Editor’s Note: The financial industry increasingly leverages artificial intelligence (AI), including generative AI (GenAI), to improve services and enhance operational efficiencies. However, this technological advancement comes with regulatory scrutiny. On June 27, 2024, the Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 24-09, reminding firms that existing securities laws and regulations apply to the use of AI tools. While AI offers significant opportunities, including better data analysis and automation, it also poses risks related to accuracy, privacy, bias, and security. Firms are advised to have appropriate supervisory systems and governance in place for compliance. The European Union’s AI Act also signals a growing regulatory focus on AI in financial services. Despite these challenges, many firms are adopting GenAI tools, seeing them as essential for staying competitive in a rapidly evolving regulatory landscape.

Content Assessment: FINRA Reaffirms Regulatory Standards for AI Adoption in Financial Services

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Industry News – Artificial Intelligence Beat

FINRA Reaffirms Regulatory Standards for AI Adoption in Financial Services

ComplexDiscovery Staff

The Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 24-09 on June 27, 2024, reminding member firms that existing securities laws and FINRA’s rules apply to the use of artificial intelligence (AI), including large language models (LLMs) and other generative AI (Gen AI) tools. This notice clarifies that while these technologies can enhance operational efficiencies and improve services, their use must still comply with established legal and regulatory frameworks.

AI technologies, such as generative AI tools, have revolutionized various business processes with their capability to predict and generate content. As per FINRA’s notice, broker-dealers can leverage AI to analyze financial data, summarize documents, and assist in investor education. However, these technological advancements come with concerns regarding accuracy, privacy, bias, and security. FINRA underscores the importance of having appropriate supervisory systems and governance in place to mitigate these risks, whether the AI tools are developed internally or sourced from third parties.

Rule 3110, which governs supervision, mandates that firms design supervisory systems tailored to their business needs. This includes considerations for technology governance, model risk management, data privacy and integrity, and the reliability and accuracy of AI models. FINRA’s rules are designed to be technologically neutral, ensuring they apply dynamically as members leverage different technologies.

Accuracy and reliability are paramount. Despite the transformative potential of generative AI, tools like ChatGPT, which often seem to understand user commands, do not actually comprehend content but predict what comes next based on learned patterns. This can lead to ‘hallucinations’ where AI tools generate false or misleading information. Therefore, a human oversight mechanism is essential to validate AI-generated content.

The application of AI in financial services poses significant regulatory challenges. Regulatory Notice 24-09 does not introduce new rules but rather emphasizes existing obligations, reminding firms that the content standards of Rule 2210 (Communications with the Public) apply equally to AI-generated communications. This means all communications, regardless of whether they are generated by humans or AI, must meet FINRA’s standards for accuracy and fairness.

Regulatory bodies are keenly observing the rapid evolution of AI in financial services. There are ongoing discussions about providing further guidance for specific AI use cases to address ambiguities in rule applications. Member firms are advised to seek interpretive guidance and maintain open dialogues with their Risk Monitoring Analysts to ensure compliance.

One area where generative AI has demonstrated significant potential is client onboarding. Traditional Know Your Customer (KYC) procedures involve manually sifting through data to identify high-risk clients. AI can streamline this process by quickly and accurately analyzing vast datasets to flag potential risks. Additionally, AI models trained on large datasets of market and news data can enhance trade capture algorithms, leading to more informed decision-making.

With the AI Act soon to be published in the Official Journal of the EU, there’s an increasing focus on providing guidance for regulated financial service providers intending to integrate AI into their operations. This reflects the global movement towards a more AI-integrated financial sector, necessitating a balanced approach that capitalizes on AI’s benefits while mitigating its risks.

The momentum behind generative AI adoption remains strong despite concerns. According to a 2024 Digital Transformation and Next-Gen Tech Study, 45% of firms allow staff to use Gen AI tools for work, with another quarter actively training their teams on these technologies. However, companies need to strike a balance between leveraging AI’s potential and addressing its limitations, which include data quality issues, legal constraints, and the risk of resource-intensive projects that may not yield significant returns.

For financial firms, the process of incorporating AI requires a strategic approach. Identifying practical and scalable use cases, ensuring alignment with long-term business strategies, and evaluating the feasibility and costs associated with AI projects are crucial steps. High-impact areas such as regulatory compliance and reporting, collateral management, and settlement processes offer promising opportunities for AI integration.

As the financial industry continues to evolve with the advent of AI, firms are urged to navigate this complex landscape with vigilance. By adopting appropriate supervisory mechanisms, seeking interpretive guidance, and engaging in proactive risk management, firms can harness the transformative power of AI while maintaining regulatory compliance and operational integrity.

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Source: ComplexDiscovery OÜ


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