SEC Predictive Analytics Proposal Targeted by Senate Republicans

Senate Republicans Tuesday introduced the Protecting Innovation in Investment Act to prevent the implementation of a proposed predictive data analytics rule from the Securities and Exchange Commission. The bill was proposed by Senators Ted Cruz, R-Texas, and Bill Hagerty, R-Tennessee.

The full name of the SEC’s proposal is “Conflicts of Interest Associated With the Use of Predictive Data Analytics by Broker-Dealers and Investment Advisers,” and it has been widely opposed by the financial industry, primarily because of the wide range of technologies covered.

The SEC’s proposal would require an adviser to “eliminate or neutralize the effect of conflicts of interest associated with the firm’s use of covered technologies in investor interactions that place the firm’s or its associated person’s interest ahead of investors’ interests.”

A covered technology refers to “a firm’s use of analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor.”

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Commenters on the proposal have said it would effectively prevent the use of several basic technologies. The ERISA Industry Commission noted in its letter to the SEC that the proposal would apply to ordinary retirement readiness calculators and chatbots that recordkeepers and other firms utilize with retirement plan participants. ERIC called on the SEC to fully withdraw the proposal.

The American Benefits Council also called for a withdrawal and Empower asked for an exemption for retirement education tools such as readiness calculators.

Supporters of the senators’ proposed bill echoed the concerns. The Insured Retirement Institute released an emailed statement Tuesday stating that “The [SEC] proposal’s broad definition of covered technology serves not to effectively establish guardrails for the future as intended but to paralyze and cast a shadow on the present.”

The Investment Company Institute wrote that the proposal would bring “everything from the most sophisticated technologies to simple spreadsheets into question under the new conflict of interest standard, and would be almost impossible to comply with, inhibiting firms’ use of technology to better serve investors.”

The bill will likely be referred to the Senate Committee on Banking, Housing and Urban Affairs and no hearing or vote on it is scheduled.

Tags: AI, conflict of interest, SEC

The U.S. 5th Circuit Court of Appeals heard oral arguments Monday in National Association of Fund Managers v. Securities and Exchange Commission, which challenges the SEC’s private fund advisers rule, finalized in August 2023.

Three judges heard oral arguments in New Orleans on Monday from the SEC and from the plaintiffs, a group led by the National Association of Private Fund Managers that also includes the American Investment Council and Managed Funds Association, according to court documents.

According to those present and to news reports from the courtroom, the judges asked pointed questions that cast doubt on whether the SEC has the authority to regulate private funds. They also suggested that the fast-growing private funds market is a sign of success, not that it requires sweeping regulation. Reports also noted, however, that one judge did not think the plaintiff’s arguments were strong enough to throw out the entire rule, only parts.

The SEC’s rule, which had received widespread industry pushback, requires private fund advisers to give their clients quarterly statements on the performance of the fund, as well as its fees and other expenses, and obtain an annual audit for every fund they advise. Advisers must also provide a valuation and fairness opinion for adviser-led sales of holdings in the private fund. Advisers are also forbidden under the rule “from providing investors with preferential treatment regarding redemptions and information if such treatment would have a material, negative effect on other investors.”

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Lastly, advisers may not pass on expenses incurred as a result of regulatory or judicial sanction for a violation of the Advisers Act and can only pass on investigation-related expenses if their clients consent to it.

A coalition of trade groups led by the National Association of Fund Managers filed a petition for review with the 5th Circuit in September 2023. The groups argued that “the new rules would fundamentally change the way private funds are regulated in America.” The petition describes the rule as arbitrary and capricious and states that it exceeded the SEC’s statutory authority to regulate private funds, which are typically invested in only by sophisticated and deep-pocketed investors who do not require the same disclosures as retail investors.

The U.S. Chamber of Commerce, a business advocacy group, filed an amicus brief in November which argued that the SEC has effectively “claimed the authority to erase the fundamental distinction between public and private funds” and is acting beyond its authority under the Investment Company Act and Advisers Act.

The 5th Circuit hears appeals from cases in Louisiana, Mississippi and Texas. In the petition, the trade groups wrote that the venue for the review was appropriate because at least one petitioner has a “‘principal office or place of business’” in the circuit. The judges assigned to the case are all Republican appointees: Circuit Judge Leslie Southwick was appointed by President George W. Bush, and Circuit Judges Kurt Engelhardt and Cory Wilson were appointed by President Donald Trump.

Tags: private funds, SEC