Some 13 industry trade groups have joined forces to lobby against the SEC's proposed conflicted analytics proposal, telling the agency in a letter that it should withdraw the draft because of serious flaws and an outstanding legal challenge to the SEC's authority to create such extensive rules, which is currently penidng in the U.S. Fifth Circuit.
The coalition said it is breadth of the proposed rules which are concerning, because for the first time the agency would require advisors and brokers dealers to eliminate rather than just disclose any conflicts arising from predictive analytics used in advice or content for investors.
The proposal is written so broadly, it could impact even advisors' use of spreadsheets, the coalition, which includes the Financial Services Institute (FSI) and the U.S. Chamber of Commerce, said in its letter to the SEC.
When the agency approved the proposal in July, SEC Chairman Gary Gensler argued the extensive regulation is needed because "today’s predictive data analytics models provide an increasing ability to make predictions about each of us as individuals. This raises possibilities that conflicts may arise to the extent that advisers or brokers are optimizing to place their interests ahead of their investors’ interests."
There's a danger that firms can use analytics to "nudge" clients in a self-serving direction. “If a firm’s optimization function takes the interest of the firm into consideration ... this can lead to conflicts of interest. What’s more, such conflicts could manifest efficiently at scale across brokers’ and advisers’ interactions with their entire investor bases,” Gensler continued.
"The commission’s continued war on technology.," is how the coalition, which includes the Insured Retirement Institue, Investment Company Institute and National Society of Compliance Professionals, characterized the proposal.
“The SEC’s proposal would have a significant impact on independent advisors, the industry and their clients. The definition of covered technology within the proposal goes beyond artificial intelligence (AI) and machine learning applications. It would capture well-established technologies, such as simple Excel spreadsheets,” David Bellaire, FSI’s Executive Vice President & General Counsel, said by email.
As written, the proposal would limit advisors' use of technology "which is already subject to a robust regulatory framework and is used by advisors and firms to enhance interactions with investors," Bellaire added. It would also "upend Reg BI" by reshaping its requirements, ultimately eliminating investors’ access to some products.
The proposal “is so broad that it effectively says that if you do any type of predictive analytics—if you provide any type of content and it’s communicated to investors and it has impact on investor behavior--you have to neutralize the conflict or not use it,” Richard L. Chen, an attorney who specializes in advisor law, said during a podcast sponsored by the Institute for the Fiduciary Standard Tuesday.
The coalition called the proposal is "unnecessary, inadequately reasoned and fatally flawed. We are also concerned that the Commission lacks statutory authority to adopt these rules. This concern is especially heightened when the same authority relied upon in the Proposal is currently pending court review,” the coalition, which includes the American Council of Life Insurers, the Insured Retirement Institute, the National Society of Compliance Professionals and the Investment Company Institute, said in its letter.
The lawsuit cited by the coalition was filed by the National Venture Capital Association (NVCA) and a coalition of asset management associations in the U.S. Court of Appeals for the Fifth Circuit against the SEC to prevent the adoption of the recently approved Private Fund Adviser rule. The ondustry plaintiffs allege the rule exceeds the SEC's authority under the Investment Advisers Act and other laws. Plaintiffs are also arguing the rule runs counter to the SEC’s stated mission to protect investors and promote competition and is arbitrary and capricious.
The coalition's reference to the NVCA lawsuit is not subtle: the outcome of the suit could undermine the SEC's ability to approve the analytics conflicts rule as currently written without the type of legal challenges that FSI and the Chamber have mounted in the past. The FSI successfully sued to force the Department of Labor to withdraw its fiduciary rule in 2018.
Whether the agency will modify the proposal enough to avoid an industry legal challenge remains to be seen, sources said.
According to the 13 trade groups, “despite claims of being 'technology neutral and not seeking to identify which technologies a firm should or should not use,' the proposal is outright hostile to the use of technology. The onerous, and in some cases operationally unfeasible requirements ... would likely make firms opt out of deploying technological innovations to avoid the prohibitive costs of compliance. The lack of discernible boundaries on what is a ‘covered technology’ is likely to operate as a de facto ban on the use of technology.”
This would harm competition in the markets and the investors the SEC is supposed to protect, the coalition argued. “As with the areas of digital assets, electronic communications, distributed ledger technology and e-delivery, with the proposal the Commission continues its resistance to technological innovation, not just by enforcing existing, outdated laws, but also by adding regulation that makes it more difficult for regulated institutions to enhance their systems and to find efficiencies for their customers and clients,” the groups added.
Legal pundits agreed. “This is probably the biggest expansion of the way I’ve seen conflicts handled, more so than the private funds rule, so my anticipation is that this would be whittled down by the SEC before being finalized,” Chen said.