Form ADV submission deadline approaching: have your AI disclosures been reviewed? - Waystone

      Form ADV submission deadline approaching: have your AI disclosures been reviewed?

      Registered investment advisers (RIAs) have rapidly integrated AI into various aspects of their operations, including investment strategy, market research, portfolio management, trading, risk management, and overall business functions.

      Responding to the widespread adoption of AI in securities markets, Securities and Exchange Commission (SEC) Chair, Gary Gensler has announced plans to prioritize tackling securities fraud related to AI disclosures and has cautioned against ‘AI washing’ among market participants. These statements underscore the SEC’s heightened focus on scrutinizing the use of AI by registrants.

      How the SEC has made AI a focus

      The agency has made AI a key focus in the following ways:

      • including AI in its 2024 examination priorities
      • conducting a sweep of RIAs to assess their use of AI in areas such as advertising and investment decisions
      • taking enforcement action against an RIA for misleading disclosures surrounding its AI-based trading tool.

      AI disclosures

      Early disclosures around AI use were often vague, with references to ‘big data’, algorithms, and machine learning. However, as adoption expands, disclosures are becoming more specific, such as:

      • detailing specific AI tools and models used
      • describing how AI is used for predictions, trend analysis, and investment themes
      • outlining how AI informs trading decisions.

      Best practices for RIAs filing Form ADV

      With this increased scrutiny, RIAs should prepare for deeper examination of their Form ADV disclosures regarding AI, particularly in Part 2A.

      1. Be transparent about your use of AI

      • Clearly state whether and how you utilize AI in your investment process. This varies by firm, so avoid a ‘one-size-fits-all’ approach.
      • Avoid overstating or understating your AI usage – if your AI is limited to operational tasks, don’t claim it impacts investment research or trading. Conversely, if you start using AI for these areas, update your disclosures accordingly.
      1. Avoid hypothetical language

      • Avoid using vague language,such as ‘may’ to describe existing AI applications. If you leverage AI for investment decisions, be honest about it.
      • The SEC has penalized RIAs for using hypothetical language, so avoid setting yourself up for future scrutiny.
      • If your AI use evolves from theoretical to actual, update your disclosures to reflect this change.
      1. Disclose AI risks comprehensively

      • as AI adoption grows, so do certain risks, including data quality, privacy, intellectual property, limitations, cyber security, bias, and transparency
      • be clear, detailed, and accurate when disclosing these risks in your Form ADV
      • the SEC has charged firms for failing to disclose or downplaying materialized risks, so be truthful and thorough in your disclosures.

      By following these best practices, RIAs can stay compliant and avoid potential issues with the SEC as they navigate the evolving landscape of AI in investment management.

      Waystone Compliance Solutions is a leading provider of cyber security consulting and compliance services to the financial services industry. If you would like to find out more about this topic or how we can help you to assess your current cyber security measures, please reach out to your usual Waystone representative or contact us below.

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