process comprising the covered technology, as well as
its resulting outcomes, it would not be possible for the firm to
satisfy the requirements paragraph (c) of the proposed conflicts rules.
However, similar to the discussion above, where firms are not able to
satisfy the requirements of paragraph (c) of the proposed conflicts
rules with a particular covered technology in its current form, firms
may be able to modify these technologies, for example by embedding
explainability features into their models and adopting back-end
controls in a manner that will enable firms to satisfy these
requirements.\205\
---------------------------------------------------------------------------

    \203\ See supra section II.A.2.a (discussion on Evaluation and
Identification).
    \204\ See id.
    \205\ See id.
---------------------------------------------------------------------------

    A high degree of specificity may not be necessary when creating the
written description of every material feature of any covered technology
used by the firm in any investor interaction. For example, if a
material feature could not reasonably be expected to be associated with
a conflict of interest (e.g., a financial model that is used to compute
whether risks are sufficiently diversified in a portfolio containing
various asset classes), a firm could reasonably determine that a simple
description of that feature would be sufficient. However, at a minimum,
it would need to describe the material features of the covered
technology used by the firm at a level of detail sufficient for the
appropriate personnel at the firm to understand whether its use would
be associated with any conflicts of interest.
    A firm would be required to update this written description
periodically. This requirement is designed to help ensure that firms
are appropriately monitoring their use of covered technologies and
accurately memorializing any material features of any covered
technology that the firm uses in any investor interaction. These
periodic updates to the written description should occur where a
covered technology has been upgraded or materially modified in a manner
that would make the previously existing written description inaccurate
or incomplete. Additionally, if firm personnel become aware of either
additional material features of the covered technology used by the
firm, or of the firm engaging in a different use of the covered
technology that was not previously contemplated by the written
description, the written description should be updated at that time to
include such information.
    We request comment on all aspects of this proposed written
description requirement found in paragraph (c)(1) of the proposed
conflicts rules, including the following items:
    67. Does the proposed conflicts rules' requirement that firms
include written descriptions as part of their policies and procedures
complement, overlap with, or duplicate the existing regulatory
framework for broker-dealers and

investment advisers? If so, in what ways? Specifically, would firms'
compliance with those other regulatory requirements contribute to
compliance with the proposed conflicts rules, and vice versa?
    68. Should we require greater specificity within the written
description as to the means a firm will use for evaluating any use or
reasonably foreseeable potential use of covered technology in any
investor interaction, in addition to a description of the firm's
process for conducting such an evaluation? If so, what additional
points of specificity should be required? Should we require less
specificity? Does the level of specificity in the proposed requirement
allow for sufficient flexibility to administer this aspect of the
policies and procedures in a variety of circumstances?
    69. Should we require that the written description of the firm's
evaluation and identification process be prepared by specific firm
personnel or approved by firm management? If so, by whom? Similarly,
should this written description require the designation of specific
individuals to carry out the process firms will use for evaluating any
use or reasonably foreseeable potential use of covered technology in
any investor interaction?
    70. What are the challenges associated with compiling a written
description of any material features of and any conflicts of interest
associated with the use of any covered technology they employ? Should
the proposed conflicts rules be revised to account for those
challenges? If so, how?
    71. As a practical matter, firms using black box technologies would
find it challenging, and potentially impossible, to meet the
requirements of the proposed rules to the extent they find it difficult
to identify and describe all conflicts of interest associated with the
use of such covered technology. In addition to these proposed
requirements, should we explicitly require that any technologies used
by firms must be explainable?
    72. Is it sufficiently clear what features of a covered technology
would constitute ``material features'' beyond those features that
present conflicts of interest? If not, what additional detail should
the Commission provide? Should the Commission define ``material
features'' for the purpose of the proposed rule? For example, should
the Commission specify as ``material features'' the types of
recommendations or advice, or other investor interactions, a covered
technology is designed to produce? Should the term also include the
types of inputs, the specific methods of analysis, or the user
interface of the technology? Why or why not?
    73. Is the proposed level of specificity and detail of the written
description of the material features of any covered technology used by
the firm in any investor interaction appropriate under the
circumstances? Should the rule explicitly require that this description
be sufficient for the appropriate personnel at the firm to understand
whether the use of the covered technology would be associated with any
conflicts of interest the appropriate standard? If not, what should be
the standard? Does the level of specificity and detail still allow for
flexible implementation in a variety of circumstances?
    74. Is the scope of covered technologies subject to this written
description requirement appropriate in light of the requirements of
paragraph (b) of this proposed conflicts rules? Should the proposed
conflicts rules be modified to only require a written description of
the material features of those covered technologies that the firm uses
in any investor interaction that the firm has identified as containing
at least one conflict of interest?
b. Written Description of Determination Process
    The proposed conflicts rules would also require that firms'
policies and procedures must include a written description of the
process for determining whether any conflict of interest identified
pursuant to paragraph (b)(1) of the proposed conflicts rules results in
an investor interaction that places the interest of the investment
adviser, broker-dealer, or the firm's associated persons ahead of the
interests of the investor.\206\ This requirement is designed to help
ensure that firms create and implement a process for determining which
of those conflicts of interest that they have identified in their use
or potential use of a particular covered technology results in an
investor interaction that would place the interests of that firm or its
associated persons ahead of the interests of the investor. While this
determination will ultimately depend on the individual conflict of
interest, covered technology, related investor interactions, and other
factors that may not be easily predictable, this process generally
should be designed to provide a consistent approach to satisfying the
requirements of paragraph (b)(2) of the proposed conflicts rules. In
doing so, this written description would assist firms in performing
this essential step to ultimately comply with the requirement in
paragraph (b)(3) of the proposed conflicts rules to eliminate, or
neutralize the effect of, such conflicts of interest. In addition to
assisting the firm's internal staff, this written description would
assist the Commission's examinations staff in assessing the firm's
compliance with the proposed rules.
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    \206\ Proposed conflicts rules at (c)(2).
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    This written description generally should clearly articulate the
process for the firm to use in determining whether any conflict of
interest that it has identified would result in placing its own
interests or the interests of its associated persons ahead of the
interests of investors. Although we recognize that the idiosyncrasies
of differing conflicts of interest or different types of investor
interactions may necessitate some manner of flexibility as to the
firm's process, the written description of the firm's process generally
should be specific enough to help ensure that the process will be
consistently effective in producing determinations by the firm that
accurately reflect those conflicts of interest that would result in
placing the interests of the firm or its associated persons ahead of
the interests of investors. The process described by the firm generally
should detail certain steps for determining the effect that the
conflict of interest has, or would have, on an investor interaction if
the covered technology or material modification were put into use by
the firm. This should include a means of determining whether the
interest of the firm, or associated person, is or would be placed ahead
of investors' interests if the firm used the covered technology or a
material modification to the covered technology in investor
interactions.
    We request comment on all aspects of this proposed written
description requirement found in paragraph (c)(2) of the proposed
conflicts rules, including the following items:
    75. Does this aspect of the proposed conflicts rules complement,
overlap with, or duplicate the existing regulatory framework for
broker-dealers and investment advisers? If so, in what ways?
Specifically, would firms' compliance with those other regulatory
requirements contribute to compliance with the proposed conflicts
rules, and vice versa?
    76. Should we require the written description of the firm's process
for determining whether any conflict of interest identified pursuant to
paragraph (b)(1) of the proposed conflicts rules results in an investor
interaction that places the interest of the firm, or associated person,
ahead of the interests of investors be prepared by specific firm

personnel or approved by firm management? If so, by whom? Similarly,
should this written description require the designation of specific
individuals, such as those in legal, compliance, technology, or
managerial positions, to carry out the process firms will use for
determining whether a particular conflict of interest places the
interest of the firm, or associated person, ahead of the interests of
the investor?
    77. Does the level of specificity in the proposed requirement allow
for sufficient flexibility to administer this aspect of the policies
and procedures in a variety of circumstances? Should we require greater
specificity within the written description as to the means a firm will
use for determining whether a conflict places the interest of the firm,
or associated person, ahead of the interest of the investor, in
addition to a description of the firm's process for making such a
determination? If so, what additional points of specificity should be
required? Should we instead require less specificity? If so, what
details should not be required to be included in this written
description?
c. Written Description of Process for Determining How To Eliminate, or
Neutralize the Effects of, Conflicts of Interest
    The proposed conflicts rules would also require that firms'
policies and procedures include a written description of the process
for determining how to eliminate, or neutralize the effect of, any
conflict of interest determined by the firm, pursuant to paragraph
(b)(2) of the proposed conflicts rules, to result in an investor
interaction that places the interest of the investment adviser, broker-
dealer, or the firm's associated persons ahead of the interests of the
investor.\207\ This element is designed to require firms to have an
established framework for eliminating, or neutralizing the effect of,
conflicts of interest, which we believe should assist those firms in
complying with paragraph (b)(3) of the proposed conflicts rules. The
description will also assist the firm's internal staff, as well as
examination staff, in assessing a firm's compliance.
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    \207\ Proposed conflicts rules at (c)(3); see also proposed
conflicts rules at (b)(2) requiring such determination by the firm,
discussed supra section II.A.2.d.
---------------------------------------------------------------------------

    The process for elimination or neutralization that a firm sets
forth in the written description should be tailored to account for the
differing circumstances presented to the firm when making its
determination as to a particular conflict of interest. For example, the
process described by the firm should account for whether the particular
conflict of interest involves a covered technology that is already
being used in investor interactions, or instead only involves a
conflict of interest from a reasonably foreseeable potential use. Where
the process pertains to a reasonably foreseeable potential use, the
firm should address how its personnel would determine whether a covered
technology has been sufficiently modified such that any identified
conflicts of interest have been eliminated, or their effect has been
neutralized, prior to any use in an investor interaction. However, if
the firm is already using the covered technology in any of its investor
interactions, the firm's written description of this process must
address how it would promptly eliminate, or neutralize the effect of,
any identified conflict of interest. The written process for a covered
technology that is already used in investor interactions might, for
example, require the firm to immediately limit access to or use of the
technology or, if possible, immediately eliminate the identified
conflict of interest, prior to considering further modifications.\208\
In either instance, the firm would need to include a written
description of the steps that the firm would take under its elimination
or neutralization procedures to prevent any investor interaction that
places the interest of the firm ahead of the interests of investors
(e.g., by explicitly eliminating consideration of the factors that
reflect the firm's interest, by disabling a part of the technology, by
training it to use reinforcement learning to prioritize investors'
interest in all cases, or by eliminating the business practice that is
associated with the conflict).
---------------------------------------------------------------------------

    \208\ Additional discussion of how firms may eliminate, or
neutralize the effect of, conflicts of interest may be found above
supra section II.A.2.e.
---------------------------------------------------------------------------

    To support their efforts at compliance with the proposed conflicts
rules, firms using covered technologies in investor interactions could
consider providing additional training to staff who will be
implementing their elimination and neutralization policies. For
example, firms may benefit from providing additional training to their
staff responsible for maintaining the covered technologies in order to
give them a better understanding of the legal framework governing their
firm's use of covered technologies. In addition, firms may consider
providing additional technical training to relevant personnel, so that
they are better able to understand how the covered technologies that
the firm uses work, and as a result can better understand the technical
aspects of what is necessary to eliminate or neutralize a given
conflict of interest.
    Because a firm's policies and procedures would need to address all
covered technologies used by the firm in any investor interaction, and
each conflict of interest involving such covered technologies, this
written description should contain a clear articulation of the process
the firm uses for determining how a conflict should be eliminated or
its effect neutralized. In addition, when a firm's policies and
procedures dictate a specific means of making such a determination, the
firm's written description would need to reflect this.
    We request comment on all aspects of this proposed written
description requirement found in paragraph (c)(3) of the proposed
conflicts rules, including the following items:
    78. Does this aspect of the proposed conflicts rules complement,
overlap with, or duplicate the existing regulatory framework for
broker-dealers and investment advisers? If so, in what ways?
Specifically, would firms' compliance with those other regulatory
requirements contribute to compliance with the proposed conflicts
rules, and vice versa?
    79. Should we require greater specificity within the written
description as to the means a firm will use for determining whether and
how a conflict should be eliminated or neutralized, in addition to a
description of the firm's process for making such a determination? If
so, what additional points of specificity should be required? Should we
require less specificity? Does the level of specificity in the proposed
requirement allow for sufficient flexibility to administer this aspect
of the policies and procedures in a variety of circumstances?
    80. Should we require that the written description of the firm's
elimination or neutralization process be prepared by specific firm
personnel or approved by firm management? If so, by whom? Similarly,
should this written description require the designation of specific
individuals to carry out the process firms will use for determining how
a particular conflict of interest must be eliminated or neutralized?
    81. Should a firm's policies and procedures be required to
specifically address the conduct of individuals? For example, should a
firm's policies and procedures be required to address conflicts of
interest where all of the benefit may accrue to one of the firm's

personnel, such as when firm personnel took an action that is designed
to increase their own compensation regardless of the overall impact on
the firm? If those persons are not registered or required to be
registered as an investment adviser, broker, or dealer, would their
actions otherwise be covered by the firm's policies and procedures?
d. Annual Review of the Adequacy and Effectiveness of the Policies and
Procedures and Written Descriptions
    The proposed conflicts rules would also require that the policies
and procedures include a review and a written documentation of that
review, no less frequently than annually, of the adequacy of the
policies and procedures established under the proposed conflicts rules
and the effectiveness of their implementation, as well as a review of
the written descriptions established pursuant to this section.\209\
During this review, firms would need to specifically evaluate whether
their policies and procedures and written descriptions have been
adequate and effective over the period under review at achieving
compliance with the proposed conflicts rules' requirements to identify
and evaluate all instances where their use or potential use of a
covered technology in an investor interaction involves a conflict of
interest, determine whether that conflict of interest places the
interest of the investment adviser, broker-dealer, or an associated
person of the firm ahead of those of the investor, and to then
eliminate, or neutralize the effect of, any such conflict of interest
promptly after the firm has, or reasonably should have, identified the
conflict. Further, firms generally should use this annual review to
consider whether there have been any changes in the business activities
of the firm or its associated persons, any changes in its use of
covered technology generally, any issues that arose from its use of
covered technologies during the previous year, any changes in
applicable law, or any other factor that might suggest that certain
covered technologies now present a different or greater risk than the
firm's policies and procedures and written descriptions had previously
accounted for, and what adjustments might need to be made to such
documents or their implementation to address these risks.
---------------------------------------------------------------------------

    \209\ Proposed conflicts rules at (c)(4).
---------------------------------------------------------------------------

    Firms would also be required to prepare written documentation of
the review that they have conducted. Such documentation would serve to
assist firms in assessing their compliance with all obligations under
the proposed conflicts rules, and any related adjustments to their
policies and procedures and written descriptions that might be
necessary. To the extent that firms' annual review identifies any
policies and procedures and written descriptions as being inadequate or
ineffective, firms would need to make sure that they are in compliance
with the requirement to establish and implement, and in the case of
broker-dealers, maintain, policies and procedures that are reasonably
designed to achieve compliance with the proposed conflicts rules.
    Under 17 CFR 275.206(4)-7 (``Advisers Act Compliance Rule''), an
investment adviser is required to adopt and implement written policies
and procedures reasonably designed to prevent violation, by the adviser
and its supervised persons, of the Advisers Act and the rules
thereunder as well as review, no less frequently than annually, the
adequacy of the policies and procedures established pursuant to the
Advisers Act Compliance Rule and the effectiveness of their
implementation. Any policies and procedures an investment adviser
adopts under the proposed conflicts rules could be reviewed in
conjunction with the annual review under the Advisers Act Compliance
Rule.
    While the Commission has no parallel rule requiring annual review
of a broker-dealer's policies and procedures for their adequacy and
effectiveness, a broker-dealer that is a FINRA member is required to
``establish, maintain, and enforce written procedures to supervise the
types of business in which it engages and the activities of its
associated persons that are reasonably designed to achieve compliance
with applicable securities laws and regulations, and with applicable
FINRA rules.'' \210\ In addition, each FINRA member broker-dealer must
``have its chief executive officer(s) (or equivalent officer(s))
certify annually . . . that the member has in place processes to
establish, maintain, review, test and modify written compliance
policies and written supervisory procedures reasonably designed to
achieve compliance with applicable FINRA rules, MSRB \211\ rules and
Federal securities laws and regulations, and that the chief executive
officer(s) has conducted one or more meetings with the chief compliance
officer(s) in the preceding 12 months to discuss such processes.''
\212\ Those broker-dealers who would be subject to the proposed
conflicts rule could conduct this annual review in conjunction with
their required review and certification obligations under FINRA's
rules, in order to increase the organizational efficiency and likely
effectiveness of this annual review.
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    \210\ See FINRA Rule 3110(b)(1).
    \211\ Municipal Securities Rulemaking Board.
    \212\ See FINRA Rule 3130(b); see also FINRA Rule 3130(c)
detailing procedures required for such certification.
---------------------------------------------------------------------------

    We request comment on all aspects of this proposed annual review
requirement found in paragraph (c)(4) of the proposed conflicts rules,
including the following items:
    82. Does this aspect of the proposed conflicts rules complement,
overlap with, or duplicate the existing regulatory framework for
broker-dealers and investment advisers? If so, in what ways?
Specifically, would firms' compliance with those other regulatory
requirements contribute to compliance with the proposed conflicts
rules, and vice versa?
    83. Should we limit the scope of the annual review requirement for
policies and procedures relating to certain covered technologies, or
types of covered technologies? For example, if a covered technology has
not changed in the past year, or if a covered technology were
considered low risk for creating conflicts or changing since the last
year, and the firm has not modified how it uses the covered technology,
would it still be necessary to require firms to conduct a review in
that area? If we were to limit the scope of the annual review
requirement, should we require firms to monitor changes in technology
more generally in order to be aware of whether, even if the covered
technology itself has not changed, its interaction with other
technologies in use by the firm could create conflicts of interest?
What limitations would be necessary and appropriate to account for any
risk of potential harm to investors if such limitations on the scope of
the annual review requirement were provided?
    84. Should we require more or less frequent reviews? For example,
monthly, quarterly, or every other year? Should we require the review
be conducted by specific firm personnel, such as a technology
compliance specialist? If so, by whom?

B. Proposed Recordkeeping Amendments

    We are proposing to amend rules 17a-3 and 17a-4 under the Exchange
Act and rule 204-2 under the Advisers Act to set forth requirements for
broker-dealers and investment advisers to

maintain and preserve, for the specific retention periods,\213\ all
books and records related to the requirements of the proposed conflicts
rules. The proposed recordkeeping amendments would also include making
and maintaining six specific types of records discussed in detail
below. These proposed recordkeeping amendments are designed to work in
concert with the proposed conflicts rules to help ensure that a record
with respect to a firm's use of covered technology is maintained and
preserved in easily accessible locations for an appropriate period of
time consistent with existing recordkeeping obligations.
---------------------------------------------------------------------------

    \213\ For broker-dealers, rule 17a-4(a) under the Exchange Act
would require that records be ``preserve[d] for a period of not less
than 6 years, the first two years in an easily accessible place.''
For investment advisers, rule 204-2(e)(1) under the Advisers Act
provides that records, including those under the proposed
recordkeeping amendments, ``shall be maintained and preserved in an
easily accessible place for a period of not less than five years
from the end of the fiscal year during which the last entry was made
on such record, the first two years in an appropriate office of the
investment adviser.''
---------------------------------------------------------------------------

    The proposed retention periods also conform to existing retention
periods for broker-dealers and investment advisers. This approach is
intended to allow firms to minimize their compliance costs by
integrating the proposed requirements into their existing recordkeeping
systems and record retention timelines. The proposed retention periods
also conform to existing rules by having consistent requirements for
maintaining records in an easily accessible location.\214\ And, as with
other recordkeeping rules, the proposed recordkeeping amendments would
help both the firm's compliance staff, as well as examinations staff
(including relevant SRO staff, as applicable), assess the firm's
compliance with the requirements of the proposed conflicts rules.
---------------------------------------------------------------------------

    \214\ See id.
---------------------------------------------------------------------------

    First, firms would be required to make and maintain written
documentation of the evaluation, pursuant to paragraph (b)(1) of the
proposed conflicts rules, of any conflict of interest associated with
the use or potential use by the firm or associated person of a covered
technology in any investor interaction.\215\ This written documentation
would include a list or other record of all covered technologies used
by the firm in investor interactions, including: (i) the date on which
each covered technology is first implemented (i.e., first deployed),
and each date on which any covered technology is materially modified,
and (ii) the firm's evaluation of the intended use as compared to the
actual use and outcome of the covered technology.\216\ Firms would also
be required to make and maintain documentation describing any testing
of the covered technology performed under paragraph (b)(1) of the
proposed conflicts rules, including: (i) the date on which testing was
completed; \217\ (ii) the methods used to conduct the testing; (iii)
any actual or reasonably foreseeable potential conflicts of interest
identified as a result of the testing; (iv) a description of any
changes or modifications made to the covered technology that resulted
from the testing and the reason for those changes; and (v) any
restrictions placed on the use of the covered technology as a result of
the testing.\218\ This documentation generally should include, for
example, a record of any research or third-party outreach the firm
conducted related to any testing of a covered technology that is
performed under the proposed conflicts rules.
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    \215\ Proposed 17 CFR 240.17-3(e)(36)(i); 17 CFR 275.204-
2(a)(24)(i).
    \216\ See id.
    \217\ See id. We are aware that in certain cases, for example
when complex technologies are involved, testing could take longer
than one day. We propose that this requirement would refer to the
date the testing was completed so that staff are able to assess
whether the firm frequently relies on ``stale'' information.
    \218\ See id.
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    This information would assist examinations staff, who would have a
record they can reference when assessing compliance. This information
also may assist firms in evaluating their initial testing methodologies
and in evaluating and, where appropriate, remediating instances when
the intended use or outcome of a covered technology differs from its
actual use or outcome. In some instances, for example where the covered
technology is using relatively straightforward mathematical models such
as those contained in spreadsheets, firms could simply list all such
technologies as a single entry, which we anticipate would ease firms'
compliance with the proposed recordkeeping amendments for these
technologies.
    Second, firms would be required to make and maintain written
documentation of the determination, pursuant to paragraph (b)(2) of the
proposed conflicts rules, whether any conflict of interest identified
pursuant to paragraph (b)(1) of the proposed conflicts rules places the
interest of the firm, or associated person of a firm, ahead of the
interests of the investor. This would include the rationale for such
determination.\219\ This written documentation of the rationale
generally should include, for example, the basis on which a firm
concludes that a conflict did or did not result in an investor
interaction that places the firm or associated person's interests ahead
of an investor. This information would assist examinations staff, who
would have records they can reference when assessing compliance with
the proposed conflicts rules. This information also may assist firms in
determining whether actual or reasonably foreseeable potential
conflicts of interest place the interests of the firm, or an associated
person of the firm, ahead of the interests of the investor, as well as
reviewing the effectiveness of the policies and procedures to achieve
compliance with this requirement pursuant to paragraph (c).
---------------------------------------------------------------------------

    \219\ Proposed 17 CFR 240.17a-3(e)(36)(ii); 17 CFR 275.204-
2(a)(24)(ii).
---------------------------------------------------------------------------

    Third, firms would be required to make and maintain written
documentation evidencing how the effect of any conflict of interest has
been eliminated or neutralized pursuant to paragraph (b)(3) of the
proposed conflicts rules.\220\ This written documentation generally
should include a record of the specific steps taken by the firm (i.e.,
show your work) in deciding how to eliminate, or neutralize the effects
of, any conflicts of interest as required under the proposed conflicts
rules. The written documentation also generally should include the
rationale for any determination to make changes or modifications to or
place restrictions on the covered technology \221\ to eliminate, or
neutralize the effect of, any identified conflicts of interest, the
methodology used to make any such determination, and a description of
the firm's analysis that resulted in any such determination. This
information would assist examinations staff, who would have records
they can reference when assessing compliance. This information also may
assist firms in the determination of how to eliminate or neutralize
conflicts of interest, as well as reviewing the effectiveness of the
policies and procedures to achieve compliance with this requirement
pursuant to paragraph (c).
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    \220\ Proposed 17 CFR 240.17a-3(e)(36)(iii); 17 CFR 275.204-
2(a)(24)(iii).
    \221\ See proposed 17 CFR 240.17a-3(e)(36)(i); 17 CFR 275.204-
2(a)(24)(i).
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    Fourth, firms would be required to maintain the written policies
and procedures, including any written descriptions, adopted,
implemented, and, with regard to broker-dealers, maintained pursuant to
paragraph (c) of the proposed conflicts rules.\222\ This documentation
would include the date

on which the policies and procedures were last reviewed.\223\ Firms
must also maintain written documentation evidencing a review, occurring
at least annually, of the adequacy of the policies and procedures
established pursuant to paragraph (c) of the proposed conflicts rules,
and the effectiveness of their implementation, as well as a review of
the written descriptions established pursuant to paragraph (c) of the
proposed conflicts rules. These provisions would assist examinations
staff in assessing firms' compliance with the proposed conflicts rules.
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    \222\ Proposed 17 CFR 240.17a-3(e)(36)(iv); 17 CFR 275.204-
2(a)(24)(iv).
    \223\ See id.
---------------------------------------------------------------------------

    To help demonstrate compliance with the proposed conflicts rules, a
firm may elect to maintain records documenting other information
regarding covered technology, which could help to demonstrate that it
took a reasonable approach when identifying and evaluating the
conflicts of interest associated with the technology. For example, a
firm may choose to maintain a record of any uses, other than in
investor interactions, that the firm reasonably foresees for each
covered technology.\224\
---------------------------------------------------------------------------

    \224\ See id.
---------------------------------------------------------------------------

    Fifth, firms would be required to make and maintain a record of any
disclosures provided to investors regarding the firm's use of covered
technologies, including, if applicable, the date such disclosure was
first provided or the date such disclosure was updated.\225\ We do not
intend this proposed requirement to impose new disclosure requirements,
nor do we intend that firms maintain documents in two locations. Many
firms could satisfy this proposed requirement by maintaining a simple
bullet-point list with cross-references to all disclosures they make to
investors regarding their use of covered technologies (whether the
disclosure is made pursuant to an existing requirement or voluntarily).
Maintaining a list of any such disclosures would assist examinations
staff in reviewing disclosures given to investors regarding a firm's
use of covered technologies, to help ensure that these disclosures are
full and fair.
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    \225\ Proposed 17 CFR 240.17a-3(e)(36)(v); 17 CFR 275.204-
2(a)(24)(v).
---------------------------------------------------------------------------

    Sixth, firms would be required to make and maintain records of each
instance in which a covered technology was altered, overridden, or
disabled; the reason for such action; and the date thereof. This
requirement would include making and maintaining records of all
instances where an investor requested that a covered technology be
altered or restricted in any manner.\226\ We believe these records will
assist in identifying which technologies may present higher risks, for
example if they require constant alterations or if certain investors
request that such technologies not be used on their accounts.
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    \226\ Proposed 17 CFR 240.17a-3(e)(36)(vi); 17 CFR 275.204-
2(a)(24)(vi).
---------------------------------------------------------------------------

    We request comment on all aspects of the proposed recordkeeping
amendments, including the following items:
    85. Do the proposed recordkeeping amendments complement, overlap
with, or duplicate the existing regulatory framework for broker-dealers
and investment advisers? If so, in what ways? Specifically, would
firms' compliance with those other regulatory requirements contribute
to compliance with the proposed recordkeeping amendments, and vice
versa?
    86. Are there additional records that firms would naturally create
as they complied with the proposed conflicts rules that we should
require them to maintain? Are there any records beyond what firms would
already naturally create that would be useful to require them to
maintain? Should we require fewer records? If so, which ones should we
eliminate and why?
    87. Would the records that firms would be required to make and
retain under the proposed recordkeeping amendments likely require firms
to retain additional ``backup'' documentation, such as logs, training
data, or other documentation? Should we make any changes as a result?
For example, should we explicitly require such information to be made
and retained? Are there reasons such information should not be required
to be made and retained? For example, is it likely that such
information would be voluminous, and could therefore be difficult for
firms to retain for the full timeframe that records would be required
to be maintained? If so, should we reduce the time that firms would be
required to retain such records?
    88. For records related to all instances where an investor
requested that a covered technology be altered or restricted, what
challenges would firms face with respect to maintaining this
information? What factors should we consider if we qualify this
requirement?
    89. Are the proposed periods of time for preserving records
appropriate, or should certain records be preserved for different
periods of time? If records should be preserved for different periods
of time, which records should have different time periods and what
should those periods of time be?
    90. We are proposing to require broker-dealers and investment
advisers to maintain the same records. Are there any differences in the
way that investment advisers and broker-dealers conduct business that
would advocate for maintaining different sets of records?
    91. Should the proposed recordkeeping requirement that advisers
maintain records of all instances where an investor requested that a
covered technology be altered or restricted in any manner apply to
prospective clients and prospective investors in a pooled investment
vehicle? Should an investment adviser be required to maintain a record
of instances where a prospective client or prospective investor in a
pooled investment vehicle requested that the covered technology be
altered or restricted, but the investment adviser rejected the request,
and the prospective client did not ultimately invest?
    92. We are proposing to require firms to maintain a record of any
disclosures provided to each investor regarding the firm's use of
covered technologies. Should the proposed recordkeeping amendments
require specific disclosures to be provided or maintained? If so, what
disclosures? Should the disclosures be limited to use of covered
technologies in investor interactions, or be broadened to include more
technology? Should we also require records of disclosures about a
firm's or associated person's conflicts associated with the use of such
technologies in investor interactions?
    93. We are proposing to require firms to make and maintain
documentation describing any testing of the covered technology
performed under paragraph (b)(1) of the proposed conflicts rules. Along
with the existing specifics, should we also require information about
who developed and/or conducted the testing (e.g., firm personnel, an
outside vendor)?

III. Economic Analysis

A. Introduction

    The Commission is sensitive to the economic consequences and
effects, including costs and benefits, of its rules. Section 3(f) of
the Exchange Act \227\ and section 202(c) of the Advisers Act \228\
provide that when engaging in rulemaking that requires it to consider
or determine whether an action is necessary or appropriate in the
public interest, the Commission shall also consider, in addition to the
protection of investors, whether the action will

promote efficiency, competition, and capital formation. Additionally,
section 23(a)(2) of the Exchange Act \229\ requires the Commission,
when making rules under the Exchange Act, to consider the impact such
rules would have on competition. Section 23(a)(2) also provides that
the Commission shall not adopt any rule which would impose a burden on
competition that is not necessary or appropriate in furtherance of the
purposes of the Exchange Act.
---------------------------------------------------------------------------

    \227\ 15 U.S.C. 78c(f).
    \228\ 15 U.S.C. 80b-2(c).
    \229\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The analysis below addresses the likely economic effects of the
proposed conflicts rules and proposed recordkeeping amendments,
including the anticipated benefits and costs of the proposed rules and
amendments, and their likely effects on efficiency, competition, and
capital formation. Where practicable, the Commission quantifies the
likely economic effects of the proposed rules and amendments; however,
the Commission is unable to quantify certain economic effects because
it lacks the information necessary to provide estimates or ranges. Some
of the benefits and costs discussed below are impracticable to quantify
because quantification would necessitate general assumptions about
behavioral responses that would be difficult to quantify. The
Commission is providing both a qualitative assessment and, where
feasible, a quantified estimate of the economic effects. The Commission
seeks comment on any data that could aid quantification of these
responses.
    The proposed conflicts rules and proposed recordkeeping amendments
may have economic implications for investors, investment advisers, and
broker-dealers, and could also affect third-party service providers.
The proposed conflicts rules would introduce requirements to identify
conflicts of interest associated with the use of covered technologies
in investor interactions and eliminate or neutralize those conflicts
that place or result in placing the interest of the firm or associated
person ahead of the interest of the investor, as well as proposed
recordkeeping requirements regarding such determinations and resulting
actions. This economic analysis aims to examine the potential benefits
and costs of the proposed rules and amendments and the impact the
proposed rules and amendments may have on the market's efficiency,
competition, and capital formation.

B. Broad Economic Considerations

    In the last two decades and after the proliferation of internet-
based services, the advent of new technologies has modified the
business operations of broker-dealers and investment advisers.\230\
Access to cheaper and more granular data, plus the additional
availability of advanced computing power, have advanced data collection
and processing techniques. These developments have significantly
enhanced the scale and scope of data analytics and their potential
applications by investment advisers and broker-dealers in their
interactions with investors. These advances have increased the ability
of each of these investor interactions to contain conflicted conduct,
given the more widespread availability of data about investors,
advances in user interface design and gamification, and business
practices that could place the firm's or an associated person's
interest ahead of investors' interests. Also, some PDA-like
technologies are now able to update their interactions with investors
dynamically, based on information or data they have gained from their
users or from other data sources, which can dynamically alter the
nature and scope of conflicts of interest.
---------------------------------------------------------------------------

    \230\ See supra section I.B.
---------------------------------------------------------------------------

    The capabilities of these technological advances--including the
data the technology uses (including any investor data) and the
inferences the technology makes (including in analyzing investor data,
other data, securities, or other assets)--may be opaque to investors
and firms. This opacity makes it more challenging for an investor to
identify the presence of a conflict of interest, understand its
importance, and take protective action when making an investment
decision or otherwise interacting with the firm. Likewise, a firm's
identification of such conflicts is more challenging without unique
efforts to both fully understand the PDA-like technology it is using
and oversee conflicts that are created by or transmitted through such
technology for purposes of the firm's compliance with applicable
Federal securities laws. Further, PDA-like technologies can have the
capacity to process data, scale outcomes from analysis of data, and
evolve at incredibly rapid rates. These traits could rapidly and
exponentially scale the effects of any conflicts of interest associated
with such technologies, which could impact the markets more
broadly.\231\
---------------------------------------------------------------------------

    \231\ See supra sections I.A and I.B. For example, a firm may
use PDA-like technologies to automatically develop advice and
recommendations that are then transmitted to investors through the
firm's chatbot, mobile trading app, and robo-advisory platform. If
the advice or recommendation is tainted by a conflict of interest,
that conflict would rapidly reach many investors. See supra note 16
and surrounding text.
---------------------------------------------------------------------------

    The Commission considered two broad economic themes raised by
firms' use of covered technology in investor interactions. First, the
use of covered technology in investor interactions can entail conflicts
of interest related to the principal-agent problem between firms and
investors, and second, the use of complex and opaque technologies can
potentially create events that can harm investors.\232\
---------------------------------------------------------------------------

    \232\ The proposed conflicts rules' definition of ``conflict of
interest'' is broader than how economists usually define ``conflicts
of interest'' such as in the context of the principal-agent problem.
One economist's definition of ``conflict of interest'' is ``a
situation in which a party to a transaction can potentially gain by
taking actions that adversely affect its counterparty.'' Hamid
Mehran & Ren[eacute] M. Stulz, The Economics of Conflicts of
Interest in Financial Institutions, 85 J. Fin. Econ. 267-296 (Aug.
2007).
---------------------------------------------------------------------------

    The principal-agent problem arises when one party, known as the
principal, hires an agent to perform a task on the principal's behalf,
but the interests of the principal and the agent are not aligned.\233\
The principal-agent problem can result in the agent acting in its own
self-interest ahead of the principal's interest. This problem is
particularly relevant in the financial industry, where firms manage
investments or execute orders on behalf of investors in exchange for
fees. Firms usually have more information about the investments they
are recommending, pricing, and market dynamics than the investors that
they serve, and can potentially place their interests ahead of
investors' interests. Similarly, firms can encourage investors to use
more services, or increase transactions, potentially placing the firm's
interest over investors' interests. These conflicts of interest are
exacerbated by firms' use of certain covered technologies because the
technologies that firms use may be complex and opaque to investors, who
may not have the knowledge or time to understand how firms' use of
these technologies may generate conflicts of interest in their
interactions with investors. If these conflicts of interest were left
unaddressed, investors could be harmed by less efficient investment

strategies \234\ and incur agency costs.\235\ This could also adversely
affect the formation of capital, as investors might choose to invest
less or might lose confidence in capital markets.
---------------------------------------------------------------------------

    \233\ Michael C. Jensen & William H. Meckling, Theory of the
Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3
J. Fin. Econ. 305 (1976) (``Jensen & Meckling'').
    \234\ A rational investor seeks out investment strategies that
are efficient in the sense that they provide the investor with the
highest possible expected net benefit, in light of the investor's
investment objective that maximizes expected utility. See, e.g.,
Andreu Mas-Colell, Michael D. Whinston & Jerry R. Green, Chapter 10:
Competitive Markets for a Discussion of Efficient Allocations of
Resources, in Microeconomic Theory (1995).
    \235\ The difference between the net benefit to the investor
from accepting a less than efficient recommendation about a
securities transaction or investment strategy, where the associated
person or broker-dealer puts its interests ahead of the interests of
the investor's interests, and the net benefit the investor might
expect from a similar securities transaction or investment strategy
that is efficient for him or her, is an agency cost. See, e.g.,
Jensen & Meckling, supra note 233 for a more general discussion of
agency costs.
---------------------------------------------------------------------------

    Disclosure can sometimes help address conflict of interest problems
in principal-agent relationships. When firms fully and fairly disclose
conflicts of interest, investors may be able to make informed decisions
about their investments. For example, investment advisers are required
to provide clients with a Form ADV, which details information about the
adviser's business practices, fees, and certain conflicts of
interest.\236\ The Commission has brought enforcement actions against
broker-dealers that failed to disclose certain conflicts to
customers.\237\ In addition, investment advisers and broker-dealers are
required to provide ``retail investors'' with Form CRS, which explains
fees, commissions, and other information that may be relevant when
choosing a firm.\238\ These disclosure requirements provide investors
with information that may help them choose among firms. They also help
to create a more transparent relationship between a firm and its
investors and potentially help investors assess whether investment
advisers and broker-dealers are placing their own interests ahead of
their investors' interests. In section III.C.3, we discuss the current
disclosures that investment advisers and broker-dealers are required to
make in addition to other obligations, and in section III.D.1, we
discuss why we believe disclosure is unlikely to be sufficient to
address the principal-agent problems generated by covered
technologies.\239\
---------------------------------------------------------------------------

    \236\ Amendments to Form ADV, Investment Adviser Act Release No.
3060 (July 28, 2010) [75 FR 49233 (Aug. 12, 2010)] (``Amendments to
Form ADV'').
    \237\ See supra note 64.
    \238\ Fiduciary Interpretation, supra note 8.
    \239\ See also Reg BI Adopting Release, supra note 8, at
III.B.4.c. (discussing the effectiveness and limitations of
disclosure).
---------------------------------------------------------------------------

    Firms may adopt certain DEPs in the use of covered technology in
investor interactions that can exploit common biases or tendencies in
investors and lead these investors to make investment decisions that
will place the firm's interest ahead of investors' interests.\240\
These practices can exacerbate the principal-agent problem, as
disclosure might not be as effective at addressing the misaligned
incentives between the firm and the investor. For example, firms could
use demographic information about an investor or their risk-taking
behavior to encourage them to take actions that place the firm's
interest ahead of the investors' interest.\241\ These could be actions
such as trading unnecessarily, allowing the firm to collect extra fees
or payments from the additional trading activity (e.g., through
increased commissions or payment for order flow) or investing in
riskier positions that are more profitable to the firm.\242\
---------------------------------------------------------------------------

    \240\ Ontario Securities Commission, Staff Notice 11-796,
Digital Engagement Practices in Retail Investing: Gamification and
Other Behavioural Techniques (2022), https://www.osc.ca/sites/default/files/2022-11/sn_20221117_11-796_gamification-report.pdf.
George M. Korniotis & Alok Kumar, Do Portfolio Distortions Reflect
Superior Information or Psychological Biases?, 48 J. Fin. Quant.
Analysis 1 (2013) (``Korniotis''); Thomas Dohmen et al., Individual
Risk Attitudes: Measurement, Determinants, and Behavioral
Consequences, 9 J. Eur. Econ. Ass'n 522-550 (June 2011) (``Thomas
Dohmen et al.''); Brad M. Barber & Terrance Odean, Trading Is
Hazardous to Your Wealth: The Common Stock Investment Performance of
Individual Investors, 55 J. Fin. 773-806 (2000) (``Trading Is
Hazardous''); Brad M. Barber & Terrance Odean, Boys Will Be Boys:
Gender, Overconfidence, and Common Stock Investment, 116 Q. J. Econ.
261-292 (Feb. 2001) (``Boys Will Be Boys''); Marie Grall-Bronnec et
al., Excessive Trading, a Gambling Disorder in its Own Right? A Case
Study on a French Disordered Gamblers Cohort, 64 Addictive Behav.
340-348 (Jan. 2017); M. Mosenhauer, et al., The Stock Market as a
Casino: Associations Between Stock Market Trading Frequency and
Problem Gambling, 10 J. Behav. Addictions 683-689 (Sept. 2021); Alex
Bradley & Richard JE James, Defining the Key Issues Discussed by
Problematic Gamblers on Web-based Forums: A Data-driven Approach, 21
Int'l Gambling Stud. 59-73 (2021).
    \241\ For example, attitudes toward risk and risk-taking
behavior have been found to be meaningfully predicted by sex, age,
height, and parental educational achievement. See Dohmen, et al.,
supra note 240.
    \242\ Korniotis, supra note 240.
---------------------------------------------------------------------------

    Studies have shown, for example, that excess trading has a negative
impact on investment returns, with frequent traders exhibiting lower
net annual returns than infrequent traders due to overconfidence.\243\
Other studies have found that some stock trading apps appear to follow
strategies employed by some firms in the gambling industry to encourage
frequent repeat betting,\244\ obscure costs, and offer complex
instruments with lottery-like large payoffs in rare cases, and that
these behavior-influencing strategies benefit from survivorship
bias.\245\ These practices might not constitute recommendations, and
therefore might not face the same obligations that recommendations
would. In addition, given that these strategies exploit psychological
biases and innate tendencies of the investor rather than information
deficiencies or asymmetries, even comprehensive, accurate, and legible
disclosure might be less effective at ensuring disinterested investor
interactions, including recommendations, which do not place the firm's
interest above that of investors.\246\ Firms could profit from these
strategies through increased fees or payment for order flow due to
higher transaction frequency and higher fees on more complex trades,
among other means. In contrast to these strategies, initial efforts at
design research as applied to financial applications identified several
practices that could improve investor thoughtfulness and informed
decision-making.\247\
---------------------------------------------------------------------------

    \243\ See, e.g., Trading is Hazardous, supra note 240.
    \244\ Philip W.S. Newall & Leonardo Weiss-Cohen, The
Gamblification of Investing: How a New Generation of Investors Is
Being Born to Lose, 19 Int. J. Env't. Res. Pub. Health (Apr. 28,
2022).
    \245\ M.W. Brandt & J.A. Gaspar, Trading on Margin: The Effect
of Financial Market Information Services and Trading Apps on Day
Trading Behavior, 33 Rev. Fin. Stud. 2331-2372 (2020).
    \246\ Human behavior exhibits conditioned responses. See William
S. Verplanck, The operant conditioning of human motor behavior, 53
Psychological Bulletin 70 (1956). Moreover, the anticipation of
monetary rewards creates similar neural circuitry to anticipation of
primary rewards in other primates. See B. Knutson et al., FMRI
visualization of brain activity during a monetary incentive delay
task, 12 Neuroimage, 20-27 (2000).
    \247\ Chaudhury & Kulkarni, supra note 53, at 777-788.
---------------------------------------------------------------------------

    The scale and scope of investor interactions that are now possible
with new technologies, and the scope and dynamic nature of the
conflicts of interest that can be generated by or associated with
firms' use of covered technology, present challenges for the use of
disclosure to address conflicts of interest. A single, large disclosure
at the beginning of the firm's relationship with the investor might be
too lengthy to be meaningful or actionable, or not specific enough to
be effective, because it would have to capture the full set of
conflicts of interest that could evolve dynamically, across investors,
through the use of PDA-like technologies, especially if the technology
rapidly adjusts in response to prior interactions

with an investor.\248\ Alternatively, attaching a disclosure to each
individual investor interaction could address the potential for
conflicts of interest that are dynamically generated through the use of
PDA. However, the overall large number of disclosures would impose
costs on firms and investors, and effectiveness of these disclosures
might be reduced because of the sheer quantity of disclosures.\249\
---------------------------------------------------------------------------

    \248\ See e.g., Maartje Elshout, et al., Study on consumers'
attitudes towards Terms and Conditions (T&Cs), European Commission
Final Report (2016); Uri Benoliel & Shmuel I. Becher, The Duty to
Read the Unreadable, 60 B. C. L. Rev. 2255 (2019); Yannis Bakos, et
al., Does Anyone Read the Fine Print? Consumer Attention to
Standard-Form Contracts, 43 J. Legal Stud. 1 (2014).
    \249\ Due to the potential scalability of these disclosures,
incremental costs for firms might be de minimis, but these
disclosures would still take costly effort by investors to
interpret.
---------------------------------------------------------------------------

    Firms' use of PDA-like technologies could also impact markets more
broadly, because these technologies can process data and amend
analytical outcomes at incredibly fast rates, thereby creating
unanticipated conflicts of interest that can affect numerous investors,
and create market disruptions that affect market participants
broadly.\250\ A given firm might not fully bear the cost of the use of
these technologies, and thus might not fully internalize the full cost
of the use of these technologies. The costs imposed on entities
external to the firm are called negative externalities, and regulatory
intervention may be needed to address these costs.
---------------------------------------------------------------------------

    \250\ SEC Staff Report, Equity and Options Market Structure
Conditions in Early 2021 (Oct. 4, 2021) (``GameStop Report''),
https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf.
---------------------------------------------------------------------------

C. Economic Baseline

1. Affected Parties
    Broadly, the proposed rules would affect investment advisers,
broker-dealers, and investors. They could also indirectly affect third-
party service providers that provide covered technologies used by these
parties.
    As of February 28, 2023, there were 15,402 investment advisers
registered with the Commission \251\ and 3,504 broker-dealers
registered with the Commission.\252\ There were 308,565 individuals
registered with FINRA as broker-dealer representatives only, 80,977
individuals registered as investment adviser representatives only,
312,317 individuals registered as both investment adviser and broker-
dealer representatives, and a total of 971,758 employees reported by
investment advisers.\253\ However, because the proposed rules would
also affect associated persons of firms these numbers may undercount
the number of affected individuals, because not all associated persons
of a firm are registered representatives of the firm. Approximately
73.5% of registered broker-dealers report retail customer
activity.\254\
---------------------------------------------------------------------------

    \251\ Based on IARD data as of Mar. 27, 2023.
    \252\ Based on SEC data as of Mar. 1, 2023, https://www.sec.gov/help/foiadocsbdfoia.
    \253\ Based on FOCUS Filing data, as of March 2023.
    \254\ Consistent with the Form CRS Adopting Release, we estimate
that 73.5% of registered broker-dealers report retail activity and
thus, would likely be subject to the proposed conflicts rule.
However, we recognize this may capture some broker-dealers that do
not have retail activity.
---------------------------------------------------------------------------

    Form ADV requires investment advisers to indicate the approximate
number of advisory clients and the amount of total regulatory assets
under management (``RAUM'') attributable to various client types.\255\
Table 1 provides information on the number of client accounts, total
RAUM, and the number of advisers by client type.
---------------------------------------------------------------------------

    \255\ If a client fits into more than one category, Form ADV
requires an adviser to select one category that most accurately
represents the client (to avoid double counting clients and assets).
    \256\ This report reflects analysis of Form ADV data downloaded
from the Enterprise Data Warehouse as of February 28, 2023. Form
ADV, Items 5C, 5D, and 5F(2)(c). Prior to the October 2017 changes
to Form ADV, clients and client RAUM were estimated based on the
midpoint of ranges reported.

                           Table 1--Clients of Investment Advisers From Form ADV \256\
----------------------------------------------------------------------------------------------------------------
                                                                    Total RAUM        Clients
                           Client type                              (billions)      (millions)         RIAs
----------------------------------------------------------------------------------------------------------------
Investment Companies............................................         $42,955           0.022           1,565
Pooled Investment Vehicles--Other...............................          34,433           0.094           5,897
High Net Worth Individuals......................................          11,664           6.898           9,166
Pension Plans...................................................           7,807           0.442           5,429
Insurance Companies.............................................           7,623           0.015           1,381
Non-High Net Worth Individuals..................................           7,030          44.092           8,493
State/Municipal Entities........................................           4,214           0.029           1,608
Corporations....................................................           3,198           0.348           5,196
Foreign Institutions............................................           2,194           0.003             752
Charities.......................................................           1,580           0.127           5,369
Other Advisers..................................................           1,385           0.904           1,202
Banking Institutions............................................             903           0.011             825
Business Development Companies..................................             213           0.000              97
----------------------------------------------------------------------------------------------------------------

    As of February 2023, 50,554 private funds were reported on Form PF,
and 5,620 registered investment advisers listed private funds on their
Form ADV.\257\ The effects of the proposed rules to firms and
associated persons would be contingent on a number of factors, such as,
among others, the types of covered technologies the firm uses, the
number of current and prospective clients or customers of the firm, the
number of investors in pooled investment vehicles advised by the firm,
the frequency of investor interactions, and the nature and extent of
the conflicts of interest. Because of the wide diversity of services
and relationships offered by firms, we expect that the obligations
imposed by the proposed rules would, accordingly, vary substantially.
The Commission seeks public comment on the number and type of these
affected parties. When developing the baseline, we considered how
current trends in technological development and the conflicts
associated with them might reasonably affect financial markets in the
absence of the proposed rules. The Commission invites public comment on
our characterization of these trends in the baseline.
---------------------------------------------------------------------------

    \257\ SEC, Div. of Investment Mgmt, Analytics Office, Private
Funds Statistics Third Calendar Quarter 2022, (Apr. 6, 2023).
---------------------------------------------------------------------------

    The proposed rules would affect investors. As discussed earlier in
this release, the proposed rules would define ``investor'' differently
for investment

advisers as compared to broker-dealers. For investment advisers,
``investor'' is defined as 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. For broker-
dealers, ``investor'' is defined to mean a natural person, or the legal
representative of such natural person, who seeks to receive or receives
services primarily for personal, family or household purposes. This
definition is identical to the one used for ``retail investor'' in Form
CRS, and it excludes non-retail investors of broker-dealers.
    According to the Federal Reserve Board's 2019 Survey of Consumer
Finances, a total of 41.3 million U.S. households have either an
individual retirement account (``IRA'') or a brokerage account; an
estimated 23.0 million U.S. households have a brokerage account, and
32.7 million households have an IRA (including 63% of households that
also hold a brokerage account).\258\ Households have increased their
use of business professionals for investment decisions, rising from
48.9 percent in 2001 to 56.5 percent in 2019. In addition, household
use of the internet for investment decisions has risen from 14.8
percent in 2001 to 45.2 percent in 2019.\259\ A 2019 survey of
households found that approximately 10 million U.S. households use
robo-advisers.\260\ In 2022, the top 10 robo-advisers reported $353.2
billion in assets under management.\261\ The Commission seeks comment
on the number of investors this definition could cause to be affected
by the proposed conflicts rules, and the extent and nature of the use
of covered technologies.
---------------------------------------------------------------------------

    \258\ The data is obtained from the Federal Reserve System's
2019 Survey of Consumer Finances (``SCF''). See Board of Governors
of the Fed. Rsrv. Sys., Survey of Consumer Finances (2019), https://www.federalreserve.gov/econres/scfindex.htm.
    \259\ See Neil Bhutta et al., Board of Governors of the Fed.
Rsrv. Sys., 106 Fed. Rsrv. Bulletin 31 (Sept. 2020) (``Business
professionals'' combines seven options: accountant, banker, broker,
financial planner, insurance agent, lawyer, and real estate agent).
    \260\ Michael Mackenzie, Demand for Advice Rises as Not All
Investors Go It Alone, Fin. Times (Sept. 13, 2020), https://www.ft.com/content/3900c943-245a-424d-b2e5-da6128655ed5.
    \261\ Barbara Friedberg, Top-10 Robo-Advisors by Assets under
Management, Forbes Advisor (July 9, 2022), https://www.forbes.com/advisor/investing/top-robo-advisors-by-aum/.
---------------------------------------------------------------------------

    The proposed conflicts rules may indirectly affect third-party
service providers of covered technologies. A firm may be using a
covered technology developed by a third-party service provider,
including through some license agreement with the third-party service
provider. A firm may also outsource certain functionality of the
covered technology to, or utilize the support or services of, a third-
party provider for a variety of reasons, including cost efficiencies,
increased automation, particular expertise, or functionality that the
firm does not have in-house.
    Based on Commission staff experience, the Commission believes that
these third-party providers play a growing role with respect to the
development of covered technologies, and the Commission anticipates
that third-party providers will likely arise to provide other types of
functionality, service, or support to firms that are not contemplated
yet today.
    Due to data limitations, we are unable to quantify or characterize
in much detail the structure of these various service provider markets.
The Commission lacks specific information on the exact extent to which
third-party service providers are retained, the specific services they
provide, and the costs for those services. We also do not have
information about the market for these services, including the
competitiveness of such markets. We request information from commenters
on the services related to covered technologies provided by third
parties to firms, the costs for those services, and the nature of the
market for these services.
    2. Technology and Market Practices
    The use of technology in investing has undergone significant
transformation in recent years.\262\ Some firms and investors in
financial markets now use new technologies such as AI, machine
learning, NLP, and chatbot technologies to communicate and make
investment decisions.\263\ In addition, improvements and new
applications for existing technologies for data-analytics, data
collection, and investor interaction continue to be developed.\264\
---------------------------------------------------------------------------

    \262\ See supra section I.A; see Shaw & Gani, supra note 75.
    \263\ Kearns & Nevmyvaka, supra note 24; Thier & dos Santos
Monteiro, supra note 24.
    \264\ Lekh & P[aacute]tek, supra note 25; Martindale, supra note
25.
---------------------------------------------------------------------------

    Financial market participants currently use AI and machine learning
technologies in a variety of ways. For example, algorithmic trading is
a widely used application of machine learning in finance, where
machine-learning models analyze large datasets and identify patterns
and signals to optimize, forecast, predict, guide, or direct
investment-related behaviors or outcomes.\265\ Several banks and other
financial institutions have developed chatbots to assist with customer
service and support, and have attempted to make the chatbot
interactions feel similar to conversations with humans.\266\ These
chatbots can help customers with a range of tasks, from checking
account balances and transactions to making payments and disputing
fraudulent charges. NLP is used to analyze financial news and social
media data, identifying trends and sentiment that may influence market
behavior. For instance, hedge funds and trading firms use NLP tools to
analyze financial news articles, press releases, and social media posts
in real-time, to identify patterns and make trading decisions based on
sentiment analysis.\267\ Some robo-advisers use chatbots and NLP
technology to provide investment advice via online platforms.\268\
These platforms may use a combination of AI, machine learning, NLP, and
chatbot technologies to provide personalized investment recommendations
to investors based on risk tolerance and investment goals.
---------------------------------------------------------------------------

    \265\ Forecasting in contexts contemplated by these rules, such
as machine learning, involves estimation of a future value based on
data which includes a temporal component. Prediction, in contrast,
is the more general estimation of unknown data from known data, for
example, missing words in a transcript. See, e.g., Mattias
D[ouml]ring, Prediction vs Forecasting, Data Science Blog (Dec. 9,
2018), https://www.datascienceblog.net/post/machine-learning/forecasting_vs_prediction/.
    \266\ See, e.g., Suman Bhattacharyya, Bank of America Wants a
Human Bridge for Its AI Help, BankingDive (Dec. 12, 2022), https://www.bankingdive.com/news/bank-america-erica-chatbot-virtual-assistant-human-middle-interaction-gopalkrishnan/638523/; Sara
Castellanos, Capital One Brings `Humanity' to Its Forthcoming
Chatbot, CIO Blog (July 19, 2017), https://www.wsj.com/articles/capital-one-brings-humanity-to-its-forthcoming-chatbot-1500488098
(retrieved from Factiva database); Moise, supra note 24.
    \267\ See, e.g., Patrick Henry & Dilip Krishna, Making the
Investment Decision Process More Naturally Intelligent, Deloitte
Insights (Mar. 2, 2021), https://www2.deloitte.com/us/en/insights/industry/financial-services/natural-language-processing-investment-management.html; see also Yong Chen et al., Sentiment Trading and
Hedge Fund Returns, 76 J. Fin. 2001 (Apr. 8, 2011).
    \268\ See supra note 41 and surrounding text.
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    Recent advancements in data collection techniques have
significantly enhanced the scale and scope of data analytics and its
potential applications. Thanks to increases in processing power and
data storage capacity, a vast amount of data is now available for high-
speed analysis using these technologies.\269\ Furthermore, the range of
data types has also expanded, with consumer shopping

histories, media preferences, and online behavior now among the many
types of data that data analytics can use to synthesize information,
forecast financial outcomes, and predict investor and customer
behavior.\270\ As a result, these technologies can be applied in novel
and powerful, yet subtle ways, such as using data layout and formatting
choices to influence trading decisions.\271\ Some technologies use
predictive data analytics and AI/machine learning along with detailed
user data to increase user engagement, and trading activity.
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    \269\ See, e.g., Andriosopoulos et al., supra note 51; Lawler et
al., supra note 51; Alex Padalka, Tech Firms Court Fidelity for Data
Heap to Build AI Systems, Fin. Advisor IQ (June 8, 2023), https://www.financialadvisoriq.com/c/4104954/529084/tech_firms_court_fidelity_data_heap_build_systems.
    \270\ Daniel Broby, supra note 52; OECD, supra note 52.
    \271\ See Chaudhuri & Kulkarni, supra note 53.
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    The use of these technologies can generate conflicts of interest if
firms use these technologies to suggest or nudge users to trade more
frequently on their platform, or to invest in products that are more
profitable for the firm but expose investors to higher costs or risks,
against investors' interests. In addition, although investors are free
to choose a firm that uses technology in a manner with which they are
comfortable, investors may have to undertake costly efforts to
understand how firms are using technology and to be comfortable with
newer technologies used by firms, including any associated disclosures
of conflicts of interest. In the case of broker-dealers, non-
recommendation interactions with investors are not subject to Reg BI's
Conflict of Interest Obligation, but can still influence investor
behavior in a way that places the firm's interests ahead of investors'
interests.
    Many of these technologies are not directly developed by investment
advisers or broker-dealers, but are instead licensed from third party
providers.\272\ This practice can harness the economies of scale in the
development and testing of a technology with broad applications, by
centralizing the costs within the service provider, rather than
spreading the costs across multiple firms independently developing
similar technologies. However, the use of third party providers can
also potentially concentrate the risks that stem from conflicts of
interest from the use of these technologies if such providers are
concentrated within the market serving covered entities and provide
products or services which operate broadly similarly across their
covered customers.
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    \272\ See, e.g., Karl Flinders, Banks Don't Want to Develop
Fintech In-house, Computer Wkly (Apr. 20, 2023), https://www.computerweekly.com/news/365535576/Banks-dont-want-to-develop-fintech-in-house; Justin L. Mack, What Advisors Really Use Fintech
For, and Why Ease of Use Matters Most: Wealthtech Weekly, Fin. Plan.
(July 7, 2023), https://www.financial-planning.com/list/what-most-financial-advisors-are-using-fintech-for-wealthtech-weekly.
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3. Regulatory Baseline
    Investment advisers and broker-dealers are currently subject to
obligations under Federal securities laws and regulations, and, in the
case of broker-dealers, rules of SROs (in particular, FINRA),\273\
which are designed to promote conduct that, among other things,
protects investors, including from certain conflicts of interest.\274\
The specific obligations are designed for the particular practices of
investment advisers and broker-dealers and, accordingly, the regulatory
baseline differs for each population.
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    \273\ See supra note 59 and surrounding text.
    \274\ See supra note 60 and surrounding text.
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a. Investment Advisers
    The Advisers Act establishes a Federal fiduciary duty for
investment advisers, which includes a duty to eliminate or disclose
conflicts of interest.\275\ An adviser's fiduciary duty, which
encompasses both a duty of loyalty and a duty of care,\276\ extends to
the entire relationship between the adviser and client.\277\
Accordingly, an investment adviser (including one who uses PDA-like
technologies) must, at all times, serve the best interest of its client
and not subordinate its client's interest to its own. In other words,
an investment adviser must not place its own interest ahead of its
client's interests. As part of meeting this fiduciary duty, investment
advisers must eliminate conflicts of interest--interests that might
incline an investment adviser, consciously or unconsciously, to render
advice that is not disinterested-- or at a minimum, make full and fair
disclosure of the conflict of interest such that a client can provide
informed consent to the conflict.\278\ Under this duty, investment
advisers must also make full and fair disclosure of all material facts
relating to the advisory relationship.\279\
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    \275\ SEC v. Capital Gains, 375 U.S. 180, 194 (1963) (``Capital
Gains''). See also Investment Adviser Codes of Ethics, Investment
Advisers Act Release No. 2256 (July 2, 2004) [69 FR 41695 (July 9,
2004)]; Compliance Programs of Investment Companies and Investment
Advisers, Investment Advisers Act Release No. 2204 (Dec. 17, 2003)
[68 FR 74713 (Dec. 24, 2003)] (``Compliance Programs Release'').
    \276\ See Fiduciary Interpretation, supra note 8, at n.15 and
accompanying text.
    \277\ See Fiduciary Interpretation, supra note 8, at section
II.A.
    \278\ See Fiduciary Interpretation, supra note 8, at section
II.C; Capital Gains, supra note 275, at 191-192 (describing a
Congressional intent to ``eliminate, or at least to expose, all
conflicts of interest which might incline an investment adviser--
consciously or unconsciously--to render advice which was not
disinterested'').
    \279\ See Fiduciary Interpretation, supra note 8, at section
II.C. See also Capital Gains, supra note 275 (``Failure to disclose
material facts must be deemed fraud or deceit within its intended
meaning.''); Amendments to Form ADV, supra note 236 (``as a
fiduciary, an adviser has an ongoing obligation to inform its
clients of any material information that could affect the advisory
relationship''); General Instruction 3 to Part 2 of Form ADV
(``Under federal and state law, you are a fiduciary and must make
full disclosure to your clients of all material facts relating to
the advisory relationship.'').
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    Advisers are required to provide clients with a Form ADV brochure,
which details information about the adviser's business practices, fees,
and certain conflicts of interest.\280\ The information provided must
be sufficiently specific that a client is able to understand the
investment adviser's business practices and conflicts of
interests,\281\ and it is essential that the information be presented
in a manner that clients are likely to read (if in writing) and
understand.\282\ In addition, investment advisers (and broker-dealers)
are required to provide ``retail investors'' with Form CRS, which
explains fees, commissions, and other information that may be relevant
when choosing a firm.\283\
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    \280\ See Amendments to Form ADV, supra note 236, at section I
(``Since 1979, the Commission has required each adviser registered
with us to deliver a written disclosure statement to clients
pursuant to rule 204-3 under the Advisers Act.'') (citations
omitted).
    \281\ See Amendments to Form ADV, supra note 236, at n.28.
    \282\ See Amendments to Form ADV, supra note 236, at section I.
(``To allow clients and prospective clients to evaluate the risks
associated with a particular investment adviser, its business
practices, and its investment strategies, it is essential that
clients and prospective clients have clear disclosure that they are
likely to read and understand.''); see also Fiduciary
Interpretation, supra note 8, at section I.C. (``In order for
disclosure to be full and fair, it should be sufficiently specific
so that a client is able to understand the material fact or conflict
of interest and make an informed decision whether to provide
consent.'') and at n.59.
    \283\ See Form CRS, General Instructions (``Under rule 17a-14
under the Securities Exchange Act of 1934 and rule 204-5 under the
Investment Advisers Act of 1940, broker-dealers registered under
section 15 of the Exchange Act and investment advisers registered
under section 203 of the Advisers Act are required to deliver to
retail investors a relationship summary disclosing certain
information about the firm.'').
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    The duty of care requires, among other things, investment advisers
to provide investment advice in the client's best interest, based on a
reasonable understanding of the client's objectives. Investment
advisers are subject more generally to the antifraud provisions,
including section 206 of the Advisers Act,\284\ which prohibits fraud
or deceit upon any client or prospective client; and 17 CFR 240.10b-5
(``Exchange Act rule 10b-5''), which

makes it unlawful for any person to engage in fraud or deceit upon any
person. Similarly, with respect to investors in pooled investment
vehicles, rule 206(4)-8 under the Advisers Act makes it unlawful to
make any untrue statement of a material fact, or to omit to state a
material fact necessary to make the statements made, in light of the
circumstances under which they were made, not misleading.\285\ It also
makes it unlawful to engage in any act, practice, or course of business
that is fraudulent, deceptive, or manipulative with respect to any
investor or prospective investor in the pooled investment vehicle.\286\
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    \284\ 15 U.S.C. 80b-6.
    \285\ Prohibition of Fraud by Advisers to Certain Pooled
Investment Vehicles, Investment Adviser Release No. 2628 (Aug. 3,
2007) [72 FR 44756 (Aug. 9, 2007)] (``[Our] intent is to prohibit
all fraud on investors in pools managed by investment advisers'').
    \286\ 17 CFR 275.206(4)-8.
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    In addition, the Advisers Act Compliance Rule requires advisers to
adopt and implement written policies and procedures reasonably designed
to prevent violations of the Act and the rules thereunder. In designing
its policies and procedures pursuant to the Advisers Act Compliance
Rule, each adviser should first identify conflicts and other compliance