In 2024, the Financial Industry Regulatory Authority (FINRA) expanded its guidance on integrating Artificial Intelligence (AI) within the securities industry, placing particular emphasis on generative AI (GenAI) and large language models.
This builds upon FINRA’s ongoing efforts since 2020 to ensure that member firms adhere to existing regulatory frameworks while adopting advanced technologies. The recent guidelines underscore the necessity for firms to maintain compliance with established rules, such as FINRA Rules 2210 and 3110, when implementing these sophisticated AI tools.
In June, FINRA released Regulatory Notice 24-09, underscoring that all member firms must comply with current FINRA rules when employing AI technologies, including generative AI and large language models. The notice highlights that the applicability of specific rules depends on the particular use cases of AI within a firm.For instance, FINRA’s Rule 2210, titled “Communications with the Public,” establishes comprehensive standards for broker-dealers’ communications, ensuring they are fair, balanced, and not misleading. The rule categorizes communications into three types:
- Correspondence: Written or electronic communications distributed to 25 or fewer retail investors within a 30-calendar-day period.
- Retail Communications: Communications distributed to more than 25 retail investors within the same timeframe.
- Institutional Communications: Communications exclusively distributed to institutional investors.
Each category has specific approval, review, and recordkeeping requirements. For instance, retail communications generally require prior approval by a qualified registered principal, unless certain exceptions apply. Additionally, Rule 2210 outlines content standards mandating that all communications provide a sound basis for evaluating facts regarding any security or service, prohibit false or misleading statements, and ensure that comparisons between investments disclose all material differences. The rule also specifies filing requirements with FINRA for certain communications and emphasizes the necessity for firms to maintain records of all communications, including approvals and related materials, for regulatory review.
Supervision of AI-Generated Communications
FINRA’s updated FAQs on advertising regulation provide further clarity on supervising AI-generated content. Firms utilizing AI technologies, such as chatbots, for investor communications are required to supervise these interactions in accordance with applicable FINRA rules, specifically Rules 2210 and 3110.
FINRA Rule 3110, known as the “Supervision” rule, mandates that member firms establish and maintain a supervisory system reasonably designed to ensure compliance with applicable securities laws, regulations, and FINRA rules.
In response to evolving remote work environments, FINRA has introduced amendments to Rule 3110 to accommodate remote supervision and inspections. Effective July 1, 2024, FINRA implemented a voluntary, three-year Remote Inspections Pilot Program under Rule 3110.18, allowing eligible firms to conduct certain supervisory inspections remotely, subject to specific conditions and safeguards. Additionally, as of June 1, 2024, FINRA established the Residential Supervisory Location (RSL) designation under Rule 3110.19, permitting private residences to function as non-branch supervisory locations if they meet defined criteria. These updates aim to provide firms with greater flexibility in supervisory practices while maintaining robust compliance standards.
Investor Protection Against AI-Driven Fraud
FINRA in collaboration with the Securities and Exchange Commission (SEC) and the North American Securities Administrators Association (NASAA), has issued a cautionary alert – Artificial intelligence (AI) and Investment Fraud– on the escalating use of AI by bad actors. Fraudsters are exploiting the growing popularity and complexity of AI to deceive investors, often by promoting unregistered or unlicensed investment platforms that falsely claim to utilize sophisticated AI technologies for superior returns. These platforms may lure investors with promises of high profitability, leveraging the allure of AI to mask fraudulent intentions.
A prevalent tactic involves “AI washing,” where companies exaggerate or fabricate their use of AI to attract investments. This deceptive practice parallels “greenwashing” in environmental claims, leading to increased scrutiny from regulatory bodies. For instance, the SEC has taken action against firms making false statements about their AI capabilities, underscoring the importance of transparency and honesty in AI representations.
AI in the Securities Industry: Applications and Considerations
FINRA’s 2020 report, “Artificial Intelligence (AI) in the Securities Industry,” should be the starting point for getting up to date on AI regulatory guidance for FINRA registered firms. The document explores the expanding role of AI across various functions within broker-dealers, including customer communications, investment processes, and operational activities. The AI adoption and implementation challenges identified in the report are as relevant today as they were four years ago – challenges such as model risk management, data governance, customer privacy, and the necessity for robust supervisory control systems. It emphasizes that while AI offers significant benefits, firms must apply due diligence to maintain compliance and protect investor interests.
FINRA’s comprehensive guidance on the integration of artificial intelligence (AI) within the securities industry underscores the necessity for firms to uphold existing regulatory standards while embracing technological advancements. By applying established rules to AI-generated communications and emphasizing the supervision of AI tools, FINRA aims to ensure that innovation does not compromise investor protection or market integrity. Firms are encouraged to engage proactively with FINRA for interpretive guidance and to remain vigilant in monitoring the evolving regulatory landscape as AI technologies continue to develop.
Subscribe to our newsletter
