AI in Securities Regulation: 2024 Developments

Here's a quick overview of AI regulations in the securities industry for 2024:

• FINRA treats AI like other technologies for regulatory purposes
• Companies must test AI tools before use and follow existing rules
• Key focus areas: conflict management, transparency, and data protection
• SEC penalizes false AI claims ("AI washing") by investment firms
• Future challenges include keeping up with tech changes and ensuring fairness

Quick comparison of regulatory bodies' actions:

Body	Key Actions
SEC	Works with FINRA, penalizes AI misuse
FINRA	Provides AI guidelines, applies existing rules to AI
Other Regulators	Developing AI-specific regulations

Companies using AI in securities must carefully monitor compliance, explain AI decision-making, and stay updated on evolving regulations.

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Research Methods

To learn about AI in securities rules for 2024, we used these methods:

1. Talking to Industry People

FINRA's Office of Financial Innovation (OFI) spoke with over 20 groups, including:

• Financial firms
• Professors
• Tech companies
• Service providers

This helped us understand how AI is used in the securities industry.

2. Checking Rules

We looked at new rules and advice, focusing on:

• FINRA asking for comments on AI issues
• SEC's views on AI in securities
• Rules in other countries that might affect U.S. markets

3. Looking at Data

We studied:

What We Looked At	What We Focused On
Market Information	How many companies use AI, effects on trading
Rule-Following Reports	AI-related problems, ways to manage risks
Tech Surveys	New ways AI is used in securities

4. Asking Experts

We talked to lawyers, rule-followers, and tech experts to understand what the rules mean now and might mean later.

5. Reading Studies

We read papers, reports, and rule documents to build a strong base for our study.

Main Regulatory Bodies and Their Actions

Key groups are shaping how AI is used in the securities industry. Let's look at what these groups are doing.

SEC's Role

The Securities and Exchange Commission (SEC) watches how AI is used in securities. While we don't have specific details about SEC actions, they usually work with FINRA to oversee AI use in finance.

FINRA's Guidance

FINRA is taking steps to address AI use, including new types like generative AI and large language models. Here's what FINRA says:

1. Rules Apply to All Tech: FINRA's rules work the same for AI as for other tech.
2. Following Rules: Companies using AI must still follow existing rules and laws. For example:

Rule	How It Applies to AI
FINRA Rule 3110	Companies need a good system to oversee AI use
Rule 2210	Applies to messages made by AI

3. Check Before Using: Companies should test AI tools before using them to make sure they follow the rules.
4. Watch Everything: AI could affect many parts of a company's work, so they need to be careful.
5. Open to Talk: FINRA wants to talk with companies about how to use AI safely.

Other Rule Makers

FINRA knows other groups might make rules about AI too:

1. More Rules Coming: Other federal and state rules might apply to AI use now or later.
2. Keep Watching: Companies should pay attention to new rules, not just from FINRA.
3. Working Together: FINRA wants to work with companies and other groups to figure out how to use AI safely.

This approach aims to help new ideas while keeping investors safe and markets fair as AI use grows in the securities industry.

Key Regulatory Changes in 2024

SEC's New AI Rules

The SEC works with FINRA to watch over AI use in finance. While we don't have specific details about SEC's new AI rules, they likely match FINRA's approach. This means treating AI like other tech and applying current rules to it.

FINRA's AI Guidelines

FINRA has set new guidelines for AI use in 2024:

1. Same Rules for All Tech: FINRA's rules work the same for AI as for other tech.
2. Check Before Using: Companies must test AI tools before using them to make sure they follow the rules.
3. Follow All Rules: AI could affect many parts of a company's work, so they need to be careful. For example:

Rule	What It Means for AI
Rule 3110 (Supervision)	Companies need a good system to watch over AI use
Rule 2210 (Communications)	AI-made messages must follow content rules

4. Be Careful with AI Vendors: Companies should check third-party AI vendors carefully. They need to think about accuracy, privacy, bias, and who owns the ideas.
5. Write Down AI Rules: Companies should have written rules about how to use and watch over AI systems.

Working Together on Rules

FINRA knows AI tech changes fast and wants to work with others on rules:

1. Talking to Everyone: FINRA wants to talk with companies, other rule-makers, and experts about AI rules.
2. Ready for Changes: FINRA knows AI rules might need to change as the tech grows.
3. Keep Talking: FINRA tells companies to keep talking to their Risk Monitoring Analysts about AI issues.

While we don't have specific info about global teamwork, FINRA's approach suggests they might work with other countries on AI rules in the future.

Effects on Industry Players

Impact on Broker-Dealers

Broker-dealers are using AI a lot in the securities industry. FINRA found that companies are using AI for:

• Talking to customers
• Making investments
• Doing office work

FINRA asked companies about problems with using and watching AI. They talked to:

• Broker-dealer firms
• Teachers
• Tech companies
• Helper companies

This helps FINRA understand how AI is used and what problems it might cause.

Changes for Investment Advisers

Investment advisers have new jobs with AI:

1. Make Rules: They need rules to stop breaking laws.
2. Keep Data Safe: They must:
   • Protect client info
   • Stop identity theft
   • Make sure AI tools don't leak customer data
   • Watch for computer threats
3. Be Careful with Others' AI: Their online info might be used by other AI tools, which could show weak spots.

Public Company Considerations

Public companies using AI need to tell people about it:

What to Do	Why It's Important
Tell SEC about AI use	It's required in forms like 10-K
Check if AI use is big	Decide if it's important to tell
Be clear and correct	Make sure AI info is right
Tell first	Many big companies are already doing this
Don't hide AI use	SEC might punish companies that don't tell

Investor Outcomes

New AI rules help investors:

1. Stop Lies: SEC stops companies from lying about AI use.
2. See More: Investors get more info about how AI is used.
3. Fair Treatment: Rules stop companies from using AI to cheat investors.
4. Safe Info: Better rules keep investor info safer.
5. Smart Choices: With more info, investors can choose better AI products.

These new rules make things clearer and safer for people using AI in finance.

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Meeting Compliance Requirements

Handling AI Conflicts of Interest

FINRA says companies must be careful about conflicts when using AI in finance. They need to:

• Test AI tools well before using them
• Think about how they'll use AI in the company
• Follow FINRA's rules

The SEC lists some conflicts to watch out for:

Conflict Type	What It Means
Predictive Models	AI might push clients to keep money with advisors
Trading Incentives	AI might encourage too much trading
Revenue Sharing	AI might favor certain investments
Company Products	AI might push a company's own products more

To fix these issues, companies should have good systems to watch over AI use.

Making AI Systems Clear

Companies need to explain how their AI works. FINRA says some AI tools are hard to understand. To follow the rules:

1. Find all possible conflicts in AI systems
2. Make rules for watching AI
3. Make sure outside AI companies protect information
4. Be able to explain how AI makes choices

Data Protection in AI

Keeping data safe is very important when using AI in finance. Companies should:

• Think about data safety before using AI
• Make sure data is correct
• Keep AI working well
• Stop data from being stolen

FINRA says companies need rules for keeping data safe and correct.

Compliance Tips

To follow the rules when using AI, companies should:

Tip	What to Do
Check AI	Test AI tools well before using them
Follow Rules	Keep following FINRA and other finance rules
Write It Down	Make written rules for watching AI
Talk to FINRA	Keep talking with FINRA about AI use
Watch for Changes	Pay attention to new AI rules

FINRA wants companies to ask questions about using AI and tell them how to make rules better for new tech while keeping investors safe.

New AI Regulation Trends

The securities industry is seeing big changes in AI rules in 2024.

AI Ethics Rules

Rule makers are focusing more on using AI ethically in securities:

• FINRA says companies should check AI tools before using them
• Companies need to think about keeping data private, making sure it's right, and not being unfair
• Companies must have good systems to watch over AI use

Watching AI Market Cheating

Rule makers are trying harder to stop AI from being used to cheat in markets:

• FINRA's rules apply to AI use in companies, no matter who made the AI
• Companies need rules for how to use AI and keep data correct
• Companies are always checking to make sure they're following the rules

AI in Rule-Following Tech

AI is being used more to help follow rules:

What It Does	How It Works
Helps follow rules	Uses AI to do rule-following jobs automatically
Always watching	Keeps checking if companies are following rules
Uses blockchain for checking customers	Makes it easier and safer to check who customers are

FINRA treats all tech the same way when making rules. This helps them keep up with new tech while keeping investors safe. FINRA wants to keep talking with companies about how to use AI safely in the securities business.

Real-World Examples

AI Misuse Penalties

The SEC has taken action against investment advisers for false statements about AI use in 2024. Two key cases show how regulators are stopping "AI washing" in securities:

1. Delphia (USA) Inc.

Delphia, a Toronto-based investment adviser, was penalized for lying about its AI use:

Issue	Details
False Claims	Said it used AI and client data since 2019
Truth	Admitted in 2021 it hadn't used client data or made an algorithm
Continued Lies	Kept making false AI claims until August 2023
Punishment	Charged with breaking laws, fined $225,000

Main lies:

• Said it used machine learning with client data for smart investing
• Claimed its AI could predict big trends before others
• Advertised that client data improved its algorithm

2. Global Predictions Inc.

Global Predictions, from San Francisco, also faced charges:

Issue	Details
False Claims	Said it was the "first regulated AI financial advisor"
Truth	Couldn't prove it had AI capabilities
Punishment	Charged with breaking laws, fined $175,000

These cases show the SEC is serious about stopping lies about AI use in securities.

Good AI Compliance Examples

While we don't have specific good examples, here are some best practices based on what we've seen:

1. Be Honest About AI

• Tell the truth about AI abilities in all materials
• Have proof to back up AI claims

2. Follow Rules Carefully

• Make clear rules for AI use, including social media
• Decide who's in charge of AI-related work

3. Check AI Systems Often

• Look at AI systems regularly to make sure they match what's been said
• Keep records of AI methods and data use up to date

4. Fix Mistakes Quickly

• If you say something wrong about AI, fix it fast
• Tell regulators, clients, and the public about fixes

5. Train Staff

• Teach workers how to use and talk about AI correctly
• Make sure rule-followers know about AI rules

Looking Ahead

Expected Rules After 2024

After 2024, we expect more rules about AI in securities. FINRA says it will give more help on how to use AI correctly. This means we'll likely see:

1. Better AI Management: Clearer steps for watching over AI in finance companies.
2. Keeping Data Safe: Rules to make sure AI uses good, fair data.
3. Understanding AI Choices: More focus on explaining how AI makes decisions.
4. Working Together: Trying to make AI rules similar in different countries.

Future Industry Challenges and Benefits

As AI grows in the securities industry, there will be good and bad things:

Challenges:

Challenge	What It Means	What Might Happen
Fast Tech Changes	Hard to keep up with new AI	Following rules gets harder
Computer Safety Risks	New ways for bad people to attack	Need better safety plans
Fairness Issues	Making sure AI is fair to everyone	Need clear rules about being fair
Not Enough Experts	Not many people know about AI rules	Need to teach more people

Benefits:

1. Better at Spotting Problems: AI can help find cheating and fraud faster.
2. Getting Work Done Faster: AI can do boring jobs, saving time and money.
3. Making Customers Happier: AI can give better service while following rules.
4. Watching for Rule-Breaking: AI can check all the time if rules are being followed.

To make the most of AI, banks, rule-makers, and tech companies need to work together. FINRA wants to talk with everyone about how to use AI safely.

In the future, we'll need to balance new ideas with keeping investors safe. As AI changes, the rules will change too. Everyone in finance needs to pay attention and be ready to change how they work.

Wrap-Up

Main Takeaways

Here are the key points about AI in securities rules for 2024:

1. Watching Over AI: The SEC and FINRA say companies must have good plans to watch their AI systems. This means making clear rules about how to use AI and follow the law.

2. Being Careful with AI Helpers: Using AI tools from other companies can be risky. Companies need to check these tools carefully and make sure they're safe to use.

3. Making AI Clear: Rule-makers want companies to explain how their AI works. This means companies should be able to show how AI makes choices.

4. Rules Keep Changing: While there aren't many AI-only rules yet, the old rules still apply to AI. Companies should keep up with new rules as they come out.

5. Working Together: FINRA wants to talk with companies about AI rules. This teamwork helps make good rules that let companies try new things while keeping investors safe.

What Companies Need to Do	Why It's Important
Make clear AI rules	To use AI safely and follow the law
Check AI tools from others	To avoid problems with data safety and accuracy
Be able to explain AI choices	To show that AI is fair and working right
Keep up with new rules	To stay on the right side of the law
Talk with rule-makers	To help make good rules for everyone

As AI keeps changing, companies in the securities business need to be careful. By focusing on these main points and talking with rule-makers, companies can use AI well while keeping investors and markets safe.

Sources

Here's a list of where we got our information:

Source	Date	Type
FINRA Regulatory Notice 24-09	June 27, 2024	Official notice
FINRA's 2024 Annual Regulatory Oversight Report	2024	Yearly report
FINRA Podcast: "An Evolving Landscape: Generative AI and Large Language Models in the Financial Industry"	March 2024	Podcast
FINRA, SEC, NASAA Investor Insight: "Artificial Intelligence (AI) and Investment Fraud"	January 2024	Joint report
National Institute of Standards and Technology (NIST) Artificial Intelligence Framework	January 2023	Government framework
FINRA Report: "Artificial Intelligence (AI) in the Securities Industry"	June 2020	Industry report
FINRA Regulatory Notice 21-29 on supervisory obligations related to outsourcing to third parties	2021	Official notice
FINRA FinTech Topic Page	N/A	Online resource
MIT Sloan School of Management: "Machine Learning, Explained" by Sara Brown	April 21, 2021	Educational article

These sources give us a good look at the rules, advice, and changes about AI in the securities industry in 2024 and before.

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