SEC Staff to Provide Recommendations on AI Regulations, Says Chairman Gensler

Securities and Exchange Commission Chairman Gary Gensler said that he has asked the SEC staff to make recommendations to the commission on the challenges of regulating artificial intelligence.

In brief remarks made to a conference on emerging trends in asset management on Friday, Gensler discussed the importance of regulations concerning AI, especially as it relates to fiduciary duties, and made yet another public confirmation that the SEC’s staff is actively working on regulatory recommendations in this area.

AI may prove to be “more transformative than the internet itself” Gensler said at the conference. He noted that AI can bring large benefits in terms of investment returns and access to markets, and specifically highlighted its potential role in sentiment analysis and advising.

As he has in other settings recently, Gensler also explained that the way AI software is programmed can create conflicts of interest if the AI tools are made to consider the interests of the adviser in addition to the client. To the extent that these are mutually exclusive, such programming would be a conflict and has implications for adviser fiduciary obligations. Here, on fiduciary status, is where Gensler’s focus is most concentrated, if his public remarks on AI are any indication.

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

Third Party Services

Gensler also briefly discussed outsourcing, custody, and cybersecurity under the umbrella of “third party services.”. He touched on the SEC’s outsourcing proposal, which would require advisers to do due diligence on their providers, identify and mitigate risks of outsourcing, and ensure an orderly termination of services at the end of their relationship, among other requirements. Gensler said that this proposal, as well as the cyber security proposals, are essential for an adviser to satisfy their fiduciary duties.

The chairman framed the new custody rule proposal, or the safeguarding rule, as belonging to this larger effort to extend adviser fiduciary duties to third parties by including their qualified custodians. This proposal, likely more than the others, have received significant pushback from industry.

Lance Dial, a partner and member of the asset management and investment funds practice at law firm K&L Gates, says that negative sentiment on this proposal is “carried by everyone in the industry.” It is unpopular for a variety of reasons, according to Dial, including its attempt to regulate custodians indirectly by requiring advisers to get assurances from their custodians. Dial explains that the contractual agreements it requires would limit the custodians that are available to advisers since they would have to negotiate with them separately, and they could lose business of clients using particular custodians.

The new custody rule would also extend these requirements to advisers engaged in discretionary trading. Though these advisers do not have custody of assets in the traditional sense, they could still unjustly take client assets through fees if they were trading excessively, a practice known as churning. Dial explains that this is more of a fiduciary problem than a custodial one, which the new proposal would not address.

Tags: Artificial Intelligence, Gary Gensler, SEC

Profit margins have been shrinking lately, owing to higher general inflation, labor costs and interest rates, plus business cutbacks to offset a long-anticipated recession. The net profit margin for the S&P 500 dipped to 11.2% in this year’s first quarter from its recent peak of 13.0% in 2021’s second period, per FactSet Research.

Artificial intelligence to the rescue. It could boost margins by four percentage points over the next decade, according to Goldman Sachs, which is very bullish on AI’s economy-enhancing prospects. The resulting fatter earnings likely would be a boon for equities, Goldman argued in a note.

If so, that would be an unexpectedly great news for the stock investors—as strategists’ market outlook is uninspiring.

Over the next 10 years, for instance, Vanguard Investments predicts U.S. equities will climb 6.4% annually, amid profit margin declines. That expected market showing falls short of the 11.6% that the S&P 500 scored over the past 10 years (a figure that includes 2022’s rout).

Want the latest institutional investment industry news and insights? Sign up for CIO newsletters. 

The effect of AI on business and the economy has been a big topic on corporate earnings calls in the last quarter, with 1,600 mentions, a whopping 2.5 times the volume of the prior-year period, a Bloomberg analysis showed.

The major thrust of AI will be the way it fuels productivity, the Goldman note concluded. The four-point projected increase is based “on the historical relationship between productivity growth and corporate profitability,” stated the report, written by Goldman strategist Ben Snider and his team.

In the short term, however, Goldman does not anticipate an immediate AI payoff. It expects the S&P 500 profit margin to slide 0.36 points this year and rise just 0.11 in 2024 The Snider report cautioned that their strategists’ rosy scenario for AI could be disrupted by government regulation and other unforeseen obstacles.

Over the longer term, in Goldman’s view, the likely bounty from AI is inspiring. A separate Goldman economic analysis, by economists Joseph Briggs and Devesh Kodnani, predicted that AI will increase world gross domestic product by 7% over the next 10 years, expanding labor productivity growth by 1.5% yearly. While many current jobs will be destroyed in the process, they wrote, many more will be created.

At that point, there will be plenty of flush consumers willing to spend on goods and services, and thus pump up profits.