TECHNOLOGY

The Impact of AI and Technology on RIAs

By Leila Shaver

The advent of artificial intelligence (AI) and advanced technology has significantly transformed the financial services industry, bringing forth both opportunities and challenges. Registered investment advisers (RIAs) are at the forefront of this transformation, leveraging AI to enhance decision-making, improve client experiences, and streamline operations. A recent survey by AI platform Totumai and market research firm 8 Acre Perspective found 12% of RIAs currently use AI technology in their businesses and 48% plan to use the technology at some point. However, with these advancements come critical compliance, legal, and data privacy considerations RIAs must navigate to mitigate risks and liabilities.

As the owner of My RIA Lawyer, a law firm providing compliance and legal services to RIAs, broker-dealers, and fund managers, I have served as CCO and general counsel to RIAs of all sizes and types. The firms standing out from their competitors, improving the customer experience, and growing are those that embrace technological advancements and use them to streamline and improve processes, such as

1. Enhanced Decision-Making: AI algorithms can analyze vast amounts of data at unprecedented speeds, providing RIAs with deeper insights and more accurate forecasts. This capability enhances investment strategies and portfolio management, enabling advisers to offer more personalized and effective advice to clients. 
2. Operational Efficiency: Automation of routine tasks such as data entry, transaction processing, and compliance checks reduces human error and frees up time for advisers to focus on more strategic activities. AI-driven tools can also monitor market trends and regulatory changes in real-time, ensuring RIAs stay compliant and up to date. Using tools like Microsoft’s CoPilot or Google’s Gemini platform helps advisers prioritize client communications, track tasks, and reduce distraction. Specifically, they help draft emails, summarize long threads, generate outlines, organize slides, generate formulas, analyze and summarize data, and summarize notes and create to-do lists.
3. Improved Client Experience: AI-powered chatbots and virtual assistants provide clients with 24/7 support, answering queries and providing information instantly. Personalized financial planning and robo-advisers offer tailored investment solutions based on individual client profiles and preferences, enhancing client satisfaction and engagement.
4. Risk Management: AI systems can identify potential risks and anomalies by analyzing historical data and patterns. Predictive analytics helps in anticipating market movements and client behavior, enabling RIAs to make proactive adjustments to mitigate risks.

Compliance and Legal Implications

The integration of AI and technology into financial services introduces a complex landscape of compliance and legal challenges:

1. Regulatory Compliance: Regulatory bodies such as the SEC and FINRA have stringent requirements for RIAs, particularly concerning data accuracy, reporting, and client communications. AI systems must be designed and monitored to ensure compliance with these regulations. Automated compliance tools can help maintain records, monitor transactions, and generate reports but advisers must ensure these systems are accurate and reliable. Ideally, there should always be a human between the AI tool and client who is verifying output.
2. Algorithmic Transparency: AI algorithms often operate as "black boxes," making it difficult to understand how decisions are made. This lack of transparency can pose compliance risks if the algorithms produce biased or erroneous outcomes. RIAs must ensure their AI systems are auditable and explainable, with clear documentation of their decision-making processes. This includes understanding the information that forms the basis for the algorithm. Platforms like ChatGPT use information from the public internet, third-party licenses, and input provided by users and human trainers. As such, if the information that goes into the algorithm is inherently biased or incorrect, the output will be as well. 
3. Cybersecurity: The use of AI and technology increases the risk of cyberattacks and data breaches. RIAs must implement robust cybersecurity measures to protect sensitive client data and ensure the integrity of their systems. Regular security audits, encryption, and multifactor authentication are essential practices to safeguard against cyber threats. As much as AI can be used to streamline processes and enhance the client experience, it can also be used to identify weaknesses in your IT infrastructure to hack you. Hackers use AI algorithms to create customized phishing emails, deep fake videos, and malware. Scams are becoming more convincing and manipulative and scammers have become better at evading detection systems.
4. Liability and Risk: While AI can enhance risk management, it can also introduce new risks. If an AI system malfunctions or produces inaccurate predictions, the adviser may face legal and financial repercussions. RIAs should have contingency plans and insurance coverage to mitigate potential liabilities arising from AI-related errors.

Data Privacy Implications

Data privacy is a paramount concern in the financial services industry, where client trust and confidentiality are critical. The use of AI and technology involves the collection, processing, and storage of vast amounts of personal and financial data, raising several privacy issues:

1. Data Protection Regulations: RIAs must comply with data protection laws, which could include the General Data Protection Regulation (GDPR) and the California Consumer Privacy Act (CCPA). These regulations mandate stringent requirements for data handling, including obtaining client consent, ensuring data accuracy, and providing clients with access to their data.
2. Data Security: AI systems must be designed to protect client data from unauthorized access, loss, or theft. Encryption, access controls, and secure data storage practices are essential to maintaining data privacy. Regular vulnerability assessments and updates are necessary to address evolving security threats.
3. Data Usage and Consent: Transparency in how client data is used by AI systems is crucial. RIAs must clearly communicate their data practices to clients and obtain explicit consent for data processing. Clients should have the right to opt out of data collection and request the deletion of their data.
4. Third-Party Vendors: Many RIAs rely on third-party vendors for AI and technology solutions. It is essential to conduct thorough due diligence on these vendors to ensure they comply with data privacy regulations and have robust security measures in place. RIAs should establish clear agreements with vendors outlining data protection responsibilities and protocols. Additionally, RIAs must, as a part of their initial and ongoing vendor due diligence, understand what AI features, if any, have been added to the technology they are using and whether they can opt out of its use if so desired. 

Drawbacks and Risks

While AI and technology offer numerous benefits, they also present potential drawbacks and risks RIAs must carefully consider:

1. Bias and Discrimination: AI systems can inadvertently perpetuate biases present in the training data, leading to discriminatory outcomes. RIAs must implement measures to detect and mitigate bias in their AI models to ensure fair and ethical decision-making.
2. Overreliance on Technology: Excessive reliance on AI and automated systems can diminish the human element of financial advising. RIAs should balance the use of technology with personal interactions to maintain client relationships and trust.
3. Complexity and Cost: Implementing and maintaining AI systems can be complex and costly. RIAs must evaluate the return on investment and ensure they have the necessary resources and expertise to manage these technologies effectively. Best practices would be to start small and simple and use AI and technology in ways that improve internal operational processes and then evaluate ways in which it can be used to improve the client experience.

Conclusion

The integration of AI and technology in the financial services industry, particularly for RIAs, presents a transformative opportunity to enhance decision-making, improve operational efficiency, and deliver superior client experiences. However, it also introduces significant compliance, legal, and data privacy challenges that must be carefully managed to mitigate risks and liabilities. By adopting a proactive approach to regulatory compliance, ensuring algorithmic transparency, implementing robust cybersecurity measures, and prioritizing data privacy, RIAs can harness the benefits of AI while safeguarding their clients and their business.

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Leila Shaver, founder and managing partner of My RIA Lawyer, has a decade of experience providing legal and compliance guidance to the financial services industry with a healthy dose of energy and fun.

image credit: Adobe Stock Images