New rules tighten use of AI models by investment advisers for stock picking

On Tuesday, Sebi said the investment advisors will be solely responsible for the investment advice, irrespective of usage of AI tools

Investment advisers (IAs) pitching client’s artificial intelligence (AI)-driven investment models need to be cautious as market regulator issues norms for use of such machine tools, experts have said.

On December 17, the Securities and Exchange Board of India (Sebi) said investment advisers would solely be responsible for the advice irrespective of the use AI tools. IAs will also be responsible for safeguarding privacy of client data and will have to disclose the extent of the use of such tools, the notification said.

Before the notification, use of AI was a grey area with some advisers even labelling their stock picks as driven by artificial intelligence models.

Use of new technology in any sector always raises concern. Unlike the regulatory stance on driverless cars, in investment services, there is no hidden ban on the use of technology, Jayesh H, co-founder, Juris Corp Advocates and Solicitors, said. “The new rules will have the service providers take pragmatic calls and deploy adequate checks and balances as regards back testing of AI and its deployment,” he said.

The move will impact wealth management platforms, brokers and other specialised investment advisory firms where registered investment advisors provide stock related advises, say experts. As on October 31, there were 944 registered investment advisers with Sebi, data showed.

“The move aims to ensure transparency and protect investor interests as AI becomes increasingly prevalent in the financial sector. Sebi has expressed concerns over potential data security risks associated with AI tools and emphasises the need for robust security measures to prevent unintended data exposure,” said Sanjay Israni, partner at Desai & Diwanji.

Following the Sebi order, IAs will have to start putting in place measures to ensure data privacy of clients if using AI tools. The regulator has also made them accountable for adverse outcomes involving output given by AI.

"Investment Advisers may need to strengthen their internal policies for employees and incorporate procedures for regular internal inspections to ensure that potential non-compliances are caught in time," Nandini Pathak, partner, Bombay Law Chambers, said.

This is also part of the larger regulatory checks and balances Sebi is planning to introduce on the use of AI by various regulated entities.

On the same day, Sebi issued another circular extending the similar safeguards to research analysts registered with it. Earlier, Sebi came out with two consulting papers — one on the use of AI tools by market institutions and second, on the use of algo trading models by retail. Both papers aim to bring more transparency and accountability in the market with respect to usage of AI tools.

With the sudden rise of use of AI tools in the stock markets, regulators across the world are playing catch-up to ensure any unintended consequences.

In October, the US Securities Exchange Commission in a report said it would step up scrutiny of investment advisers and brokers who use AI tools.  It will also monitor measures being taken by these intermediaries’ risks related to trading, fraud and anti-money laundering policies.