SEC Proposes Requirements on Use of Predictive Data Analytics

The SEC proposed a rulemaking that would require broker-dealers and investment advisers to eliminate conflicts of interest associated with the use of predicative data analytic ("PDA") technologies.

Under the proposed Exchange Act Rule 15l-2 and Advisers Act Rule 211(h)(2)-4, the SEC would require broker-dealers and investment advisers, respectively, to:

• eliminate or neutralize the effect of conflicts of interest arising from the use of PDA technologies by identifying potential conflicts of interest that could arise from investor interactions with a covered technology; and
• adopt and implement written procedures to achieve compliance with the proposed conflicts of interest requirements, in addition to reviewing the written procedures no less than annually to assess their effectiveness.

The proposal would also amend Exchange Act Rules 17a-3 ("Records to be made by certain exchange members, brokers and dealers") and 17a-4 ("Records to be Preserved by Certain Exchange Members, Brokers and Dealers") and Advisers Act Rule 204-2 ("Books and records to be maintained by investment advisers") to require market participants to keep books and records that document compliance with the proposed requirements.

The SEC stated that the proposal is "sufficiently broad and principles-based" to allow for continued technology innovation and provide market participants with the flexibility to develop approaches consistent with their respective business models. In addition, the SEC stated that the proposal is "technology neutral," meaning that it is not meant to identify technologies that should or should not be used by market participants.

Statements

• SEC Chair Gary Gensler said that firms are already required to act in their investors’ best interest, but that the proposal would ensure firms’ interests are not placed ahead of their investors by requiring conflicts of interest to be addressed that can arise from interactions with PDA technologies.
• SEC Commissioner Hester M. Peirce criticized the proposal for (i) its "hostile," rather than its purported neutral, stance towards technology, and (ii) for "degradation of a principles-based regulatory regime" by replacing it with "overly prescriptive rules." She said that the SEC was rejecting disclosure as one its "primary regulatory tools," by requiring firms to eliminate the use of a covered technology if it involves a potential conflict of interest rather than providing a disclosure. Further, Ms. Peirce stated that the proposal risks "depriving investors of the benefits of technological advancement" and admits in a release that a consequence of the rulemaking could be a firm "opt[ing] not to use an automated investment advice technology because of the costs associated with complying with the proposed rules."
• SEC Commissioner Mark T. Uyeda expressed concern that the proposal could hinder technology innovation due to its "regulatory vagueness and considerable compliance challenges." He added that the proposal is "wholly unnecessary," following the SEC’s recent measures to strengthen its regulatory framework to address conflicts of interest.
• SEC Commissioner Jaime Lizárraga referred to the SEC’s "extensive analysis" on whether current rules ensure protection for retail investors against emerging technologies, and emphasized the importance of revising conflicts of interest-related requirements. He warned that the "cumulative impact of unaddressed conflicts of interest falls on investors" and that technology has the potential to benefit firms at the expense of investors’ interests.
• SEC Commissioner Caroline A. Crenshaw stated that with "increased accessibility comes great responsibility." Ms. Crenshaw cautioned that conflicts of interest in favor of firms, while yielding potential benefits, can cause investors to use more services, increase transactions or make risky investments.