SEC's Gensler Promises 'War' On AI Fraud

(February 13, 2024, 8:56 PM EST) -- U.S. Securities and Exchange Commission Chair Gary Gensler told an audience of Yale Law School students on Tuesday that financial firms using so-called artificial intelligence could face the agency's wrath if they don't put proper safeguards in place to combat fraud against investors.

Gensler quoted a nearly 100-year-old speech given by Joseph Kennedy, the agency's first chair, when discussing how the agency might address potential fraud in the AI space.

Kennedy "may have said it best in his very first speech he gave as chair of the SEC: 'The commission will make war without quarter on any who sell securities by fraud and manipulation,'" Gensler said.

"From my perspective, as a chair of an agency, fraud is fraud, and bad actors just have a new tool called AI to exploit the public," he said.

The regulation of AI has been a frequent topic of discussion for Gensler in recent months, with the agency proposing rules last summer to govern the technology's use by market intermediaries.

That proposal, which could be adopted by the end of this year, would require brokerage firms and investment advisers to eliminate the use of predictive data analytics and related tools that put the firm's interest before that of its investors.

While Gensler briefly addressed the proposal in Tuesday's discussion, he also spoke in-depth about the potential for AI-based fraud.

While some companies may be intentionally committing securities fraud using AI, it's also possible that some market participants are not vetting the technology they use to check for compliance problems around practices like spoofing and front-running, he said.

Gensler warned companies against being "reckless" by not testing technology before putting it into service.

"Investor protection requires that humans who deploy a model put in place appropriate guardrails," he said. "It's not like, 'Oh, I don't need to make sure it doesn't do bad things.'"

The difficulty for the SEC may come, he said, in addressing potentially unpredictable harm created by some AI models.

"How does one hold liable the persons who deploy AI models that create truly unpredictable harm? Now, I emphasize, what's truly unpredictable?" Gensler said. "But some of this will play out in the courts."

Gensler didn't indicate when the conflicts of interest proposal could come up for a final vote, nor another closely watched proposal that could require publicly traded companies to disclose more information about the effects of climate change on their businesses.

But he recognized the possibility of a lawsuit challenging the climate proposal if it is finalized.

Gensler said that the agency has only been sued over six of the 34 rules adopted under his leadership, and that only one of those rules has been overturned so far, and not on First Amendment grounds.

The conservative-dominated Fifth Circuit, however, has indicated that it is prepared to overturn at least one other recently enacted SEC regulation governing the private fund industry.

"I think we're doing everything according to the law and how the courts interpret the law," Gensler said. "And as the courts shift their interpretations, jobs like mine are both more challenging and more interesting. It's kind of thinking about, where are the courts in 2024? Where might they be in '25 and '26, interpreting these matters of administrative authority?"

--Editing by Dave Trumbore.

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