[Federal Register Volume 88, Number 152 (Wednesday, August 9, 2023)]
[Proposed Rules]
[Pages 53960-54024]
[FR Doc No: 2023-16377]

Vol. 88

Wednesday,

No. 152

August 9, 2023

Part II

Securities and Exchange Commission

-----------------------------------------------------------------------

17 CFR Parts 240 and 275

Conflicts of Interest Associated With the Use of Predictive Data
Analytics by Broker-Dealers and Investment Advisers; Proposed Rule

Federal Register / Vol. 88 , No. 152 / Wednesday, August 9, 2023 /
Proposed Rules

-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 275

[Release Nos. 34-97990; IA-6353; File No. S7-12-23]
RIN 3235-AN00; 3235-AN14

Conflicts of Interest Associated With the Use of Predictive Data
Analytics by Broker-Dealers and Investment Advisers

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission (``Commission'' or
``SEC'') is proposing new rules (``proposed conflicts rules'') under
the Securities Exchange Act of 1934 (``Exchange Act'') and the
Investment Advisers Act of 1940 (``Advisers Act'') to eliminate, or
neutralize the effect of, certain conflicts of interest associated with
broker-dealers' or investment advisers' interactions with investors
through these firms' use of technologies that optimize for, predict,
guide, forecast, or direct investment-related behaviors or outcomes.
The Commission is also proposing amendments to rules under the Exchange
Act and Advisers Act that would require firms to make and maintain
certain records in accordance with the proposed conflicts rules.

DATES: Comments should be received on or before October 10, 2023.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's internet comment form (https://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include
File Number S7-12-23 on the subject line.

Paper Comments

     Send paper comments to Vanessa A. Countryman, Secretary,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-1090.

All submissions should refer to File Number S7-12-23. This file number
should be included on the subject line if email is used. To help the
Commission process and review your comments more efficiently, please
use only one method of submission. The Commission will post all
comments on the Commission's website (https://www.sec.gov/rules/proposed.shtml). Comments are also available for website viewing and
printing in the Commission's Public Reference Room, 100 F Street NE,
Washington, DC 20549, on official business days between the hours of 10
a.m. and 3 p.m. Operating conditions may limit access to the
Commission's Public Reference Room. Do not include personal
identifiable information in submissions; you should submit only
information that you wish to make available publicly. We may redact in
part or withhold entirely from publication submitted material that is
obscene or subject to copyright protection.
    Studies, memoranda, or other substantive items may be added by the
Commission or staff to the comment file during this rulemaking. A
notification of the inclusion in the comment file of any such materials
will be made available on the Commission's website. To ensure direct
electronic receipt of such notifications, sign up through the ``Stay
Connected'' option at www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT: Blair B. Burnett, Senior Counsel,
Investment Company Regulation Office, Michael Schrader, Senior Counsel,
Chief Counsel's Office, Sirimal R. Mukerjee, Senior Special Counsel,
and Melissa Roverts Harke, Assistant Director, Investment Adviser
Regulation Office, Division of Investment Management, at<PHONE_NUMBER>
or [email protected], and Kyra Grundeman and James Wintering, Special
Counsels, Anand Das, Senior Special Counsel, Kelly Shoop, Branch Chief,
Devin Ryan, Assistant Director, John Fahey, Deputy Chief Counsel, and
Emily Westerberg Russell, Chief Counsel, Office of Chief Counsel,
Division of Trading and Markets, at<PHONE_NUMBER> or
[email protected], Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION: The Commission is proposing for public
comment: 17 CFR 240.15l-2 under the Exchange Act \1\ (``proposed rule
240.151-2'') and 17 CFR 275.211(h)(2)-4 under the Advisers Act \2\
(``proposed rule 275.211(h)(2)-4'' and, together with proposed rule
240.15l-2, ``proposed conflicts rules''); and amendments to 17 CFR
240.17a-3 and 17 CFR 240.17a-4 (``rules 17a-3 and 17a-4'') under the
Exchange Act and 17 CFR 275.204-2 under the Advisers Act (``rule 204-
2'' and, together with the proposed amendments to rules 17a-3 and 17a-
4, ``proposed recordkeeping amendments'').
---------------------------------------------------------------------------

    \1\ Unless otherwise noted, when we refer to the Exchange Act,
we are referring to 15 U.S.C. 78, and when we refer to rules under
the Exchange Act, we are referring to title 17, part 240 of the Code
of Federal Regulations [17 CFR 240].
    \2\ Unless otherwise noted, when we refer to the Advisers Act,
we are referring to 15 U.S.C. 80b, and when we refer to rules under
the Advisers Act, we are referring to title 17, part 275 of the Code
of Federal Regulations [17 CFR 275].
---------------------------------------------------------------------------

Table of Contents

I. Introduction
    A. Overview
    B. Background
    1. Evolution in the Investment Industry and its Technology Use
    2. Current PDA-Like Technology Use and Expected Growth
    3. Commission Protection of Investors as Technology Has Evolved
    4. Use of Predictive Data Technologies in Investor Interactions
    5. Request for Information and Comment
    C. Overview of the Proposal
II. Discussion
    A. Proposed Conflicts Rules
    1. Scope
    2. Identification, Determination, and Elimination, or
Neutralization of the Effect of, a Conflict of Interest
    3. Policies and Procedures Requirement
    B. Proposed Recordkeeping Amendments
III. Economic Analysis
    A. Introduction
    B. Broad Economic Considerations
    C. Economic Baseline
    1. Affected Parties
    2. Technology and Market Practices
    3. Regulatory Baseline
    D. Benefits and Costs
    1. Benefits
    2. Costs
    E. Effects on Efficiency, Competition, and Capital Formation
    1. Efficiency
    2. Competition
    3. Capital Formation
    F. Reasonable Alternatives
    1. Expressly Permit, or Require, the Use of Independent Third-
Party Analyses
    2. Require That Senior Firm Personnel and/or Specific Technology
Subject-Matter Experts Participate in the Process of Adopting and
Implementing These Policies and Procedures
    3. Provide an Exclusion for Technologies That Consider Large
Datasets Where Firms Have No Reason To Believe the Dataset Favors
the Interests of the Firm From the Identification, Evaluation, and
Testing Requirements
    4. Apply the Requirements of the Proposed Conflicts Rule and
Proposed Recordkeeping Amendments Only to Broker-Dealer Use of
Covered Technologies That Have Non-Recommendation Investor
Interaction
    5. Require That Firms Test Covered Technologies on an Annual
Basis, or at a Specific Minimum Frequency
    6. Require That Firms Provide a Prescribed and Standardized
Disclosure
    G. Request for Comment
IV. Paperwork Reduction Act
    A. Introduction
    B. Proposed Conflicts Rules and Proposed Recordkeeping
Amendments
    C. Request for Comment
V. Initial Regulatory Flexibility Analysis

    A. Reason for and Objectives of the Proposed Action
    1. Proposed Rules 151-2 and 211(h)(2)-4
    2. Proposed Amendments to Rules 17a-3 and 17a-4 and Rule 204-2
    B. Legal Basis
    C. Small Entities Subject to the Rules and Rule Amendments
    1. Small Advisers Subject to Proposed Rule 211(h)(2)-4 and
Proposed Amendments to Recordkeeping Rule
    D. Small Broker-Dealers Subject to Proposed Conflicts Rule and
Amendments to Recordkeeping Rules
    E. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
    1. Proposed Conflicts Rules
    2. Proposed Amendments to Rule 204-2
    3. Proposed Amendments to Rules 17a-3 and 17a-4
    F. Duplicative, Overlapping, or Conflicting Federal Rules
    1. Proposed Rule 211(h)(2)-4 and Proposed Amendments to Rule
204-2
    2. Proposed Rule 15l-2 and Proposed Amendments to Rules 17a-3
and 17a-4
    G. Significant Alternatives
    H. Solicitation of Comments
VI. Consideration of Impact on the Economy
Statutory Authority
Text of Proposed Rules and Form Amendments

I. Introduction

    The adoption and use of newer technologies, such as predictive data
analytics (``PDA''), by broker-dealers and investment advisers
(together, ``firms'') have accelerated.\3\ In some instances, firms'
use of PDA and similar technologies may be subject to statutory or
regulatory investor protections, but in other cases, it may not. Firms'
use of PDA-like technologies can bring benefits in market access,
efficiency, and returns. To the extent that firms are using PDA-like
technologies to optimize for their own interests in a manner
(intentionally or unintentionally) that places these interests ahead of
investor interests, however, investors can suffer harm. Further, due to
the scalability of these technologies and the potential for firms to
reach a broad audience at a rapid speed, as discussed below, any
resulting conflicts of interest could cause harm to investors in a more
pronounced fashion and on a broader scale than previously possible.\4\
---------------------------------------------------------------------------

    \3\ See Deloitte, Artificial intelligence: The next frontier for
investment management firms (Feb. 5, 2019), https://www.deloitte.com/global/en/Industries/financial-services/perspectives/ai-next-frontier-in-investment-management.html (``AI is
providing new opportunities which extend far beyond cost reduction
and efficient operations. Many investment management firms have
taken note and are actively testing the waters, applying cognitive
technologies and AI to various business functions across the
industry value chain.''); Blake Schmidt and Amanda Albright, AI Is
Coming for Wealth Management. Here's What That Means, Bloomberg
Markets (Apr. 21, 2023), https://www.bloomberg.com/news/articles/2023-04-21/vanguard-fidelity-experts-explain-how-ai-is-changing-wealth-management (discussing experts views on AI impact on the
wealth management industry). As discussed more below, in addition to
PDA, firms have adopted and used artificial intelligence (``AI''),
including machine learning, deep learning, neural networks, natural
language processing (``NLP''), or large language models (including
generative pre-trained transformers or ``GPT''), as well as other
technologies that make use of historical or real-time data, lookup
tables, or correlation matrices (collectively, ``PDA-like
technologies''). See, e.g., Q. Zhu and J. Luo, Generative Pre-
Trained Transformer for Design Concept Generation: An Exploration,
Proceedings of the Design Society, Design Vol 2 (May 2022), https://www.cambridge.org/core/journals/proceedings-of-the-design-society/article/generative-pretrained-transformer-for-design-concept-generation-an-exploration/41894D82DCBC0610B5B6E68967B7047F (``GPT
are language models pre-trained on vast quantities of textual data
and can perform a wide range of language-related tasks.'')
(citations omitted).
    \4\ See infra section I.C.
---------------------------------------------------------------------------

    We believe the current regulatory framework should be updated to
help ensure that firms are appropriately addressing conflicts of
interests associated with the use of PDA-like technologies. As a
result, we are proposing specific protections to complement those
already required under existing regulatory frameworks \5\ to better
protect investors from harms arising from these conflicts.
---------------------------------------------------------------------------

    \5\ See infra section III.C.3.
---------------------------------------------------------------------------

A. Overview

    Broker-dealers may have a range of conflicts of interest with their
retail investors.\6\ Likewise, investment advisers may have conflicts
of interest with respect to advisory clients and investors in their
pooled investment vehicle clients.\7\ Some of these conflicts of
interest are inherent to the relationship between these firms and
investors. For example, an investment adviser that is paid a percentage
fee based on assets under management has an incentive to encourage a
client to move assets into his or her advisory account, which could
conflict with investors' interest, for example, to retain assets in a
401(k) plan or other retirement account. Similarly, a broker-dealer
that receives transaction-based (e.g., commission) compensation has an
incentive to maximize the frequency of transactions, which could
increase costs to the investor or expose them to other risks associated
with excess trading.
---------------------------------------------------------------------------

    \6\ While the proposed conflicts rules do not use or define the
term ``retail investors,'' we use that term in this release 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,'' which is consistent with
the definition of ``retail investor'' in Form CRS and would include
both current and prospective retail customers. See Form CRS, Sec.
11.E. Separately, we note that, for broker-dealers, the proposed
conflicts rule defines ``investor'' consistent with the definition
of ``retail investor'' in Form CRS.
    \7\ Proposed rule 275.211(h)(2)-4 would apply to clients and
prospective clients of advisers as well as investors and prospective
investors in pooled investment vehicles advised by those advisers.
---------------------------------------------------------------------------

    Many broker-dealers and investment advisers also have conflicts of
interest associated with other common business practices. For example,
some investment product sponsors offer revenue sharing payments,
creating an incentive for broker-dealers and investment advisers that
accept such payments to favor those investments. Similarly, firms that
offer proprietary products have an incentive to favor those products
over other non-proprietary alternatives. Dual registrant and affiliated
firms that offer both brokerage and advisory accounts have an incentive
to steer investors toward the account type that is most profitable for
the firm, regardless of whether it is in the best interest of the
investor. Unless adequately addressed, these conflicts of interest can
cause broker-dealers and investment advisers to place their interests
ahead of investors' interests.
    Broker-dealers and investment advisers operate within regulatory
frameworks that in many cases require them to, as applicable, disclose,
mitigate, or eliminate conflicts.\8\ These regulatory frameworks play a
fundamental role in protecting retail investors of broker-dealers,
clients of investment advisers, and investors in pooled investment
vehicle clients of investment advisers (together, ``investors'') from
the negative effects of firms placing their own interests ahead of
investors' interests. As the markets grow and evolve, however, and
specifically, as firms adopt and utilize newer technologies to interact
with investors, we are evaluating our regulations' effectiveness in
protecting investors from the potentially harmful impact of conflicts
of interest.
---------------------------------------------------------------------------

    \8\ See https://www.sec.gov/rules/final/2019/34-86031.pdf,
Exchange Act Release No. 86031 (June 5, 2019) [84 FR 33318 (July 12,
2019)] (``Reg BI Adopting Release''); Commission Interpretation
Regarding Standard of Conduct for Investment Advisers, Advisers Act
Release No. 5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)], at
section II.C. (``Fiduciary Interpretation'') (describing an
adviser's fiduciary duties to its clients). Additionally, rule
206(4)-8 under the Advisers Act prohibits certain statements,
omissions, and other acts, practices, or courses of business as
fraudulent, deceptive, or manipulative with respect to any investor
or prospective investor in a pooled investment vehicle.
---------------------------------------------------------------------------

    Recently, firms' adoption and use of PDA-like technologies \9\ have

accelerated.\10\ While this adoption and use can bring potential
benefits for firms and investors (e.g., with respect to efficiency of
operations, which can generate cost savings for investors, or enhancing
the efficiency of identifying investment opportunities that match an
investor's preferences, profile, and risk tolerances), they also raise
the potential for conflicts of interest associated with the use of
these technologies to cause harm to investors more broadly than
before.\11\
---------------------------------------------------------------------------

    \9\ Artificial intelligence is generally used to mean the
capability of a machine to imitate intelligent human behavior and
machine learning is a subfield of artificial intelligence that gives
computers the ability to learn without explicitly being programmed.
See generally Sara Brown, Machine Learning, Explained, MIT Sloan
School of Management (Apr. 21, 2021), https://mitsloan.mit.edu/ideas-made-to-matter/machine-learning-explained. Predictive data
analytics draws inferences from large data sets, relying on
hypothesis-free data mining and inductive reasoning to uncover
patterns to make predictions about future outcomes, and may use
natural language processing, signal processing, topic modeling,
pattern recognition, machine learning, deep learning, neural
networks, and other advanced statistical methods. See Nathan Cortez,
Predictive Analytics Law and Policy: Mapping the Terrain:
Challenging Issues in Specific Private Sector Contexts,
Substantiating Big Data in Health Care, 14 ISJLP 61, 65 (Fall 2017).
See generally Financial Industry Regulatory Authority, Inc.
(``FINRA''), Artificial Intelligence (AI) in the Securities Industry
5 (June 2020) (``FINRA AI Report''), https://www.finra.org/sites/default/files/2020-06/ai-report-061020.pdf; Financial Stability
Board, Artificial Intelligence and Machine Learning in Financial
Services: Market Developments and Financial Stability Implications
(Nov. 1, 2017) (``FSB AI Report''), https://www.fsb.org/wp-content/uploads/P011117.pdf; see also Department of the Treasury, et al.,
Request for Information and Comment on Financial Institutions' Use
of Artificial Intelligence, Including Machine Learning (Feb. 2021)
[86 FR 16837, 16839-40 (Mar. 31, 2021)] (``Treasury RFI'').
    \10\ See infra section I.B.
    \11\ See, e.g., For AI in Asset Management, Tomorrow is Here,
Markets Media (Mar. 28, 2023), https://www.marketsmedia.com/for-ai-in-asset-management-tomorrow-is-here/ (citing possible benefits for
investment managers in generating alpha, improving efficiency,
enhancing product and content distribution, and enhancing risk
management and customer experience); Christine Schmid, AI in Wealth:
from Science Fiction to Science Fact, FinExtra (June 8, 2023),
https://www.finextra.com/blogposting/24323/ai-in-wealth-from-science-fiction-to-science-fact (citing potential benefits in
personalized portfolio creation, enhanced investor engagement,
democratized personalized investing, and reduced information
overload).
---------------------------------------------------------------------------

    While the presence of conflicts of interest between firms and
investors is not new, firms' increasing use of these PDA-like
technologies in investor interactions may expose investors to unique
risks. This includes the risk of conflicts remaining unidentified and
therefore unaddressed or identified and unaddressed. The effects of
such unaddressed conflicts may be pernicious, particularly as this
technology can rapidly transmit or scale conflicted actions across a
firm's investor base.\12\ For example, conflicts of interest can arise
from the data the technology uses (including any investor data) and the
inferences the technology makes (including in analyzing that data,
other data, securities, or other assets). These issues may render a
firm's identification of such conflicts for purposes of the firm's
compliance with applicable Federal securities laws more challenging
without specific efforts both to fully understand the PDA-like
technology it is using \13\ and to oversee conflicts that are created
by or transmitted through its use of such technology.\14\
---------------------------------------------------------------------------

    \12\ See, e.g., Sophia Duffy and Steve Parrish, You Say
Fiduciary, I Say Binary: A Review and Recommendation of Robo-
Advisors and the Fiduciary and Best Interest Standards, 17 Hastings
Bus. L.J. 3, at 26 (2021) (stating that the impact of firm conflicts
of robo-advisors ``are arguably more detrimental than personal
conflicts between an advisor and client because the number of
clients impacted by the firm conflict is potentially exponentially
higher.'') (``Robo-Advisors and the Fiduciary and Best Interest
Standards'').
    \13\ See, e.g., infra section II.A.2.b and II.A.3 (discussing
the testing and policies and procedures requirements, respectively,
of the proposed conflicts rules, which if implemented in accordance
with the proposal, would necessitate firms' developing an
understanding of the PDA-like technologies they use).
    \14\ See, e.g., Sohnke M. Bartram, Jurgen Branke & Mehrshad
Motahari, Artificial Intelligence in Asset Management (2020) (``AI
in Asset Management'') (``Understanding and explaining the
inferences made by most AI models is difficult, if not impossible.
As the complexity of the task or the algorithm grows, opacity can
render human supervision ineffective, thereby becoming an even more
significant problem.'').
---------------------------------------------------------------------------

    Moreover, PDA-like technologies may have the capacity to process
data, scale outcomes from analysis of data, and evolve at rapid
rates.\15\ While valuable in many circumstances, these technologies
could rapidly and exponentially scale the transmission of any conflicts
of interest associated with such technologies to investors.\16\ 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, push notifications on its mobile trading
application (``app''), and robo-advisory platform. If the advice or
recommendation transmitted is tainted by a conflict of interest because
the algorithm drifted \17\ to advising or recommending investments more
profitable to the firm or because the dataset underlying the algorithm
was biased toward investments more profitable to the firm, the
transmission of this conflicted advice and recommendations could spread
rapidly to many investors.
---------------------------------------------------------------------------

    \15\ See, e.g., Eray Elicik, Artificial Intelligence vs. Human
Intelligence: Can a game-changing technology play the game? (Apr.
20, 2022), https://dataconomy.com/2022/04/is-artificial-intelligence-better-than-human-intelligence/ (``Compared to the
human brain, machine learning (ML) can process more data and do so
at a faster rate.''); David Nield, Google Engineers `Mutate' AI to
Make It Evolve Systems Faster Than We Can Code Them (Apr. 17, 2020),
https://www.sciencealert.com/coders-mutate-ai-systems-to-make-them-evolve-faster-than-we-can-program-them (``[R]esearchers have tweaked
[a machine learning system] to incorporate concepts of Darwinian
evolution and shown it can build AI programs that continue to
improve upon themselves faster than they would if humans were doing
the coding.'').
    \16\ See Robo-Advisors and the Fiduciary and Best Interest
Standards, supra note 12, at 26. See also FINRA AI Report, supra
note 9 (discussing exploration of the use of AI tools by market
participants and noting, among other things, that firms should
ensure sound governance and supervision, including effective means
of overseeing suitability of recommendations, conflicts of interest,
customer risk profiles and portfolio rebalancing) (internal
quotations and citation omitted); Y. Minsky, Communications of the
ACM, OCaml for the Masses (Sept. 27, 2011), https://dl.acm.org/doi/pdf/10.1145/2018396.2018413 (explaining that ``technology carries
risk. There is no faster way for a trading firm to destroy itself
than to deploy a piece of trading software that makes a bad decision
over and over in a tight loop'' and that the author's employer seeks
to control these risks by ``put[ting] a very strong focus on
building software that was easily understood--software that was
readable.'').
    \17\ See infra note 157 and accompanying text.
---------------------------------------------------------------------------

    Unless adequately addressed, the use of these PDA-like technologies
may create or transmit conflicts of interest that place a firm's
interests ahead of investors' interests. This may arise not only when a
firm is providing investment advice or recommendations, but also in the
firm's sales practices and investor interactions more generally, such
as design elements, features, or communications that nudge or prompt
more immediate and less informed action by the investor.\18\ In light
of these developments and risks, and for the reasons we describe
further below, we are proposing that a firm's use of certain PDA-like
technologies in an investor interaction that places the firm's
interests ahead of the investors' interests involves a conflict of
interest that must be eliminated or its effects neutralized in
accordance with the proposed conflicts rules.
---------------------------------------------------------------------------

    \18\ See, e.g., CFA Institute, Ethics and Artificial
Intelligence in Investment Management: A Framework for Professionals
(2022) (stating that professionals should ensure they understand the
sources of any potential conflicts generated by the use of
algorithms and work with developers to ensure that such systems do
not inappropriately incorporate fee considerations in the algorithm
generating the investment advice).
---------------------------------------------------------------------------

B. Background

1. Evolution in the Investment Industry and Its Technology Use
    Over the last several decades, firms' use of technology to interact
with investors and provide products and services has evolved
significantly, and with it, the nature and extent of the conflicts of
interest this use can create. When Congress first enacted the

Exchange Act and the Advisers Act, firms were increasingly deploying
what were then considered advanced technologies, such as punch cards
and telex machines. As technology improved, firms began adopting other
technologies, such as computers, email, spreadsheets, and the internet.
The Commission has previously observed that these and other
technologies have helped to promote transparency, liquidity, and
efficiency in our capital markets.\19\ If responsibly implemented and
overseen by firms, new technologies can aid firms' interactions with
investors, and bring greater access and product choice, potentially at
a lower cost, without compromising investor protection, capital
formation, and fair, orderly, and efficient markets.
---------------------------------------------------------------------------

    \19\ See Interpretation on Use of Electronic Media, Investment
Company Act Release No. 24426 (Apr. 28, 2000) [65 FR 25843 (May 4,
2000)], at section I; see also Investment Adviser Marketing,
Investment Advisers Act No. 5653 (Dec. 22, 2020) [86 FR 13024 (Mar.
5, 2021)], at section I (``Investment Adviser Marketing Release'')
(noting that the rules are ``designed to accommodate the continual
evolution and interplay of technology and advice'').
---------------------------------------------------------------------------

    Where once investors placed trades with their broker in-person,
they eventually began to place orders over the phone, and then through
a website. Now investors can instantaneously place a trade directly
through an app on a smart phone and, instead of a recommendation
delivered by a human, they may receive push notifications potentially
designed to affect trading behavior. These technological interactions
can be designed to respond to human behavior, for example, sending
increased notifications for certain investment products depending on
where the person scrolling through investment products pauses on her
smartphone. As technology continues to evolve, we believe that firms
are likely to increase their reliance on behavioral science frameworks
in influencing investor behavior.\20\ Investors that previously met in
person with their advisers are now able to access computer-generated
advice that is delivered rapidly in an app to many investors by, for
example, a robo-adviser. Rather than advertising in local newspapers,
making cold calls, or relying on referrals, firms are now digitally
targeting investors.\21\
---------------------------------------------------------------------------

    \20\ See, e.g., Robert W. Cook, President and CEO of FINRA,
Statement Before the Financial Services Committee U.S. House of
Representatives (May 6, 2021), https://www.finra.org/media-center/speeches-testimony/statement-financial-services-committee-us-house-representatives (addressing the ``recent trends of retail trading
platforms is the use of `game-like' and other features that may
encourage investor behaviors'' and ``the growing prevalence of these
features''); Margaret Franklin, Investment Gamification: Not All
Cons, Some Important Pros, Kiplinger (Feb. 20, 2023), https://www.kiplinger.com/investing/investment-gamification-pros-and-cons
(discussing the use of behavioral techniques and the rising
influence of social media, and stating that the gamification ``style
of trading, ushered in largely by the next generation of investors,
is likely here to stay.''). See also James Tierney, Investment
Games, 72 Duke L.J. 353, 355 (Nov. 2022) (describing the growth of
retail investing and discussing gamification, including how ``mobile
app developers have innovated in user-interface design to compete
with incumbent brokers [by including features such as] intuitive and
appealing design, as well as digital engagement practices that
encourage interaction with the app and that shape the information
users consider in investing,''); Jill E. Fisch, GameStop and the
Reemergence of the Retail Investor, 102 B.U. L. Rev. 1799, 1802
(Oct. 2022) (discussing gamification and the ``evidence that retail
investment and engagement will both continue and evolve.''); Ernst &
Young, Social investing: behavioral insights for the modern wealth
manager (Apr. 2021), https://www.ey.com/en_us/wealth-asset-management/social-investing-behavioral-insights-for-the-modern-wealth-manager (``As firms continue to develop social investing
operating models, they can use behavioral science frameworks to
better understand how their client segments are influenced by
digital design and choice architecture[.]'').
    \21\ See, e.g., Disclosure Innovations in Advertising and Other
Communications with the Public, FINRA Regulatory Notice 19-31 (Sept.
19, 2019), https://www.finra.org/rules-guidance/notices/19-31; see
also Leslie K. John, Tami Kim, and Kate Barasz, Ads that Don't
Overstep, Harvard Bus. Rev. (Jan.- Feb. 2018), https://hbr.org/2018/01/ads-that-dont-overstep.
---------------------------------------------------------------------------

    In recent years, we have observed a rapid expansion in firms'
reliance on technology and technology-based products and services.\22\
The use of technology is now central to how firms provide their
products and services to investors.\23\ Some firms and investors in
financial markets now use new technologies such as AI, machine
learning, NLP, and chatbot technologies to make investment decisions
and communicate between firms and investors.\24\ In addition, existing
technologies for data-analytics and data collection continue to improve
and find new applications.\25\
---------------------------------------------------------------------------

    \22\ See generally Marc Andreessen, Why Software Is Eating the
World, Wall St. J. (Aug. 20, 2011), http://www.wsj.com/articles/SB10001424053111903480904576512250915629460 (discussing, among other
things, the transformation of the financial services industry by
software over the last 30 years) (``Why Software is Eating the
World''); Robo-Advisors and the Fiduciary and Best Interest
Standards, supra note 12, at 4 (stating that ``[o]ver the past
decade, robo-advisors, or automated systems for providing financial
advice and services, are becoming more and more popular'' and
discussing estimated growth); Nicole G. Iannarone, Fintech's
Promises and Perils Computer as Confidant: Digital Investment Advice
and the Fiduciary Standard, 93 Chi.-Kent L. Rev. 141, 141 (2018)
(``Automated investment advisers permeate the investment industry.
Digital investment advisers are the fastest growing segment of
financial technology (FinTech) and are disrupting traditional
investment advisory delivery models.'') (citations omitted).
    \23\ See, e.g., Investment Adviser Marketing Release, supra note
19, at section I (``The concerns that motivated the Commission to
adopt the advertising and solicitation rules [in 1961 and 1979,
respectively] still exist today, but investment adviser marketing
has evolved with advances in technology. In the decades since the
adoption of both the advertising and solicitation rules, the use of
the internet, mobile applications, and social media has become an
integral part of business communications. Consumers today often rely
on these forms of communication to obtain information, including
reviews and referrals, when considering buying goods and services.
Advisers and third parties also rely on these same types of outlets
to attract and refer potential customers.''); FINRA Investor
Education Foundation, Investors in the United States: The Changing
Landscape (Dec. 2022) https://www.finrafoundation.org/sites/finrafoundation/files/NFCS-Investor-Report-Changing-Landscape.pdf
(discussing, among others, website and mobile app use for placing
trades and use of social media sites for obtaining investment
information).
    \24\ Michael Kearns & Yuriy Nevmyvaka Machine Learning for
Market Microstructure and High Frequency Trading, High Frequency
Trading--New Realities for Traders, Markets and Regulators (David
Easley, Marcos Lopez de Prado & Maureen O'Hara editors, Risk Books,
2013); see also Christian Thier & Daniel dos Santos Monteiro, How
Much Artificial Intelligence Do Robo-Advisors Really Use? (Aug. 31,
2022), https://ssrn.com/abstract=4218181; Imani Moise, Bond
Investing Gets the Robo-Adviser Treatment, The Wall Street Journal
(June 7, 2023), https://www.wsj.com/articles/buying-bonds-is-hard-heres-a-way-to-let-a-robot-do-it-70a4587b.
    \25\ Natasha Lekh & Petr P[aacute]tek, What's the Future of Web
Scraping in 2023?, APIFY Blog (Jan. 20, 2023), https://blog.apify.com/future-of-web-scraping-in-2023/; Jon Martindale, Best
Apps to Use GPT-4, Digitaltrends (May 4, 2023), https://www.digitaltrends.com/computing/best-apps-to-use-gpt-4/.
---------------------------------------------------------------------------

2. Current PDA-Like Technology Use and Expected Growth

    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 for, predict, guide, forecast, or direct
investment-related behaviors or outcomes.\26\ Moreover, the advent and
growth of services available on certain digital platforms, such as
those offered by online brokerages and robo-advisers, have multiplied
the opportunities for retail investors, in particular, to invest and
trade in securities, and in small amounts through fractional
shares.\27\

This increased accessibility has been one of the key factors associated
with the increase of retail investor participation in U.S. securities
markets in recent years.\28\ Firms have also expanded their use of
technology to include ``digital engagement practices'' or ``DEPs,''
such as behavioral prompts, differential marketing, game-like features
(commonly referred to as ``gamification''), and other design elements
or features designed to engage retail investors when using a firm's
digital platforms (e.g., website, portal, app) \29\ for services such
as trading, robo-advice, and financial education. Our staff has
observed that firms use technology to more efficiently develop
investment strategies, including by using technology to automate their
services, and to analyze the success of specific features and marketing
practices at influencing retail investor behavior.\30\ Firms may also
seek to lower expenses by replacing customer service personnel with
chatbots that can address common customer questions, and outsourcing
their back office operations to vendors that rely heavily on
technology.\31\
---------------------------------------------------------------------------

    \26\ See generally Alessio Azzutti, Wolf-Goerge Ringe, H.
Siegfried Stiehl, Machine Learning, Market Manipulation, and
Collusion on Capital Markets: Why the ``Black Box'' Matters, 43 U.
Pa. J. Int'l L. 1 (2021), https://scholarship.law.upenn.edu/cgi/viewcontent.cgi?article=2035&context=jil (``Machine Learning and
Market Manipulation'') (discussing current uses of algorithmic
trading and exploring the risks to market integrity in connection
with the evolving uses of artificial intelligence in algorithmic
trading).
    \27\ See, e.g., Nolan Schloneger, A Case for Regulating Gamified
Investing, 56 Ind. L. Rev. 175 (2022) (``Th[e] rise [of investing
applications] is largely attributed to zero commission and
fractional-share trading.''); John Csiszar, How Our Approach to
Investing Has Changed Forever, YAHOO! (Mar. 10, 2021), https://www.yahoo.com/now/approach-investing-changed-forever-190007929.html
(``Fractional share trading is just in its infancy but appears well
on its way to changing how consumers approach investing. With
fractional share trading, you can invest any dollar amount into
stock, even if you don't have enough to buy a single share . . . .
Fractional share investing allows nearly anyone to get involved in
the stock market without needing $100,000 or more to buy a properly
diversified portfolio of individual stock names.''). See also Staff
Report on Equity and Options Market Structure Conditions in Early
2021 (Oct. 14, 2021), https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf (``Some brokers
have sought to attract new customers by offering the ability to
purchase fractional shares. Fractional shares give investors the
ability to purchase less than 1 share of a stock.''). Any staff
statements represent the views of the staff. They are not a rule,
regulation, or statement of the Commission. Furthermore, the
Commission has neither approved nor disapproved their content. These
staff statements, like all staff statements, have no legal force or
effect: they do not alter or amend applicable law; and they create
no new or additional obligations for any person.
    \28\ See, e.g., Maggie Fitzgerald, Retail Investors Continue to
Jump Into the Stock Market After GameStop Mania, CNBC (Mar. 10,
2021), https://www.cnbc.com/2021/03/10/retail-investor-ranks-in-the-stock-market-continue-to-surge.html (providing year-over-year app
download statistics for Robinhood, Webull, Sofi, Coinbase, TD
Ameritrade, Charles Schwab, E-Trade, and Fidelity from 2018-2020,
and monthly figures for January and February of 2021); John
Gittelsohn, Schwab Boosts New Trading Accounts 31% After Fees Go to
Zero, Bloomberg (Nov. 14, 2019), https://www.bloomberg.com/news/articles/2019-11-14/schwab-boosts-brokerage-accounts-by-31-after-fees-cut-to-zero (noting that Charles Schwab opened 142,000 new
trading accounts in October, a 31% jump over September's pace).
    \29\ Examples of DEPs include the following: social networking
tools; games, streaks and other contests with prizes; points,
badges, and leaderboards; notifications; celebrations for trading;
visual cues; ideas presented at order placement and other curated
lists or features; subscriptions and membership tiers; and chatbots.
    \30\ See, e.g., SEC Investor Bulletin: Robo-Advisers (Feb. 23,
2017), https://www.sec.gov/oiea/investor-alerts-bulletins/ib_robo-advisers (discussing automated digital investment advisory
programs); see also FINRA AI Report, supra note 9 (discussing three
areas where broker-dealers are evaluating or using AI in the
securities industry: communications with customers, investment
processes, and operational functions).
    \31\ See, e.g., SS&C Gets Automation Rolling with 180 `Digital
Workers', Ignites (Feb. 9, 2023), https://www.ignites.com/c/3928224/508304?referrer_module=searchSubFromIG&highlight=SS&C.
---------------------------------------------------------------------------

    The rate at which PDA-like technologies continues to evolve is
increasing \32\ and firms are exploring and deploying AI-based
applications across different functions of their organizations,
including customer facing, investment, and operational activities.\33\
These PDA-like technologies are complex and may include several
categories of machine learning \34\ algorithms, such as deep
learning,\35\ supervised learning,\36\ unsupervised learning,\37\ and
reinforcement learning \38\ processes.\39\ In the past few years, these
PDA-like technologies have made increasing use of natural language
processing and natural language generation.\40\ For example, AI has
revolutionized chatbots by enabling them to understand and respond to
natural language more accurately and learn and improve responses over
time, leading to more personalized interactions with users. Recently, a
new wave of online chatbots has rapidly moved machines using AI into
new territory.\41\ Some of these chatbots have passed what is known as
the ``Turing test'' and have become virtually indistinguishable from
humans in particular situations.\42\ AI use is increasing year over
year and in an array of applications.\43\ For instance, some robo-
advisers use chatbots and NLP technology for their online platforms to
provide investment advice and manage investment portfolios.\44\ These
platforms may use a combination of AI, machine learning, NLP, and
chatbot technologies to provide personalized investment recommendations
to customers based on customer risk tolerance and investment goals.
---------------------------------------------------------------------------

    \32\ See, e.g., Robin Feldman and Kara Stein, AI Governance in
the Financial Industry, 27 Stan. J.L. Bus. & Fin. 94, 122 (2022)
(describing AI as ``a technology that is rapidly evolving and
capable of learning.'').
    \33\ See, e.g., Merav Ozair, FinanceGPT: The Next Generation of
AI-Powered Robo Advisors and Chatbots (June 27, 2023), https://www.nasdaq.com/articles/financegpt-the-next-generation-of-ai-powered-robo-advisors-and-chatbots (describing current uses and
development) (``FinanceGPT'').
    \34\ FINRA described ``Machine Learning (ML)'' as ``a field of
computer science that uses algorithms to process large amounts of
data and learn from it. Unlike traditional rules-based programming,
[machine learning] models learn from input data to make predictions
or identify meaningful patterns without being explicitly programmed
to do so. There are different types of [machine-learning] models,
depending on their intended function and structure[.]'' See FINRA AI
Report, supra note 9.
    \35\ FINRA described a ``deep learning model'' as a model
``built on an artificial neural network, in which algorithms process
large amounts of unlabeled or unstructured data through multiple
layers of learning in a manner inspired by how neural networks
function in the brain. These models are typically used when the
underlying data is significantly large in volume, obtained from
disparate sources, and may have different formats (e.g., text,
voice, and video).'' See id.
    \36\ FINRA described a ``supervised machine learning'' as a
model that ``is trained with labeled input data that correlates to a
specified output. . . . The model is continuously refined to provide
more accurate output as additional training data becomes available.
After the model has learned from the patterns in the training data,
it can then analyze additional data to produce the desired output .
. . .'' See id.
    \37\ As described by FINRA, in unsupervised machine learning,
``the input data is not labeled nor is the output specified.
Instead, the models are fed large amounts of raw data and the
algorithms are designed to identify any underlying meaningful
patterns. The algorithms may cluster similar data but do so without
any preconceived notion of the output . . . .'' See id.
    \38\ As described by FINRA, in reinforcement learning, ``the
model learns dynamically to achieve the desired output through trial
and error. If the model algorithm performs correctly and achieves
the intended output, it is rewarded. Conversely, if it does not
produce the desired output, it is penalized. Accordingly, the model
learns over time to perform in a way that maximizes the net reward .
. . .'' See id.
    \39\ See also FSB AI Report, supra note 9; Treasury RFI, supra
note 9.
    \40\ See, e.g., FINRA AI Report, supra note 9.
    \41\ See Cade Metz, How Smart Are the Robots Getting?, The New
York Times (Jan. 20, 2023, updated Jan. 25, 2023).
    \42\ Id. The Turing test is a subjective test determined by
whether the person interacting with a machine believes that they are
interacting with another person. See id.
    \43\ Embracing the Rapid Pace of AI, MIT Technology Review
Insights (May 19, 2021), https://www.technologyreview.com/2021/05/19/1025016/embracing-the-rapid-pace-of-ai/.
    \44\ See, e.g., FinanceGPT, supra note 33 (describing current
uses and development).
---------------------------------------------------------------------------

    As a result of a growing desire to perform functions remotely and
through automated means, the COVID-19 pandemic accelerated the adoption
of certain PDA-like technologies.\45\ Many

expect this momentum to continue, with AI becoming a mainstream
technology across many industries, including the financial sector.\46\
Organizations, including firms in the securities industry,\47\ are
using AI in a multitude of ways, including responding to customer
inquiries, automating back-office processes, quality control,\48\ risk
management, client identification and monitoring, selection of trading
algorithms, and portfolio management.\49\ Others are actively
developing investment advisory services based on PDA-like
technologies.\50\ Further, recent advancements in data collection
techniques have significantly enhanced the scale and scope of data
analytics, and its potential applications. Due to increases in
processing power and data storage capacity, a vast amount of data is
now available for high-speed analysis using these technologies.\51\
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.\52\ Consequently, these technologies can be applied
in novel and powerful ways which may be subtle, such as using the
layout of an app and choice of data presentation and formatting to
influence trading decisions.\53\ Some trading apps use PDA and AI/
machine learning along with detailed user data to increase user
engagement and trading activity.\54\
---------------------------------------------------------------------------

    \45\ See, e.g., Joe McKendrick, AI Adoption Skyrocketed Over the
Last 18 Months, Harvard Bus. Rev. (Sept. 27, 2021), https://hbr.org/2021/09/ai-adoption-skyrocketed-over-the-last-18-months (``The
[COVID-19] crisis accelerated the adoption of analytics and AI, and
this momentum will continue into the 2020s, surveys show. Fifty-two
percent of companies accelerated their AI adoption plans because of
the Covid crisis, a study by PwC finds. Just about all, 86%, say
that AI is becoming a `mainstream technology' at their company in
2021. Harris Poll, working with Appen, found that 55% of companies
reported they accelerated their AI strategy in 2020 due to Covid,
and 67% expect to further accelerate their AI strategy in 2021.'');
KPMG, Thriving in an AI World: Unlocking the Value of AI Across
Seven Key Industries (May 2021), at 5, https://advisory.kpmg.us/articles/2021/thriving-in-an-ai-world.html (``Thriving in an AI
World''); Blake Schmidt and Amanda Albright, AI Is Coming for Wealth
Management. Here's What That Means, Bloomberg Markets (Apr. 21,
2023), https://www.bloomberg.com/news/articles/2023-04-21/vanguard-fidelity-experts-explain-how-ai-is-changing-wealth-management
(discussing experts views on AI impact on the wealth management
industry).
    \46\ Id.
    \47\ See IOSCO, The use of artificial intelligence and machine
learning by market intermediaries and asset managers (Sept. 2021),
at 1 (``IOSCO AI/ML Report''), iosco.org/library/pubdocs/pdf/IOSCOPD684.pdf (``Artificial Intelligence (AI) and Machine Learning
(ML) are increasingly used in financial services, due to a
combination of increased data availability and computing power. The
use of AI and ML by market intermediaries and asset managers may be
altering firms' business models.'').
    \48\ See Thriving in an AI World, supra note 45; see also FINRA
AI Report, supra note 9, at 5-10 (noting the use of AI in the
securities industry for communications with customers, investment
processes, and operational functions); FINRA, Deep Learning: The
Future of the Market Manipulation Surveillance Program https://www.finra.org/media-center/finra-unscripted/deep-learning-market-surveillance (``FINRA's Market Regulation and Technology teams
recently wrapped up an extensive project to migrate the majority of
FINRA's market manipulation surveillance program to using deep
learning in what is perhaps the largest application of artificial
intelligence in the RegTech space to date.''); Machine Learning and
Market Manipulation, supra note 26; IOSCO AI/ML Report, id.
    \49\ IOSCO AI/ML Report, supra note 47.
    \50\ See, e.g., Hugh Son, JPMorgan is developing a ChatGPT-like
A.I. service that gives investment advice, CNBC (May 25, 2023),
https://www.cnbc.com/2023/05/25/jpmorgan-develops-ai-investment-advisor.html (discussing a trademark application filed by JPMorgan
for a product called IndexGPT that will utilize ``cloud computing
software using artificial intelligence'' for ``analyzing and
selecting securities tailored to customer needs[.]'').
    \51\ See, e.g., Dimitris Andriosopoulos et al., Computational
Approaches and Data Analytics in Financial Services: A Literature
Review, 70 J. Operational Rsch. Soc. 1581 (2019), https://doi.org/10.1080/01605682.2019.1595193; James Lawler & Anthony Joseph, Big
Data Analytics Methodology in the Financial Industry, 15 Info. Sys.
Ed. J. 38 (July 2017), https://isedj.org/2017-15/n4/ISEDJv15n4p38.html.
    \52\ Daniel Broby, The Use of Predictive Analytics in Finance, 8
J. Fin & Data Sci. 145 (Nov. 2022), https://doi.org/10.1016/j.jfds.2022.05.003; OECD, Artificial Intelligence, Machine Learning
and Big Data in Finance: Opportunities, Challenges, and Implications
for Policy Makers (2021), https://www.oecd.org/finance/financial-markets/Artificial-intelligence-machine-learning-big-data-in-finance.pdf.
    \53\ See, e.g., Sayan Chaudhury and Chinmay Kulkarni, Design
Patterns of Investing Apps and Their Effects on Investing Behaviors
(2021) (``Chaudhury & Kulkarni''), dl.acm.org/doi/fullHtml/10.1145/3461778.3462008 (``investing apps can be considered as technical and
social choice architectures that influence investing behavior'').
    \54\ See, e.g., Alex McFarland, 10 ``Best'' AI Stock Trading
Bots, Unite.AI (June 4, 2023), https://www.unite.ai/stock-trading-bots/.
---------------------------------------------------------------------------

    Any risks of conflicts of interest associated with AI use will
expand as firms' use of AI grows. These risks will have broad
consequences if AI makes decisions that favor the firms' interests and
then rapidly deploys that information to investors, potentially on a
large scale.\55\ Firms' nascent use of AI may already be exposing
investors to these types of risks as well as others.\56\ We are
concerned that firms will intentionally or unintentionally take their
own interest into account in the data or software underlying the
applicable AI, as well as the applicable PDA-like technologies,
resulting in investor harm. Among other things, a firm may use these
technologies to optimize for the firm's revenue or to generate
behavioral prompts or social engineering to change investor behavior in
a manner that benefits the firm but is to the detriment of the
investor.
---------------------------------------------------------------------------

    \55\ See, e.g., Robo-Advisors and the Fiduciary and Best
Interest Standards, supra note 12 (stating that the impact of firm
conflicts of robo-advisors ``are arguably more detrimental than
personal conflicts between an advisor and client because the number
of clients impacted by the firm conflict is potentially
exponentially higher.''). See also AI in Asset Management, supra
note 14 (``AI can make wrong decisions based on incorrect inferences
that have captured spurious or irrelevant patterns in the data. For
example, ANNs [artificial neural networks] that are trained to pick
stocks with high expected returns might select illiquid, distressed
stocks.''); FINRA AI Report, supra note 9, at 11-19 (noting that the
use of AI ``raises several concerns that may be wide-ranging across
various industries as well as some specific to the securities
industry. Over the past few years, there have been numerous
incidents reported about AI applications that may have been
fraudulent, nefarious, discriminatory, or unfair, highlighting the
issue of ethics in AI applications.''); FINRA AI Report, supra note
9, at 13 (``Depending on the use case, data scarcity may limit the
model's analysis and outcomes, and could produce results that may be
narrow and irrelevant. On the other hand, incorporating data from
many different sources may introduce newer risks if the data is not
tested and validated, particularly if new data points fall outside
of the dataset used to train the model.'').
    \56\ See, e.g., FINRA AI Report, supra note 9, at 5 (``The use
of AI-based applications is proliferating in the securities
industry[.]''); Sophia Duffy and Steve Parrish, You Say Fiduciary, I
Say Binary: A Review and Recommendation of Robo-Advisors and the
Fiduciary and Best Interest Standards, 17 Hastings Bus. L.J. 3, at
26 (2021) (``robo-advisors can be, and often are, intentionally
programmed to favor the institution by making recommendations that
favor the institution's products, rebalance client portfolios in
ways which will allow the institution to earn more fees, and
otherwise make recommendations that benefit the firm'').
---------------------------------------------------------------------------

3. Commission Protection of Investors as Technology Has Evolved
    As noted above, firms' use of technology and subsequent adaptation
incorporating emerging technologies are not new.\57\ At the same time,
the Commission has addressed firms' relationships with investors in a
variety of ways to ensure investor protection as use of technology in
those relationships has evolved over time.\58\ The proposal, thus, is
consistent with the Commission's practice of evolving our regulation in
light of market and technological developments.
---------------------------------------------------------------------------

    \57\ See supra section I.B.2.
    \58\ See infra note 114.
---------------------------------------------------------------------------

    Broker-dealers and investment advisers are currently subject to
extensive obligations under Federal securities laws and regulations,
and, in the case of broker-dealers, rules of self-regulatory
organizations,\59\ that are

designed to promote conduct that, among other things, protects
investors, including protecting investors from conflicts of
interest.\60\ To the extent PDA-like technologies are used in investor
interactions that are subject to existing obligations, those
obligations apply. These obligations include, but are not limited to,
obligations related to investment advice and recommendations; \61\
general and specific requirements aimed at addressing certain conflicts
of interest, including requirements to eliminate, mitigate, or disclose
certain conflicts of interest; disclosure of firms' services, fees, and
costs; disclosure of certain business practices, advertising,
communications with the public (including the use of ``investment
analysis tools''); supervision; and obligations related to policies and
procedures.\62\ In addition to these obligations, Federal securities
laws and regulations broadly prohibit fraud by broker-dealers and
investment advisers as well as fraud by any person in the offer,
purchase, or sale of securities, or in connection with the purchase or
sale of securities.
---------------------------------------------------------------------------

    \59\ Any person operating as a ``broker'' or ``dealer'' in the
U.S. securities markets must register with the Commission, absent an
exception or exemption. See Exchange Act section 15(a), 15 U.S.C.
78o(a); see also Exchange Act sections 3(a)(4) and 3(a)(5), 15
U.S.C. 78c(a)(4) and 78c(a)(5) (definitions of ``broker'' and
``dealer,'' respectively). Generally, all registered broker-dealers
that deal with the public must become members of FINRA, a registered
national securities association, unless the broker or dealer effects
transactions in securities solely on an exchange of which it is a
member. See Exchange Act section 15(b)(8), 15 U.S.C. 78o(b)(8); see
also 17 CFR 240.15b9-1 (providing an exemption from Section
15(b)(8)). FINRA is the sole national securities association
registered with the SEC under Section 15A of the Exchange Act.
Because this release is focused on broker-dealers that deal with the
public and are FINRA member firms (unless an exception applies), we
refer to FINRA rules as broadly applying to ``broker-dealers,''
rather than to ``FINRA member firms.''
    \60\ See infra section III.C.3; Fiduciary Interpretation, supra
note 8, at section II.C. (``The duty of loyalty requires that an
adviser not subordinate its clients' interests to its own.''); see
also Reg BI Adopting Release, supra note 8, at section II.A.1. (The
``without placing the financial or other interest . . . ahead of the
interest of the retail customer'' phrasing recognizes that while a
broker-dealer will inevitably have some financial interest in a
recommendation--the nature and magnitude of which will vary--the
broker-dealer's interests cannot be placed ahead of the retail
customer's interest''). Additionally, broker-dealers often provide a
range of services that do not involve a recommendation to a retail
customer--which is required in order for Reg BI to apply--and those
services are subject to general and specific requirements to address
associated conflicts of interest under the Exchange Act, Securities
Act of 1933, and relevant self-regulatory organization (``SRO'')
rules as applicable. See also FINRA Report on Conflicts of Interest
(Oct. 2013), at Appendix I (Conflicts Regulation in the United
States and Selected International Jurisdictions) (``FINRA Conflict
Report''), https://www.finra.org/sites/default/files/Industry/p359971.pdf (describing broad obligations under SEC and FINRA rules
as well as specific conflicts-related disclosure requirements under
FINRA rules).
    \61\ See, e.g., 17 CFR 240.15l-1(a)(1) (``Exchange Act rule 15l-
1(a)(1)'') (requiring broker-dealers and their associated persons to
act in the best interest of retail customers when making
recommendations, without placing the financial or other interest of
the broker-dealer or its associated person ahead of the interest of
the retail customer).
    \62\ Compliance with the proposed conflicts rules would not
alter a broker-dealer's or investment adviser's existing obligations
under the Federal securities laws. The proposed conflicts rules
would apply in addition to any other obligations under the Exchange
Act and Advisers Act, along with any rules the Commission may adopt
thereunder, and any other applicable provisions of the Federal
securities laws and related rules and regulations.
---------------------------------------------------------------------------

    The Commission has long acted to protect investors against the harm
that can come when a firm acts on its conflicts of interest.\63\ For
example, the Commission has brought enforcement actions regarding an
investment adviser's fiduciary duty to its clients with respect to
conflicts of interest.\64\ Similarly, the Commission has reinforced
fraud protection for investors in pooled investment vehicles against
conflicts of interest through rule 206(4)-8.\65\ The Commission
regulates investment adviser advertising and marketing practices to
protect against, among others, adviser conflicts of interest that may
taint such marketing, including through recent amendments adapting
those protections in light of the evolution of practices and
technologies.\66\
---------------------------------------------------------------------------

    \63\ See infra section III.C.
    \64\ See, e.g., SEC Press Release, SEC Share Class Initiative
Returning More Than $125 Million to Investors: Reflecting SEC's
Commitment to Retail Investors, 79 Investment Advisers Who Self-
Reported Advisers Act Violations Agree to Compensate Investors
Promptly, Ensure Adequate Fee Disclosures (Mar. 11, 2019), https://www.sec.gov/news/press-release/2019-28 (describing settled orders
against 79 investment advisers finding that the settling investment
advisers placed their clients in mutual fund share classes that
charged 12b-1 fees when lower-cost share classes of the same fund
were available to their clients without adequately disclosing that
the higher cost share class would be selected; according to the
SEC's orders, the 12b-1 fees were routinely paid to the investment
advisers in their capacity as brokers, to their broker-dealer
affiliates, or to their personnel who were also registered
representatives, creating a conflict of interest with their clients,
as the investment advisers stood to benefit from the clients' paying
higher fees); SEC v. Sergei Polevikov, et al., Litigation Release
No. 25475 (Aug. 17, 2022) (settled order) (final judgment against
employee working as a quantitative analyst at two asset management
firms ``for perpetrating a front-running scheme that generated
profits of approximately $8.5 million''); SEC Brings Settled Actions
Charging Cherry-Picking and Compliance Failures, Adm. Proc. File No.
3-20955 (Aug 10, 2022) (settled order) (alleged multi-year cherry-
picking scheme of former investment adviser representative of
registered investment adviser preferentially allocating profitable
trades or failing to allocate unprofitable trades to a adviser's
personal accounts at the expense of the advisers client accounts).
    \65\ 17 CFR 275.206(4)-8; see, e.g., In re. Virtua Capital
Management, LLC, et al., Advisers Act Release No. 6033 (May 23,
2022) (allegedly failing to disclose conflicts of interest and
associated fees, and breaching fiduciary duty to multiple private
investment funds) (settled order).
    \66\ See Investment Adviser Marketing Release, supra note 19, at
section I (``The concerns that motivated the Commission to adopt the
advertising and solicitation rules [in 1961 and 1979, respectively]
still exist today, but investment adviser marketing has evolved with
advances in technology. In the decades since the adoption of both
the advertising and solicitation rules, the use of the internet,
mobile applications, and social media has become an integral part of
business communications. Consumers today often rely on these forms
of communication to obtain information, including reviews and
referrals, when considering buying goods and services. Advisers and
third parties also rely on these same types of outlets to attract
and refer potential customers.'').
---------------------------------------------------------------------------

    Likewise, broker-dealers have long been subject to Commission and
SRO regulations and rules that govern their business conduct, including
general and specific obligations to address conflicts of interest.\67\
For example, under existing antifraud provisions of the Exchange Act, a
broker-dealer has a duty to disclose material adverse information to
its customers.\68\ Indeed, the Commission has enforced a broker-
dealer's duty to disclose material conflicts of interest under the
antifraud provisions.\69\ Broker-dealers are subject to specific FINRA
rules aimed at addressing certain conflicts of interest.\70\ Moreover,
in 2019 the Commission adopted Regulation Best Interest (``Reg BI''),
which was designed to enhance the quality of broker-dealer
recommendations to retail customers and reduce the potential harm to
retail customers that may be caused by conflicts of interest,\71\ by
requiring broker-dealers that make recommendations to retail customers
to, among other things, establish, maintain, and enforce policies and
procedures reasonably designed to identify and

disclose, mitigate, or eliminate, conflicts associated with a
recommendation, including conflicts of interest that may result through
the use of PDA-like technology to make recommendations (Reg BI's
``Conflict of Interest Obligation'').\72\
---------------------------------------------------------------------------

    \67\ See infra section III.C.3
    \68\ A broker-dealer may be liable if it does not disclose
``material adverse facts of which it is aware.'' See, e.g., Chasins
v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2nd Cir. 1970); SEC v.
Hasho, 784 F. Supp. 1059, 1110 (S.D.N.Y. 1992); In the Matter of
RichMark Capital Corp., Exchange Act Release No. 48758 (Nov. 7,
2003) (Commission Opinion) (``When a securities dealer recommends
stock to a customer, it is not only obligated to avoid affirmative
misstatements, but also must disclose material adverse facts of
which it is aware. That includes disclosure of `adverse interests'
such as `economic self-interest' that could have influenced its
recommendation.'') (citations omitted).
    \69\ See, e.g., In re. Edward D. Jones & Co, Securities Act
Release No. 8520 (Dec. 22, 2004) (settled order) (broker-dealer
violated antifraud provisions of Securities Act and Exchange Act by
failing to disclose conflicts of interest arising from receipt of
revenue sharing, directed brokerage payments and other payments from
``preferred'' families that were exclusively promoted by broker-
dealer); In re. Morgan Stanley DW Inc., Securities Act Release No.
8339 (Nov. 17, 2003) (settled order) (broker-dealer violated
antifraud provisions of Securities Act by failing to disclose
special promotion of funds from families that paid revenue sharing
and portfolio brokerage).
    \70\ FINRA rules establish restrictions on the use of non-cash
compensation in connection with the sale and distribution of mutual
funds, variable annuities, direct participation program securities,
public offerings of debt and equity securities, investment company
securities, real estate investment trust programs, and the use of
non-cash compensation to influence or reward employees of others.
See FINRA Rules 2310, 2320, 2331, 2341, 5110, and 3220. These rules
generally limit the manner in which members can pay or accept non-
cash compensation and detail the types of non-cash compensation that
are permissible.
    \71\ See Reg BI Adopting Release supra note 8, at text
accompanying n.21.
    \72\ 17 CFR 240.15l-1(a)(2)(iii) (``Exchange Act rule 15l-
1(a)(2)(iii)'').
---------------------------------------------------------------------------

    The Commission has and will continue to bring enforcement actions
for violations of the Federal securities laws that entail the use of
PDA-like technologies. However, the rapid acceleration of PDA-like
technologies and their adoption in the investment industry,\73\ the
additional challenges associated with identifying and addressing
conflicts of interest resulting from the use of these new technologies,
and the concerns relating to scalability, discussed above, reinforce
the importance of ensuring our regulatory regime specifically addresses
these issues. In particular, disclosure may be ineffective in light of,
as discussed above, the rate of investor interactions, the size of the
datasets, the complexity of the algorithms on which the PDA-like
technology is based, and the ability of the technology to learn
investor preferences or behavior, which could entail providing
disclosure that is lengthy, highly technical, and variable, which could
cause investors difficulty in understanding the disclosure.
---------------------------------------------------------------------------

    \73\ See, e.g., Amy Caiazza, Rob Rosenblum, and Danielle
Sartain, Investment Advisers' Fiduciary Duties: The Use of
Artificial Intelligence, Harvard Law School Forum on Corporate
Governance (June 11, 2020), https://corpgov.law.harvard.edu/2020/06/11/investment-advisers-fiduciary-duties-the-use-of-artificial-intelligence/ (``Artificial intelligence (AI) is an increasingly
important technology within the investment management industry.'');
FINRA AI Report, supra note 9, at 5 (``The use of AI-based
applications is proliferating in the securities industry and
transforming various functions within broker-dealers.'').
---------------------------------------------------------------------------

    In light of these concerns, and the harm to investors that can
result when firms act on conflicts of interest, we are proposing rules
to address conflicts of interest associated with a firm's use of PDA-
like technologies when interacting with investors that are contrary to
the public interest and the protection of investors. In particular, the
recent and rapid expansion of PDA-like technologies in the context of
investment-related activities, without specific oversight obligations
tailored to the specific risks involved in their use, can lead to
outcomes that financially benefit firms at the expense of investors.
Such a harm to investors might include the use of PDA-like technologies
that prompt investors to enroll in products or services that
financially benefit the firm but may not be consistent with their
investment goals or risk tolerance, encourage investors to enter into
more frequent trades or employ riskier trading strategies (e.g., margin
trading) that will increase the firm's profit at the investors'
expense, or inappropriately steer investors toward complex and risky
securities products inconsistent with investors' investment objectives
or risk profiles that result in harm to investors but that financially
benefit the firm. Due to the inherent complexity and opacity of these
technologies as well as their potential for scaling, we are proposing
that such conflicts of interest should be eliminated or their effects
should be neutralized, rather than handled by other methods of
addressing the conflicts, such as through disclosure and consent.
Moreover, many of these technologies provide means--for example, A/B
testing \74\--to empirically assess the conflicts' impact and thus to
neutralize the effect of a conflict on investors. Further, reliance on
scalable, complex, and opaque PDA-like technologies can result in
operational challenges or shortcomings. For example, failure to
identify and address conflicts that may be present in the PDA-like
technology used to steer investors toward a product or service could
result in a firm's failure to identify the risks to investors of
certain investing behaviors that place the firm's interest ahead of
investors' interest as well as inadequate compliance policies and
procedures that would assist the firm in curbing these practices. As a
consequence, this could result in the failure to take sufficient steps
to address the potentially harmful effect of those conflicts.\75\ For
these additional reasons, we are proposing that such conflicts of
interest be eliminated or their effects be neutralized, rather than
handled by other methods of addressing the conflicts, such as through
disclosure and consent.
---------------------------------------------------------------------------

    \74\ A/B testing refers to running a learning model on two
different datasets with a single change between the two, which can
help identify causal relationships and, through understanding how
changes affect outcomes, gain a better understanding of the
functionality of a model. See Seldon, A/B Testing for Machine
Learning (July 7, 2021) (``Seldon''), https://www.seldon.io/a-b-testing-for-machine-learning.
    \75\ See, e.g., William Shaw and Aisha S. Gani, Wall Street
Banks Seizing AI to Rewire the World of Finance, Financial Review
(June 1, 2023) (in discussing fiduciary duty obligation when using
AI in finance quoting a law firm partner as saying: ``How do you
demonstrate to investors and regulators that you've done your duty
when you've used an output without really knowing what the inputs
are?'').
---------------------------------------------------------------------------

4. Use of Predictive Data Technologies in Investor Interactions
    Firms may use PDA-like technologies to transform user interfaces
and the interactions that investors have on digital platforms.\76\ For
example, firms may collect data from a variety of internal sources
(e.g., trading desks, customer account histories, and communications)
and external sources (e.g., public filings, social media platforms, and
satellite images) in both structured and unstructured formats,\77\
enabling them to develop an understanding of investor preferences and
adapt the interface and related prompts to appeal to those preferences.
Firms may use these tools to increase the quantity of information used
to support investment ideas,\78\ leverage investor data to send
targeted questionnaires to investors regarding evolving investment
goals, identify which investors might be open to a new investment
product, or identify which investors are most likely to stop using a
firm's services.\79\ We are concerned, however, that a firm's use of
PDA-like technologies when engaging or communicating with--including by
providing information to, providing recommendations or advice to, or
soliciting--a prospective or current investor could take into
consideration the firm's interest in a manner that places its interests
ahead of investors' interests and thus harm investors.\80\ For example,
some members of the public have expressed concern that firms' use of
these PDA-like technologies encourages practices that are profitable
for the firm but may increase investors' costs, undermine investors'
performance, or expose investors to

unnecessary risks based on their individual investment profile, such
as: (i) excessive trading,\81\ (ii) using trading strategies that carry
additional risk (e.g., options trading and trading on margin), and
(iii) trading in complex securities products that are more remunerative
to the firm but pose undue risk to the investor.\82\
---------------------------------------------------------------------------

    \76\ See, e.g., FSB AI Report, supra note 9, at 14-15 (chatbots
are being introduced by a range of financial services firms, often
in mobile apps or social media, and chatbots are ``increasingly
moving toward giving advice and prompting customers to act'').
    \77\ See FINRA AI Report, supra note 9, at 4.
    \78\ See Deloitte, Artificial intelligence: The next frontier
for investment management firms (Feb. 5, 2019), https://www.deloitte.com/global/en/Industries/financial-services/perspectives/ai-next-frontier-in-investment-management.html.
    \79\ See Ryan W. Neal, Three Firms Where Artificial Intelligence
is Helping with Financial Planning (Jan. 17, 2020), https://www.investmentnews.com/artificial-intelligence-advisers-176541
(describing current uses of AI and their potential application to
broker-dealers and investment advisers).
    \80\ While the proposed rules apply more broadly to the use of
covered technology in investor interactions, as discussed below,
firms using covered technology to provide advice or make
recommendations are subject to standards of conduct, among other
regulatory obligations, that already apply to such advice or
recommendations. See infra section III.C.3. The proposed conflicts
rules would apply in addition to these standards of conduct and
other regulatory obligations.
    \81\ See, e.g., Comment Letter from Pace Investor Rights Clinic
(Oct. 1, 2021) (``Pace University Letter'') (``DEPs can lead
investors to trade more frequently and more often than is in their
best interest. For example, the push notification feature provides
investors with live price updates. This intentionally prompts
investors to check their portfolios after receiving the
notification, which can lead them to make additional trades or spend
more time on the platform than they would have otherwise.
Traditionally, the goal of investing for most retail investors is to
save for the long term. Frequently checking their portfolio may
cause investors to make decisions not in line with the goal of long-
term saving and generational wealth building.''). See also, e.g.,
Feedback Flyer Response of Lincoln Li on S7-10-21 (Aug. 27, 2021)
(``I started half a decade ago following value investing practices.
However, [online investment and trading apps], that I used for a
short time got me into day trading and speculation more frequently.
I ended up stopping using these apps because they took up so much
time with little gain. I spent more time long term trading based off
of proper market factors and evaluation. There's a big concern to
me, especially as a professional game designer, as to how
gamification in life impacting subjects can have negative impact on
society, culture and personal finances. I have friends who got into
technical trading and day trading due to these apps, who talk more
like gamblers than actual investors. It sets a very poor precedent
for this industry and behavior.''); Feedback Flyer Response of
Richard Green on S7-10-21 (Sept. 25, 2021) (responding to a question
about online trading and investment platforms: ``[m]y broker rewards
referrals by offering free stocks for each referral. I think this
pulls new investors into trading, which makes a lot of money for the
broker, as newer investors are more likely to trade too frequently
or make mistakes.''); Feedback Flyer Response of Joseph on S7-10-21
(Aug. 28, 2021) (``[A trading app's] user interface is set up in a
way to subconsciously influence retail traders to trade more
frequently and engage in riskier investment products (options) than
the average amount.'').
    \82\ In Congressional hearings related to market events in
January 2021, investor protection concerns were identified relating
to the use of certain types of DEPs, including advertisements
targeted towards specific groups of investors on digital platforms
and game-like features on mobile apps. See Game Stopped? Who Wins
and Loses When Short Sellers, Social Media, and Retail Investors
Collide: Hearing Before the H. Comm. on Fin. Servs., 113th Cong.
(2021), https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407107; Game Stopped? Who Wins and Loses
When Short Sellers, Social Media, and Retail Investors Collide, Part
II: Hearing Before the H. Comm. on Fin. Servs., 113th Cong. (2021),
https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=406268, Game Stopped? Who Wins and Loses
When Short Sellers, Social Media, and Retail Investors Collide, Part
III: Hearing Before the H. Comm. on Fin. Servs., 113th Cong. (2021),
https://financialservices.house.gov/calendar/eventsingle.aspx?EventID=407748; Who Wins on Wall Street? GameStop,
Robinhood, and the State of Retail Investing: Hearing Before the S.
Comm. On Banking, Hous., & Urban Affairs, 113th Cong. (2021),
https://www.banking.senate.gov/hearings/who-wins-on-wall-street-gamestop-robinhoodand-the-state-of-retail-investing.
---------------------------------------------------------------------------

    In some cases, the use of PDA-like technologies to place a firm's
interests ahead of investors' interests could reflect an intentional
design choice.\83\ In other cases, however, the actions that place a
firm's interests ahead of the interest of investors may instead reflect
the firm's failure to fully understand the effects of its use of PDA-
like technologies or to provide appropriate oversight of its use of
such technologies.\84\ For example, AI and other similar technology are
only as good as the data upon which it is based. Corrupted or
mislabeled data, biased data, or data from unknown sources, can
undermine data quality, leading to skewed outcomes with opaque biases
as well as unintended failures.\85\
---------------------------------------------------------------------------

    \83\ See, e.g., Megan Ji, Note, Are Robots Good Fiduciaries?
Regulating Robo-Advisors Under the Investment Advisers Act of 1940,
117 Colum. L. Rev. 1543, 1580 (Oct. 2017) (recommending that the
Commission adopt regulations in which ``robo-advisors, in their
disclosures, clearly delineate between conflicts that are programmed
into their algorithms and conflicts that may affect the design of
algorithms.'').
    \84\ See Catherine Thorbecke, Plagued with errors: A news
outlet's decision to write stories with AI backfires, CNN (Jan. 23,
2023), https://www.cnn.com/2023/01/25/tech/cnet-ai-tool-news-stories/index.html.
    \85\ See, e.g., Regulation Systems Compliance and Integrity,
Release No. 34-97143 (Mar. 15, 2023) [88 FR 23146 (Apr. 14, 2023)]
(describing the potential market impact of a corrupted data
security-based swap data repository). See also National Institute of
Science and Technology Special Publication 1270, Towards a Standard
for Identifying and Managing Bias in Artificial Intelligence (Mar.
2022), at section 3.1 (describing dataset challenges resulting in AI
bias, discrimination, and systematic gaps in performance); Thor
Olavsrud, 7 famous analytics and AI disasters (Apr. 15, 2022),
https://www.cio.com/article/190888/5-famous-analytics-and-ai-disasters.html.
---------------------------------------------------------------------------

    While the risk of poor data quality or skewed data is not unique to
AI, the ability of PDA-like technologies used in investor interactions
to process data more quickly than humans, and the potential for
technology to disseminate the resulting communications to a mass
market, can quickly magnify conflicts of interest and any resulting
negative effects on investors. Moreover, erroneous data considered by a
firm's algorithm could have the effect of optimizing for the firm's
interest over investors' interest by, for example, relying on outdated,
previously higher cost information of investment options sponsored by
other firms but relying on updated, lower cost information of identical
investment options sponsored by the firm. This could result in a
recommendation, advice, or other investor interaction that favors the
firm's sponsored products and creates a conflict, regardless of whether
the firm intentionally developed the algorithm to optimize for its
interest.\86\ Poor data quality or skewed data could not only limit the
learning capability of an AI or machine learning system but could also
potentially negatively impact how it makes inferences and decisions in
the future,\87\ giving rise to erroneous or poor predictions, resulting
in a failure to achieve the system's intended objectives,\88\ and
benefiting the firm over investors (whether intentionally or
unintentionally).
---------------------------------------------------------------------------

    \86\ In this example, it is also possible that erroneous data
could result in the reverse effect, generating a recommendation in
favor of a non-sponsored product when the firm's sponsored product
may be more cost-effective. This would not result in a conflict
under the proposed rules but would nonetheless be subject to firms'
obligations under their respective regulatory regimes, including the
applicable standard of conduct.
    \87\ See Artificial Intelligence/Machine Learning Risk &
Security Working Group (AIRS), Artificial Intelligence Risk &
Governance, at 2.1.1 (accessed Apr. 18, 2023) (``AIRS White
Paper''), https://aiab.wharton.upenn.edu/research/artificial-intelligence-risk-governance/.
    \88\ Id.
---------------------------------------------------------------------------

    We have observed instances where conflicts of interest associated
with a firm's use of PDA-like technologies have resulted in harm to
investors. A recent enforcement action involved allegations that an
adviser marketed that its ``no fee'' robo-adviser portfolios were
determined through a ``disciplined portfolio construction methodology''
when they allegedly were pre-set to hold a certain percent of assets in
cash because the adviser's affiliate was guaranteed a certain amount of
revenue at these levels. The adviser allegedly did not disclose its
conflict of interest in setting the cash allocations; that this
conflict resulted in higher cash allocations, which could negatively
impact performance in a rising market; and that the cash allocations
were higher than other services because clients did not pay a fee.\89\
While the focus of that action was on the alleged disclosure failure,
it also highlights the potential for PDA-like technologies to be used
in ways that advance a firm's interests at the expense of its
investors' interests. The proposed conflicts rules would require a firm
to analyze its investor interactions that use PDA-like technology for
the types of conflicts of interest that were at issue in that action in
order to determine whether the investor interaction places the firm's
interests ahead of its investors' interests and, if so, eliminate, or
neutralize the effect of, the conflicts of interest on investors. In
addition, the Commission's 2021 Request for Information and Comments on
Broker-Dealer and

Investment Adviser Digital Engagement Practices, Related Tools and
Methods, and Regulatory Considerations and Potential Approaches
(``Request'') \90\ solicited comments related to conflicts of interest,
among other areas.\91\ In response, the Commission received comments
reflecting perceived conflicts of interest related to the use of online
investing and trading applications, which some commenters indicated
undermine their faith in the fairness of the markets.\92\
---------------------------------------------------------------------------

    \89\ In re. Charles Schwab & Co., Inc., et al., Exchange Act
Release No. 95087 (June 13, 2022) (settled order).
    \90\ See Request for Information and Comments on Broker-Dealer
and Investment Adviser Digital Engagement Practices, Related Tools
and Methods, and Regulatory Considerations and Potential Approaches,
Exchange Act Release No. 92766 (Aug. 27, 2021) [86 FR 49067 (Sept.
1, 2021)].
    \91\ See id., questions 1.26, 2.6, 3.5, 3.16, and 4.15. For
additional discussion regarding the Request, see infra section I.B.5
    \92\ See, e.g., Feedback Flyer Response of Tomas Liutvinas on
S7-10-21 (Aug. 28, 2021) (``It seems like there is no conflict of
interest regulations in the US financial system. This makes me
uneasy. Until the rights are fully explained, reported, and undone I
will recommend to anyone I know to stay away from US markets. For
myself, I've invested in a certain position with plans to leave the
investment for the future generations of my family, to hold on
hopefully up to a point when markets will be made transparent and
fair.''); Feedback Flyer Response of Jasper Pummell on S7-10-21
(Aug. 28, 2021) (``I believe that online brokerages have a conflict
of interest and financial regulation is needed to ensure that the
markets are a safe place for retail traders.''); Feedback Flyer
Response of Robert on S7-10-21 (Aug. 27, 2021) (``Retail needs a
fair and transparent market. There are blantant [sic] conflicts of
interest in the market which should be rectified immediately.
Failure to do so will have a mass exodus of investors from the US
stock market.''). See also FINRA AI Report, supra note 9, at 11
(``However, use of AI also raises several concerns that may be wide-
ranging across various industries as well as some specific to the
securities industry. Over the past few years, there have been
numerous incidents reported about AI applications that may have been
fraudulent, nefarious, discriminatory, or unfair, highlighting the
issue of ethics in AI applications.''). But see, e.g., Comment
Letter from David Dusseault, President, Robinhood Financial, LLC
(Oct. 1, 2021) (``Robinhood Letter'') (stating that conflicts of
interest are not new to the financial industry and that the
regulatory frameworks established by the SEC, such as Reg BI and the
disclosure requirements of the Investment Advisers Act of 1940, rest
on the principle that conflicts of interest exist, but investors are
able to navigate them when they are adequately disclosed); Comment
Letter from Investment Adviser Association (Oct. 1, 2021) (``IAA
Letter''); Comment Letter from Kevin M. Carroll, Managing Director
and Associate General Counsel, Securities Industry and Financial
Markets Association (Oct. 1, 2021) (``SIFMA Letter'') (generally
opposing new rules, guidance, or interpretations to address the use
of digital engagement practices). These comments are all available
in the comment file at https://www.sec.gov/comments/s7-10-21/s71021.htm.
---------------------------------------------------------------------------

    Failures to appropriately oversee these PDA-like technologies
compound the risk that conflicts of interest may not be appropriately
identified or managed. Due to the complexity and opacity of certain
technologies, firms should have robust practices to appropriately
oversee and understand their use and take steps to identify and
appropriately address any associated conflicts of interest. For
example, without appropriate personnel, a firm may not have the ability
to modify the software or may lack the expertise to understand,
monitor, or appropriately update code, limiting the firm's ability to
identify and appropriately address associated conflicts of interest.
Furthermore, if the firm does not understand how the technology
operates--including whether it takes into consideration the firm's
interest and how it can influence investor conduct--the firm may not
fully understand whether, how, or the extent to which it is placing the
firm's interests ahead of investors' interests. As a result of the
complexity and opacity of PDA-like technologies, a firm needs different
and specific practices to evaluate its use of the technology and
recognize the risk of conflicts presented by that use compared to other
practices. Without appropriate oversight and understanding of the
conflicts of interest that could be amplified when the technology is
incorporated into investor-facing interactions, such as design
elements, features, or communications that nudge or prompt certain or
more immediate action by an investor, investor harm can result.
5. Request for Information and Comment
    In August 2021, the Commission issued a request for information and
public comment on the use of DEPs by broker-dealers and investment
advisers, as well as the analytical and technological tools and methods
used in connection with these DEPs.\93\ For purposes of the Request,
the Commission defined DEPs broadly to include behavioral prompts,
differential marketing, game-like features, and other design elements
or features designed to engage retail investors.\94\ The Commission
stated that DEPs may be designed to encourage account opening, account
funding and trading, or may be designed solely to increase investor
engagement with investing apps, as there may be value in the number of
investors interacting with the platform, how often they visit, and how
long they stay.\95\ The Request was issued in part to assist the
Commission and its staff in better understanding the market practices
associated with the use of DEPs by firms, facilitate an assessment of
existing regulations and consideration of whether regulatory action may
be needed to further the Commission's mission in connection with firms'
use of DEPs, as well as to provide a forum for market participants
(including investors), and other interested parties to share their
perspectives on the use of DEPs and the related tools and methods,
including potential benefits that DEPs provide to retail investors, as
well as potential investor protection concerns.\96\
---------------------------------------------------------------------------

    \93\ See Request, supra note 90.
    \94\ See id. at 49067.
    \95\ See id. at 49069.
    \96\ As noted in the Request, the market practices explored
included: (i) the extent to which firms use DEPs; (ii) the types of
DEPs most frequently used; (iii) the tools and methods used to
develop and implement DEPs; and (iv) information pertaining to
retail investor engagement with DEPs, including any data related to
investor demographics, trading behaviors, and investment
performance. See id. at 49068.
---------------------------------------------------------------------------

    The Commission received over 2,300 public comments, including
submissions provided through an online ``feedback flyer'' that
accompanied the Request and was provided to better facilitate responses
from retail investors.\97\ Commenters offered a wide range of
perspectives on broker-dealers' and investment advisers' use of DEPs,
addressing their purpose, providing information on how investors
interact with them, and offering broad reflections on potential
regulatory action. Commenters also provided views on benefits and risks
related to firms' use of DEPs, as well as the AI/machine learning and
behavioral psychology that firms use to develop and deploy DEPs.\98\
---------------------------------------------------------------------------

    \97\ The ``Feedback Flyer'' was attached as Appendix A to the
Request and asked individual investors to provide their comments
with regard to online trading or investment platforms, such as
websites and mobile applications, to provide the Commission with a
better understanding of retail investors' experiences on these
platforms. The Feedback Flyer provided 11 different question
prompts, with an array of both multiple choice, and free text
response options whereby respondents could submit relevant comments.
Comments received in response to the Request are available at
https://www.sec.gov/comments/s7-10-21/s71021.htm.
    \98\ See, e.g., Comment Letter from American Securities
Association (Sept. 30, 2021); Comment Letter from Securities
Arbitration Clinic and Professor of Clinical Legal Education, St.
John's University School of Law Securities Arbitration Clinic, (Oct.
1, 2021) (``St. John's Letter''); Comment Letter from Morningstar,
Inc. and Morningstar Investment Management, LLC (Oct. 1, 2021)
(``Morningstar Letter''); Comment Letter from James F. Tierney,
Assistant Professor of Law, University of Nebraska College of Law
(Oct. 1, 2021) (``Tierney Letter''); Pace University Letter; Comment
Letter from Law Office of Simon Kogan, (Oct. 17, 2021) (``Kogan
Letter'').
---------------------------------------------------------------------------

    A number of commenters also provided detailed feedback regarding
the potential need for additional action to address the issues
presented by DEPs and their underlying technology. For example,
multiple commenters raised concerns over the risks of harm to investors
if the Commission did not act, and requested that the Commission
interpret existing regulations in a way

that would apply to most DEPs and/or adopt additional regulations to
address those risks.\99\ Many of these commenters suggested a need to
address the standards of conduct applicable to broker-dealers and
investment advisers when interacting with retail investors through
digital platforms.\100\ Some of these commenters noted that Reg BI does
not apply to firms with a self-directed brokerage business model,
including those that use DEPs \101\ and provided additional suggestions
that the Commission could take to address firms' use of DEPs.\102\
Others provided detailed opinions as to the application of an
investment adviser's fiduciary duty to DEPs.\103\ A significant number
of commenters also addressed other laws and regulations and their
sufficiency, or lack thereof, in their application to DEPs, including
discussion addressing (i) antifraud and general standards of conduct;
\104\ (ii) regulation of advertising, marketing, and communications
with the public; \105\ (iii) compliance and supervision obligations;
\106\ (iv) data privacy and cybersecurity concerns; \107\ (v) customer
onboarding obligations; \108\ (vi) Commission Staff's 2017 Robo-Adviser
Guidance; \109\ and (vii) the Advisers Act recordkeeping rule.\110\
---------------------------------------------------------------------------

    \99\ See, e.g., Comment Letter from Scopus Financial Group
(Sept. 20, 2021); Comment Letter from Better Markets, Inc. (Oct. 1,
2021) (``Better Markets Letter''); Comment Letter from Public
Investors Advocate Bar Association (Oct. 1, 2021) (``PIABA
Letter''); Comment Letter from University of Miami School of Law
Investor Rights Clinic et al. (Oct 1, 2021) (``University of Miami
Letter''); Comment Letter from Fidelity Investments (Oct. 1, 2021);
St. John's Letter; Morningstar Letter. We also considered views
received from the SEC's Investor Advisory Committee on ethical
guidelines for artificial intelligence and algorithmic models used
by investment advisers. See Investor Advisory Committee,
Establishment of an Ethical Artificial Intelligence Framework for
Investment Advisors (Apr. 6, 2023), https://www.sec.gov/files/20230406-iac-letter-ethical-ai.pdf.
    \100\ See, e.g., Pace University Letter (``We believe that
retail investors, particularly novice investors, believe that they
are receiving advice or recommendations from DEPs. This includes the
top mover list, analyst ratings, push notifications, and other DEPs
that encourage investment activity. Many of our survey participants
stated that they believe that these DEPs influenced their decision-
making. At the same time, DEPs may also influence investor decision-
making without investors being conscious of it.''); Comment Letter
from North American Securities Administrators Association (Oct. 1,
2021) (``NASAA Letter'') (``To assist with compliance and to protect
investors, the Commission should provide further guidance as to when
DEP-based communications constitute recommendations. However, given
the speed of technology, NASAA suggests that guidance should not be
limited to any particular DEP, but rather should be focused on the
effects of technologies on investor behavior generally.''); Comment
Letter from Fiduciary Insights and Practice Growth Partners (Sept.
30, 2021) (``Aikin/Mindicino Letter'') (``[A]s the complexity and
heterogeneity of wants, needs, and capabilities of the clientele
rises, the sophistication and artificial intelligence and machine
learning (AI/ML) of the DEPs must increase dramatically.
Commensurately, the internal oversight and regulatory guardrails to
assure that customer/client best interests are served must also
increase.''); see also Comment Letter from Morgan Stanley Wealth
Management (Oct. 1, 2021) (``Morgan Stanley Letter'') (while noting
existing protections, stating that ``[s]hould the Commission believe
additional guidance is necessary, we suggest the adoption of
principles-based, technology neutral adjustments to the existing
regulatory regime to address the fast evolving technological
landscape''); Better Markets Letter; University of Miami Letter
(``As the SEC continues its review of standards applicable to
financial professional[s], it is critical to enhance investor
protection in the fast-growing and increasingly harmful digital
platform environment.'').
    \101\ See, e.g., Robinhood Letter (``The SEC acknowledged the
benefits of a self-directed model such as Robinhood's in adopting
Reg BI, explicitly stating that Reg BI does not apply to this
model.'').
    \102\ See, e.g., Pace University Letter (``DEPs and online
platforms have expanded access to the market to new investors, while
at the same time influencing the decision-making of those
investors--particularly novice investors--in ways that are often in
conflict with their bests interest.''); see also Tierney Letter;
Better Markets Letter; SIFMA Letter; Morningstar Letter; Morgan
Stanley Letter; University of Miami Letter (``Due to the influential
nature of DEPs, the SEC should enhance the Regulation Best Interest
disclosure obligation and conflict of interest obligation by
requiring firms to flag investor trades and/or positions where there
is a likelihood that the firm will act in a manner adverse to the
investor's position and to notify investors of these potential
actions.'').
    \103\ See, e.g., IAA Letter (``Some advisers also use various
analytical and technological tools to develop and provide investment
advice, including through online platforms or as part of enhancing
their in-person investment advisory services. Investment advisers
may also engage in DEPs to develop and provide investor education
and related tools.''); see also Comment Letter from Envestnet Asset
Management, Inc. (Oct. 1, 2021) (``Envestnet Letter''); Comment
Letter from Julius Leiman-Carbia, Chief Legal Officer, Wealthfront
Corporation (Oct. 8, 2021) (``Wealthfront Letter''); NASAA Letter;
Aikin/Mindicino Letter; Better Markets Letter; SIFMA Letter;
University of Miami Letter; Morgan Stanley Letter.
    \104\ See, e.g., Comment Letter from Jennifer Schulp, Director
of Financial Regulation Studies, Center for Monetary and Financial
Alternatives, CATO Institute (Oct. 1, 2021) (``CATO Institute
Letter''); Comment Letter from Brandon Krieg, CEO, Stash Financial,
Inc. and Stash Investments LLC (Oct. 1, 2021) (``Stash Letter'');
Wealthfront Letter; IAA Letter; Robinhood Letter; SIFMA Letter;
Tierney Letter.
    \105\ See, e.g., PIABA Letter; CATO Institute Letter; IAA
Letter.
    \106\ See, e.g., Comment Letter from James J. Angel, Ph.D., CFP,
CFA, Associate Professor of Finance, McDonough School of Business,
Georgetown University (Sept. 30, 2021); IAA Letter; Stash Letter;
Aikin/Mindicino Letter; PIABA Letter; CATO Institute Letter.
    \107\ See, e.g., NASAA Letter; Envestnet Letter; Kogan Letter.
    \108\ See, e.g., University of Miami Letter.
    \109\ See, e.g., Comment Letter from Penny Lee, CEO, Financial
Technology Association (Oct. 1, 2021); IAA Letter.
    \110\ See, e.g., Comment Letter from Pamela Lewis Marlborough,
Managing Director and Associate General Counsel, Teachers Insurance
and Annuity Association of America (Oct. 1, 2021); SIFMA Letter;
University of Miami Letter.
---------------------------------------------------------------------------

C. Overview of the Proposal

    In view of Commission staff observations, our experience
administering our existing rules, the discussion in section 1.B. above
on the development of PDA-like technologies in firm investor
interactions and the unique risks they raise regarding conflicts of
interest, and comments received in response to the Request, we are
proposing to update the regulatory framework to help ensure that firms
are appropriately addressing conflicts of interest associated with the
use of PDA-like technologies. Specifically, we propose that firms
should be required to identify and eliminate, or neutralize the effect
of, certain conflicts of interest associated with their use of PDA-like
technologies because the effects of these conflicts of interest are
contrary to the public interest and the protection of investors.\111\
---------------------------------------------------------------------------

    \111\ See infra section II.A.2.e.
---------------------------------------------------------------------------

    Proposed rules 15l-2 under the Exchange Act (17 CFR 240.15l-2) and
211(h)(2)-4 under the Advisers Act (17 CFR 275.211(h)(2)-4)
(collectively, the ``proposed conflicts rules'') are designed to
address the conflicts of interest associated with firms' use of PDA-
like technology when engaging in certain investor interactions, and the
proposed rules would do so in a way that aligns with (and in some
respects may satisfy) firms' existing regulatory obligations.\112\
Except as specifically noted, the texts of proposed conflicts rule
applicable to brokers and dealers (17 CFR 240.15l-2) and the proposed
conflicts rule applicable to investment advisers (17 CFR 275.211(h)(2)-
4) would be substantially identical.\113\ The proposed conflicts rules
would only apply where the firm uses defined covered technology--more
specifically, an analytical, technological, or computational function,
algorithm, model, correlation matrix, or similar method or process that
optimizes for, predicts, guides, forecasts, or directs investment-
related behaviors or outcomes in an investor interaction.
---------------------------------------------------------------------------

    \112\ See id.
    \113\ Citations herein to the ``proposed conflicts rules''
reference each of the proposed conflicts rules as they would be
codified in each location. Citations to a particular section of the
CFR reference only the proposed conflicts rule that would apply to
broker-dealers or to investment advisers, as applicable.
---------------------------------------------------------------------------

    The proposal is designed to be sufficiently broad and principles-
based to continue to be applicable as technology develops and to
provide firms with flexibility to develop approaches to their use of
technology consistent with their business model, subject to the over-
arching requirement

that they need to be sufficient to prevent the firm from placing its
interests ahead of investor interests. The proposal is also designed to
be consistent with the Commission's prior actions regarding
technological innovation.\114\ We note that the staff has also provided
their views on the industry's expanding use of technology in the
context of robo-advisers \115\ and shared examination findings and
risks associated with the use of robo-advisory products,\116\ among
other areas.
---------------------------------------------------------------------------

    \114\ Historically, the Commission has reviewed the changing
technology landscape, provided guidance, and if necessary amended
its regulatory framework to protect investors while still allowing
firms' use of technology to innovate and benefit investors. See,
e.g., Use of Electronic Media for Delivery Purposes, Release No.
7233 (Oct. 6, 1995) [60 FR 53458 (Oct. 10, 1995] (providing
Commission views with respect to the use of electronic media for
information delivery under the Securities Act of 1933, the
Securities Exchange Act of 1934, and the Investment Company Act of
1940); Use of Electronic Media by Broker-Dealers, Transfer Agents,
and Investment Advisers for Delivery of Information, Exchange Act
Release No. 37182 (May 9, 1996) [61 FR 24644 (May 15, 1996)] (``1996
Release'') (providing Commission views on electronic delivery of
required information by broker-dealers, transfer agents and
investment advisers); and Use of Electronic Media, Exchange Act
Release No. 42728 (Apr. 28, 2000) [65 FR 25843 (May 4, 2000)]
(``2000 Release'') (providing interpretive guidance on the use of
electronic media to deliver documents on matters such as telephonic
and global consent; issuer liability for website content; and legal
principles that should be considered in conducting online
offerings). In addition, the Commission has amended regulations to
accommodate evolving technologies and changes in the way investors
consume information. See, e.g., Tailored Shareholder Reports for
Mutual Funds and Exchange-Traded Funds; Fee Information in
Investment Company Advertisements, Investment Company Act Release
No. 34731 (Oct. 26, 2022) (87 FR 72758 [Nov. 25, 2022]) (requiring
layered disclosure for funds' shareholder reports and graphical
representations of fund holdings); Investment Adviser Marketing,
Investment Advisers Act Release No. 5653 (Dec. 22, 2020) [86 FR
13024 (Mar. 5, 2021)] (adopting ``principles-based provisions
designed to accommodate the continual evolution and interplay of
technology and advice,'' and providing specific guidance regarding,
among others, the use of social media). Further, the Commission has
amended regulations to expand the use of electronic filing options
by investment advisers and institutional investment managers and
updated recordkeeping requirements to make them adaptable to new
technologies in electronic recordkeeping. See, e.g., Electronic
Submission of Applications for Orders under the Advisers Act and the
Investment Company Act, Confidential Treatment Requests for Filings
on Form 13F, and Form ADV-NR; Amendments to Form 13F, Advisers Act
Release No. 6056 (June 23, 2022) [87 FR 38943 (June 30, 2022)]; see
also Electronic Recordkeeping Requirements for Broker-Dealers,
Security-Based Swap Dealers, and Major Security-Based Swap
Participants, Exchange Act Release No. 96034 (Oct. 12, 2022) [87 FR
66412 (Nov. 3, 2022)] (``Electronic Recordkeeping Release'').
    \115\ See Robo-Advisers, Division of Investment Management
Guidance Update No. 2017-02 (Feb. 2017) (``2017 IM Guidance''),
https://www.sec.gov/investment/im-guidance-2017-02.pdf (addressing
among other things, presentation of disclosures, provision of
suitable advice, and effective compliance programs).
    \116\ See Observations from Examinations of Advisers that
Provide Electronic Investment Advice, Division of Examinations Risk
Alert (Nov. 9, 2021) (``2021 Risk Alert''), https://www.sec.gov/files/exams-eia-risk-alert.pdf (noting, ``[n]early all of the
examined advisers received a deficiency letter, with observations
most often noted in the areas of: (1) compliance programs, including
policies, procedures, and testing.'').
---------------------------------------------------------------------------

    The proposal draws upon our authority under section 211(h) of the
Advisers Act and section 15(l) of the Exchange Act. The Dodd-Frank Wall
Street Reform and Consumer Protection Act of 2010 (``Dodd-Frank Act'')
added section 211(h)(2) to the Advisers Act and section 15(l)(2) to the
Exchange Act, each of which, among other things, authorizes the
Commission to ``promulgate rules prohibiting or restricting certain
sales practices, conflicts of interest, and compensation schemes for
brokers, dealers, and investment advisers that the Commission deems
contrary to the public interest and the protection of investors.''
\117\
---------------------------------------------------------------------------

    \117\ See Section 913 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010). As
noted in note 8 to subsection (l), another subsection (l) is set out
after the first subsection (k) of the Exchange Act.
---------------------------------------------------------------------------

    The proposal is intended to be technology neutral. We are not
seeking to identify which technologies a firm should or should not use.
Rather, the proposal builds off existing legal standards and, as
discussed throughout the release, is designed to address certain risks
to investors associated with firms' use of certain technology in their
interactions with investors, regardless of which such technology is
used.\118\ The proposal also is designed to permit firms the ability to
employ tools that they believe would address these risks that are
specific to the particular technology they use consistent with the
proposal. The Commission has long acted to protect investors from the
harms arising from conflicts of interests and will continually assess
the harms and revise those protections in light of the evolution of
practices, including with regard to firms' use of technologies. As
discussed in further detail below, conflicts associated with the use of
PDA-like technologies should be eliminated or their effects neutralized
to protect investors from conflicts of interest associated with firms'
use of PDA-like technologies that results in investor interactions that
place the interests of the firm and its associated persons ahead of
investors' interests.
---------------------------------------------------------------------------

    \118\ Firms' use of PDA-like technology may also be subject to
other potential legal and contractual restrictions on the ability
for advisers and brokers to collect and use customer information.
See, e.g., 17 CFR part 248, subpart A (Regulation S-P), requiring,
among other things, brokers, dealers, investment companies, and
registered investment advisers to adopt written policies and
procedures for administrative, technical, and physical safeguards to
protect customer records and information.
---------------------------------------------------------------------------

    In particular, the proposed conflicts rules would generally require
the following:
     Elimination, or neutralization of effect of, conflicts of
interest. The proposed conflicts rules would require a firm to (i)
evaluate any use or reasonably foreseeable potential use by the firm or
its associated person \119\ of a covered technology in any investor
interaction to identify any conflict of interest associated with that
use or potential use; \120\ (ii) determine whether any such conflict of
interest places or results in placing the firm's or its associated
person's interest ahead of the interest of investors; and (iii)
eliminate, or neutralize the effect of, those conflicts of interest
that place the firm's or its associated person's interest ahead of the
interest of investors.
---------------------------------------------------------------------------

    \119\ As used in this release, the term ``associated person''
means, for investment advisers, a natural person who is a ``person
associated with an investment adviser'' as defined in section
202(a)(17) of the Advisers Act and, for broker-dealers, a natural
person who is an ``associated person of a broker or dealer'' as
defined in section 3(a)(18) of the Exchange Act.
    \120\ Covered technology, conflict of interest, investor
interaction are each defined terms under the proposed rules. See
proposed rules 211(h)(2)-4(a) and 15l-2(a); see also infra sections
II.A.1 and II.A.2.c.
---------------------------------------------------------------------------

     Policies and procedures. The proposed conflicts rules
would require a firm that has any investor interaction using covered
technology to adopt, implement, and, in the case of broker-dealers,
maintain, written policies and procedures reasonably designed to
achieve compliance with the proposed conflicts rules, including (i) a
written description of the process for evaluating any use (or
reasonably foreseeable potential use) of a covered technology in any
investor interaction; (ii) a written description of any material
features of any covered technology used in any investor interaction and
of any conflicts of interest associated with that use; (iii) a written
description of the process for determining whether any conflict of
interest identified pursuant to the proposed conflicts rules results in
an investor interaction that places the interest of the firm or person
associated with the firm ahead of the interests of the investor; (iv) a
written description of the process for determining how to eliminate, or
neutralize the effect of, any conflicts of interest determined pursuant
to the proposed conflicts rules to result in an investor interaction
that

places the interest of the firm or associated person ahead of the
interests of the investor; and (v) a review and written documentation
of that review, no less frequently than annually, of the adequacy of
the policies and procedures established pursuant to the proposed
conflicts rules and the effectiveness of their implementation as well
as a review of the written descriptions established pursuant to the
proposed conflicts rules.
    Proposed amendments to applicable recordkeeping rules, rules 17a-3
and 17a-4 under the Exchange Act and rule 204-2 under the Advisers Act,
would require firms to make and keep books and records related to the
requirements of the proposed conflicts rules. These proposed amendments
are designed to help facilitate the Commission's examination and
enforcement capabilities, including assessing compliance with the
requirements of the proposed conflicts rules.
    The proposal is designed to prevent firms' conflicts of interest
from harming investors while allowing continued technological
innovation in the industry.

II. Discussion

A. Proposed Conflicts Rules

1. Scope
    The proposed conflicts rules would apply only when a firm uses
covered technology in an investor interaction. The proposed definitions
are designed to identify those conflicts of interest that firms must
evaluate to determine whether they result in investor interactions that
place the firm's interest ahead of investors' interest and must
therefore be eliminated or their effect neutralized.\121\ The proposed
conflicts rules would apply to all broker-dealers and to all investment
advisers registered, or required to be registered, with the Commission.
---------------------------------------------------------------------------

    \121\ See supra section I.B.4 (describing existing technologies
that may involve conflicts of interest) and infra section II.A.2.c
(discussing the proposed definition of a conflict of interest).
---------------------------------------------------------------------------

a. Covered Technology
    The proposed conflicts rules would define covered technology as an
analytical, technological, or computational function, algorithm, model,
correlation matrix, or similar method or process that optimizes for,
predicts, guides, forecasts, or directs investment-related behaviors or
outcomes.\122\ The proposed definition is designed to capture PDA-like
technologies, such as AI, machine learning, or deep learning
algorithms, neural networks, NLP, or large language models (including
generative pre-trained transformers), as well as other technologies
that make use of historical or real-time data, lookup tables, or
correlation matrices among others.
---------------------------------------------------------------------------

    \122\ Proposed conflicts rules at (a).
---------------------------------------------------------------------------

    The rate at which these technologies evolve has increased in recent
years and may continue to increase.\123\ Accordingly, the proposed
definition of covered technology is also designed to capture the
variety of technologies and methods that firms currently use as well as
those technologies and methods that may develop over time. The proposed
definition would include widely used and bespoke technologies, future
and existing technologies, sophisticated and relatively simple
technologies, and ones that are both developed or maintained at a firm
or licensed from third parties.\124\
---------------------------------------------------------------------------

    \123\ See e.g., Deloitte, Artificial intelligence: The next
frontier for investment management firms (Feb. 5, 2019), https://www.deloitte.com/global/en/Industries/financial-services/perspectives/ai-next-frontier-in-investment-management.html
(stating, for example, that ``[f]irms have recognized a new
opportunity to gain direct distribution to investors, benefit from
enhanced efficiencies in servicing small accounts, and offer value-
added services for advisors. This has translated into a wave of
investment activity, with asset managers and intermediaries
acquiring or investing in robo-advice technology.'') See also Bob
Veres and Joel Bruckstein, T3/Inside Information Advisor Software
Survey (Mar. 14, 2023), https://t3technologyhub.com/wp-content/uploads/2023/03/2023-T3-and-Inside-Information-Software-Survey.pdf.
    \124\ The SEC has proposed a new rule under the Advisers Act to
prohibit registered investment advisers from outsourcing certain
services or functions without first meeting minimum requirements.
See Outsourcing by Investment Advisers, Investment Advisers Act
Release No. 6176; File No. S7-25-22 (Oct. 26, 2022) [87 FR 68816
(Nov. 16, 2022)] (``Proposed Outsourcing Rule''). We encourage
commenters to review that proposal to determine whether it might
affect comments on this proposal.
---------------------------------------------------------------------------

    The proposed definition, however, would be limited to those
technologies that optimize for, predict, guide, forecast, or direct
investment-related behaviors or outcomes. The use of these terms in the
proposed conflicts rules is designed to capture a broad range of
actions. This could include providing investment advice or
recommendations, but it also encompasses design elements, features, or
communications that nudge, prompt, cue, solicit, or influence
investment-related behaviors or outcomes from investors. Investment-
related behavior or outcomes can manifest themselves in many forms in
addition to buying, selling, and holding securities, such as an
investor making referrals or increasing trading volume and/or
frequency. This broad proposed definition is designed to help ensure
that, as innovation and technology evolve and firms expand their
reliance on technologies to provide services to, and to interact with,
investors, our rules remain effective in protecting investors from the
harmful impacts of conflicts of interest.
    The proposed definition would apply to the use of PDA-like
technologies that analyze investors' behaviors (e.g., spending
patterns, browsing history on the firm's website, updates on social
media) to proactively provide curated research reports on particular
investment products, because the use of such technology has been shown
to guide or influence investment-related behaviors or outcomes.
Similarly, using algorithmic-based tools, such as investment analysis
tools, to provide tailored investment recommendations to investors
would fall under the proposed definition of covered technology because
the use of such tools is directly intended to guide investment-related
behavior. As an additional example, a firm's use of a conditional auto-
encoder model to predict stock returns would be a covered
technology.\125\ Similarly, if a firm utilizes a spreadsheet that
implements financial modeling tools or calculations, such as
correlation matrices, algorithms, or other computational functions, to
reflect historical correlations between economic business cycles and
the market returns of certain asset classes in order to optimize asset
allocation recommendations to investors, the model contained in that
spreadsheet would be a covered technology because the use of such
financial modeling tool is directly intended to guide investment-
related behavior. Likewise, covered technology would include a
commercial off-the-shelf NLP technology that a firm may license to
draft or revise advertisements guiding or directing investors or
prospective investors to use its services.
---------------------------------------------------------------------------

    \125\ An autoencoder return model is an unsupervised learning
method that attempts to model a full panel of asset returns using
only the returns themselves as inputs. See generally S. Gu, B.
Kelly, and D. Xiu, Autoencoder Asset Pricing Models (Sept. 30,
2019), https://www.aqr.com/Insights/Research/Working-Paper/Autoencoder-Asset-Pricing-Models.
---------------------------------------------------------------------------

    The proposed definition, however, would not include technologies
that are designed purely to inform investors, such as a website that
describes the investor's current account balance and past performance
but does not, for example, optimize for or predict future results, or
otherwise guide or direct any investment-related action. Similarly, the
proposed definition also would not include a technology that predicts
whether an investor would be approved for a particular credit card