In March 2023, SEC Chairman Gary Gensler described Artificial Intelligence as “the most transformative technology of our time, on par with the internet and mass production of automobiles".

When any groundbreaking tool arrives, a period of adaptation is required. This is more pronounced for regulators, who need to quickly assimilate enough information to not only understand, but eventually govern the technology in question. Meanwhile, that technology permeates the industry at a breakneck pace and new habits are established, for better or worse.

The role of regulators, already under pressure, becomes even more challenging with the advent of artificial intelligence. AI introduces significant complexity and responsibility, making effective governance crucial. This is a pivotal moment in human development, with lessons to be learned for various sectors, including finance.

Below we’ll analyse the regulators’ current positions, existing frameworks that AI already falls into, and where its regulation could be heading.

Regulators’ Positions

SEC: In July 2023, SEC Chairman Gensler raised concerns about AI in investment decisions, highlighting risks of tech platform dominance and potential biases in AI models. His scepticism was notable given that AI-generated misinformation had falsely suggested his resignation.

In June 2024, the SEC's Investor Advisory Committee held a panel discussion on the use of AI, and Gensler reiterated his concerns, stressing that it could lead to conflicts of interest between a platform and its customers. He also emphasized that fundamental requirements still apply, and “market participants still need to comply with our time-tested laws”.

Despite this, there had been little concrete guidance provided up to that point, with some proposals discussed last year remaining under consideration.

FINRA: In the 2024 FINRA Annual Regulatory Oversight Report, FINRA explicitly classified AI as an ‘emerging risk’, recommending that firms consider its pervasive impact and the regulatory consequences of its deployment.

Ornella Bergeron, FINRA senior vice president of member supervision, said that despite the operational efficiencies afforded by developments in AI, there were worries.

“While these tools can present really promising opportunities, their development has raised concerns about things like accuracy, privacy, bias and intellectual property."

In May 2024, FINRA released updated FAQs to clarify its stance around AI-created content. These essentially stressed that regulatory standards still applied, and firms were accountable for their output regardless of whether it was generated by humans or AI.

CFTC: The Commodity Futures Trading Commission (CFTC) has been relatively active around AI. In May, it released a report entitled “Responsible Artificial Intelligence in Financial Markets: Opportunities, Risks & Recommendations.” This seemed to signal the CFTC’s desire to oversee the space.

The agency was concerned that AI might undermine public trust in financial markets due to its opaque decision-making. While the CFTC was ready to lead, the report emphasized ongoing federal collaboration and suggested public roundtable discussions to enhance understanding and develop transparent policies.

How Are Existing Frameworks Impacted?

Fundamental recordkeeping regulations like the SEC Marketing Rule and FINRA rule 2210 put strong emphasis on the accuracy and integrity of information that a firm communicates to its customers. The use of AI tools may well jeopardize these tenets due to the unpredictable and often inaccurate rhetoric that language models have built a reputation for.

As FINRA earlier clarified, it is the content itself that firms will be held accountable for – the tools that are used to create it are not necessarily relevant. This means that at the very least, all machine-generated output should be reviewed thoroughly before publication.

AI-Washing

Despite much regulation around AI barely reaching the proposal stage, we have already begun to see enforcement in some relevant areas.

In March, the SEC launched enforcement actions targeting ‘AI-washing’ — accusing two investment advisory firms of exaggerating the use of AI in their products and services to mislead investors. While the penalties imposed in these cases were minimal, the director of the SEC’s Enforcement Division, Gurbir Grewal, confirmed that they hoped to send a message to the industry.

“I hope these actions put the investment industry on notice. If you are rushing to make claims about using AI in your investment processes to capitalize on growing investor interest, stop. Take a step back, and ask yourselves: do these representations accurately reflect what we are doing or are they simply aspirational?

“If it’s the latter, your actions may constitute the type of “AI-washing” that violates the federal securities laws.”

What’s Next?

SEC: At June’s Investment Advisory Committee meeting, the SEC discussed rules which were initially proposed in July 2023, addressing potential conflicts of interest from using predictive data analytics (PDA) in investor interactions. The proposals called for any of these conflicts of interest to be recorded, and then quickly eliminated.

The June 6th panel participants were largely supportive of these proposals, which are now expected to proceed quickly. In the meantime, by quickly applying punishments and sending a message on AI-washing, the SEC appears eager to show strength through enforcement in more clear-cut scenarios.

FINRA: As well as confirming companies’ responsibility for chatbot generated output, the updates to FINRA’s FAQs stressed that firms must also supervise these communications. This means that policies and procedures must be established.

Those guidelines could address how technologies are selected in the procurement phase, how staff are trained to use them, what level of human oversight exists after content has been generated etc. If firms have already adopted chatbot technology, or if they’re considering it, the next step should be to develop this internal framework.

CFTC: The CFTC showed strong commitment to AI regulation, advocating for public discussion and cross-agency collaboration. Their report outlined key opportunities, risks, and recommendations for a formal framework.

The Department of the Treasury followed with a request for information, noting a potential shortage of skilled employees to manage AI tools. Their involvement supports the CFTC, FINRA, and SEC’s efforts, with regulators now using AI to aid their progress.

“The SEC has begun analyzing how generative AI models could potentially help tackle the regulators’ workload”, said Scott Gilbert, vice-president, risk monitoring, member supervision with FINRA, at the FINRA conference.

The Human Touch

A recent FINRA report shows that, despite AI's growing role, few consumers trust it for personal finance advice, supporting regulatory concerns about AI. This skepticism suggests stricter governance is likely. As with past delays in regulating new technologies, regulators might eventually backdate penalties to uphold their principles. Meanwhile, firms should document all AI and human-generated outputs to ensure comprehensive compliance.