MFDF Series: Dear Board Doc - How do I keep up with rapid advancements in AI and what is my role with respect to its use in the fund industry?

Q. AI is evolving rapidly, and it is impacting many aspects of the financial services industry. As a fund board member, what do I need to know and what factors should I consider with respect to managers and fund service providers that utilize AI?

A.  As AI continues to evolve, it is important that boards develop an understanding of key terminology used in AI, the primary ways in which it is used by their funds and applicable service providers, and the potential impact it may have on services provided to funds. Below are a few factors fund boards should consider regarding the use of AI:

  • AI Terminology – Boards should develop an understanding of key terminology utilized in AI, including machine learning, deep learning, large language models, and generative AI. The MFDF webinar linked below provides an overview of key terms.
  • Regulatory Developments – Chair Gensler has stated that his agency is currently considering new rules to regulate artificial intelligence. To that end, boards of regulated investment companies should not be surprised to see AI included as a component in routine regulatory examinations of the advisers of their funds. In the interim, the SEC proposed rules earlier this year (PDA Conflicts Rules) that would address conflicts of interest associated with advisers that leverage algorithms to predict and guide investor decisions through phone apps or web interfaces.
  • Use of AI by Investment Advisers – Advisers should be able to explain how they are using AI in the context of portfolio management, digital engagement practices and other applications. In each instance, boards should consider inquiring whether AI is being optimized for the investor’s best interest. In addition, boards can ask fund advisers how AI models operate, how they are tested on an ongoing basis and the type of data underlying each model. They should also consider asking the adviser what its methodology is for monitoring the model’s output.
  • Use of AI by Service Providers – Boards evaluating fund service providers should consider whether each service provider has assessed the uses, risks, monitoring, and oversight of AI as they relate to services provided to the funds. Boards can ask how service providers are using AI and the risk policies they have implemented. Cybersecurity presents unique and complex AI concerns and will be addressed in an upcoming blog post.

The following resources may be helpful in providing further background information about AI:

  • Mutual Fund Director’s Forum Webinar - Generative AI: It’s Here (available here)
  • SEC Letter to Investor Advisory Committee regarding Establishment of an Ethical Artificial Intelligence Framework for Investment Advisors (click here)
  • SEC Predictive Data Analytics Rule Proposal Fact Sheet (click here)
  • SEC Risk Alert Regarding Electronic Investment Advice (click here)
  • Biden Administration AI Bill of Rights (click here)

The MFDF’s Board Doc is an occasional feature of the Daily News Feed that features questions from our readers. The answers and commentary provided in our responses do not constitute legal advice and should not be treated as such. Please consult with your independent counsel on questions of compliance with the securities laws and director fiduciary duties. If you would like the Board Doc to consider your questions, please e-mail BoardDoc@mfdf.org.