Navigating the New SEC Marketing Rule for Fintech Companies

The world of investment advising is rapidly evolving, and AI is at the forefront of this transformation.  With these advancements, however, come new regulations designed to ensure transparency and fairness. The SEC Marketing Rule, revamped in 2020, has significant implications for fintech companies, especially those leveraging AI.

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About the authors:
Louis Froelich
Joshua Wabnik

Transcript

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The world of investment advising is rapidly evolving, and AI is at the forefront of this transformation.  With these advancements, however, come new regulations designed to ensure transparency and fairness. The SEC Marketing Rule, revamped in 2020, has significant implications for fintech companies, especially those leveraging AI. 

The SEC has a long history of regulating advertising by investment advisers. Traditionally, this included registered advisers and private fund managers. However, the rise of technology-oriented firms—like quantitative hedge funds and digital advisory apps—has expanded the scope of these regulations.

The Marketing Rule was overhauled in 2020 to address modern challenges. This revamp aims to ensure that advertising practices keep pace with technological advancements, particularly in AI and big data.

The rule applies to all investment advisers, including those incorporating AI and algorithms in their processes. This means tech-driven firms must adhere to the same rigorous standards as traditional advisers.

AI, machine learning, and big data are transforming the fintech industry. These technologies offer significant benefits, such as enhanced decision-making and efficiency. However, they also pose challenges, particularly around transparency and accuracy.

The SEC is increasingly scrutinizing AI-related claims. Firms must ensure that their marketing materials accurately reflect their AI capabilities and misleading claims can lead to severe penalties.

In one example, Delphia used data and software in trading, claiming to leverage AI and machine learning to manage client funds. However, the SEC found discrepancies between their advertised claims and actual practices.
The SEC discovered that Delphia did not use AI as advertised, and this misrepresentation led to a $225,000 penalty, among other sanctions.
The enforcement action against Delphia underscores the importance of aligning advertised AI capabilities with actual practices.

In another case, Global Predictions offered investment advice through its PortfolioPilot platform, claiming to use AI-driven forecasts.

Like Delphia, Global Predictions could not substantiate its AI claims, resulting in a $175,000 penalty.

These cases highlight the risks of "AI washing"—misleading claims about AI capabilities—and the severe repercussions under the Marketing Rule.

The SEC has also taken action against firms that inappropriately advertised hypothetical performance metrics - a term that refers to backtested, projected, and model performance metrics. These actions emphasize the need for transparency and relevance in performance advertising.

Firms should take steps to verify and substantiate their AI capabilities before advertising. Regular audits and thorough documentation are essential.
Not only that, but performance metrics must be tailored to the intended audience and presented transparently. Accurate benchmark construction is crucial.
Consistency between marketing materials and actual business practices is vital. The SEC Marketing Rule is critical for fintech companies, particularly those using AI and hypothetical performance advertising. Ensuring accuracy and transparency in marketing materials is essential.

In summary, Fintech firms must prioritize compliance to avoid penalties and build trust with their clients. Staying informed about regulatory trends and adapting to new rules will be key to long-term success.

By understanding and adhering to the SEC Marketing Rule, fintech companies can not only work to avoid enforcement actions but also foster a culture of transparency and trust. 

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