Compliance

The AI Balancing Act: 2024 FINRA AI Guidance on Juggling Innovation and Compliance

November 01, 2024by Tiffany Magri

As someone deeply immersed in regulatory compliance, I had the privilege of attending two pivotal FINRA conferences this year: the FINRA Advertising Regulation Conference and the Small Firm Conference. Both events featured sessions on artificial intelligence (AI) that provided invaluable insights into how this transformative technology is reshaping the financial services industry. Below, I'm excited to share my key takeaways and reflections on how AI is changing the regulatory landscape for financial professionals.

Why it matters

Artificial intelligence is everywhere, and although regulated industries are understandably cautious, they are also enthusiastic about the potential efficiency and competitive advantage that AI can offer. Organizations should avoid blindly adopting AI technologies and integrations; however, playing the “wait and see” game may cause organizations to fall behind. These insights aim to help firms strike a balance between being cautious and fostering innovation to achieve future-focused goals.

Regulatory framework: How to adapt existing rules to emerging technologies

FINRA's approach to AI regulation is evolving, but its foundation remains consistent and existing rules still apply. This technology-neutral stance means that regardless of the innovation, firms must ensure their AI implementations comply with long-standing regulations. However, FINRA is acutely aware of the unique challenges AI presents and is actively engaging with firms to better understand these hurdles.

A notable moment from the Advertising Regulation Conference was the discussion around FINRA Notice 24-09, issued in June 2023, which served two important purposes:

Affirming existing rules: The notice clarified that FINRA rules and federal securities laws extend to the use of generative AI. This ensures that AI remains within the boundaries of regulations designed to be evergreen and applicable to new technologies.
Inviting engagement: Recognizing the revolutionary potential of AI, FINRA is encouraging firms to share the specific challenges they face when applying AI to supervisory and compliance programs.

The collaborative approach of FINRA Notice 24-09 is encouraging, as it emphasizes FINRA's recognition of the challenges firms face in navigating AI within the current regulatory framework. While the rules are not changing, the expectation is clear: firms must find ways to apply existing regulations to AI technologies. This includes crucial issues like recordkeeping – specifically, how firms maintain compliance with SEC books and records rules when dealing with AI-generated content.

AI in the industry: Where do financial services firms stand on AI?

A live poll conducted during the Advertising Regulation Conference provided fascinating insights into the current state of generative AI adoption among attendees:

While these results suggest a cautious approach to AI implementation, the Small Firm Conference revealed that AI adoption might be more widespread than these numbers indicate. Many firms may be unknowingly using AI through off-the-shelf products or vendor services with integrated AI capabilities. Most organizations have caught on that with every software update, the common tools and platforms we use every day could be integrating some element of machine learning, which may not be obvious to the average user. This 'shadow AI' use introduces compliance risks that firms must actively manage.

Unsurprisingly, discussions revealed a dichotomy in AI adoption across different areas of business. While AI applications are gaining traction in various operational processes, firms are approaching implementation selectively and cautiously. Even the most advanced AI tools are fallible. AI lacks human critical thinking as it sifts through the finite amount of information it’s been fed to determine what is true and false, as well as what is applicable and irrelevant. There's a clear recognition that human expertise and judgment remain crucial, even in AI-enhanced operations.

When it comes to customer-facing applications, an even more prudent stance prevails. This caution is understandable given the potential risks of deploying AI in direct client interactions. As one panelist noted, "Right now we have not heard of any generative AI products being used at broker-dealers that are customer-facing." While I think there's certainly an appetite for client-facing AI applications, this measured approach reflects the industry's commitment to thorough risk management and compliance before introducing these technologies to clients.

Best practices: Navigating the AI landscape safely

Both conferences were packed with practical advice for firms looking to implement AI. Here are some best practices that emerged:

Risk assessment: Conduct thorough risk evaluations for each AI use case. As the sessions pointed out, risks aren't uniform across all AI applications. This should be the foundation for all AI implementation decisions.
Ethical frameworks: Develop comprehensive guidelines covering purpose, transparency, manipulation mitigation, and continuous testing. Firms must ensure they can explain the "why" behind their AI decisions.
Conservative implementation: Consider starting with internal AI applications before moving to customer-facing solutions. This allows firms to manage risks and gain experience before exposing clients to the technology.
Team education: Upskilling employees on ethical AI use is crucial. This was highlighted several times as being foundational for responsible AI implementation.
Human oversight: The importance of a "human-in-the-loop" process was emphasized repeatedly across both conferences. This involves having human review and approval of AI outputs before they are used or disseminated. One additional tip: Include how you’re integrating human oversight, specifically in your procedures.
Vendor due diligence: As AI becomes embedded in third-party services, updating contracts and understanding how vendors use AI is critical. Some key considerations on this topic included firms proactively reaching out to all their vendors about generative AI use, and reviewing and potentially updating their vendor due diligence processes to account for AI-specific concerns.

The compliance journey ahead

The insights from these FINRA conferences paint a picture of an industry at a crossroads. The potential of AI to revolutionize financial services is clear, but so too are the risks and regulatory challenges. The message from FINRA is equally emphatic: we can't let innovation outpace responsibility.

To my fellow compliance professionals, our task ahead is to stay informed about AI developments, actively engage in risk management strategies, and work closely with both our firms and regulators to navigate this new frontier. By doing so, we can help ensure that AI integration in financial services is not just innovative, but also responsible and compliant.

Learn how your firm can leverage the power of generative AI while maintaining compliance with Smarsh Capture for the ChatGPT Compliance API, a compliance solution purpose-built for financial services firms.

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Tiffany Magri

Senior Regulatory Advisor at Smarsh

As a Regulatory Advisor at Smarsh, Tiffany Magri monitors, evaluates and consults on the financial services regulatory landscape. Tiffany has more than 10 years of experience facilitating compliance with laws and regulations, policies, and risk management. Prior to joining Smarsh, Tiffany was a Senior Associate at Benefit Street Partners and a Compliance Analyst at Broadstone and Manning & Napier Advisors.

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