My last note touched on a recent SEC rule proposal regarding Predictive Data Analytics, and a speech by Chair Gary Gensler highlighting a number of AI-related concerns. The SEC's interest in the use of AI does not appear limited to rule proposals and speeches, however. According to various sources, the SEC staff is currently conducting sweep examinations of private fund advisers using AI (the "AI sweep"). Questions posed by SEC examiners in the AI sweep include requests for:

  1. A description of the AI models and techniques used by the advisers.
  2. A list of algorithmic trading signals and associated models.
  3. The sources and providers of their data.
  4. Internal reports of any incidents where AI use raised regulatory, ethical, or legal issues.
  5. Copies of any AI compliance written supervisory policies and procedures.
  6. Contingency plans in case of AI system failures or inaccuracies.
  7. Client profile documents used by the AI system to understand a client's risk tolerance and investment objectives.
  8. AI-related security measures.
  9. A list and description of all data acquisition errors and/or adjustments to algorithmic modifications due to data acquisition errors.
  10. Samples of any reports detailing the validation process and performance of robo-advisory algorithms.
  11. A list of those who develop, implement, operate, manage, or supervise AI software systems.
  12. A list of all board, management, or staff committees with specific AI-related responsibilities, the frequency of any meetings, a list of the members of each committee, and whether minutes are kept.
  13. All disclosure and marketing documents to clients where the use of AI by the adviser is stated or referred to specifically in the disclosure, including audio and video marketing in which the adviser's use of AI is mentioned.
  14. A list of all media used to advertise, market or promote products and services, including social media, chat forums, websites, due diligence questionnaire responses, PPMs, pitch books, presentations, newsletters, annual reports, and podcasts and/or other video or audio marketing, and two recent examples of each kind of ad.

These questions go far beyond the conflict-of-interest issues central to the PDA Conflicts Rules. Some sweep questions appear focused on AI-related trading practices and may tie into AI-related financial stability and interconnectedness concerns. Others extend beyond trading, including questions about marketing practices and AI-related disclosures, security and contingency planning, and specific individuals and governing bodies with AI-related responsibilities. All advisers and broker-dealers should pay attention to these broader questions, as they appear relevant to any use of AI by a broker-dealer or adviser.

"Examiners seek lists of employees, execs, [and] board members with cyber responsibilities"

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