Navigating the AI Frontier: FINRA's Regulatory Notice 24-09 on Generative AI and Large Language Models

By Bart Layton, CEO - AI Guardian

Fact Checked by Robin Hackney

Technology is reshaping every facet of our lives and the financial industry is no exception. The advent of Artificial Intelligence (AI) and Large Language Models (LLMs) offers transformative potential for financial services, promising enhanced operational efficiencies and improved investor experiences. However, these innovations come with a set of regulatory challenges that cannot be ignored - highlighted in prior communications from FINRA. On June 27, 2024, FINRA published Regulatory Notice 24-09, reminding member firms of their regulatory obligations when incorporating Generative AI (Gen AI) and LLMs into their operations.

Understanding the Scope of AI in Finance

Artificial Intelligence, broadly defined as the capability of machines to imitate intelligent human behavior, encompasses a range of technologies including machine learning (ML), deep learning, neural networks, and natural language processing (NLP). Specifically, Gen AI and LLMs have shown remarkable abilities to generate text, synthesize data, and create media based on prompts. These tools can analyze vast sets of financial data, summarize complex documents, and provide educational resources, significantly aiding both investors and financial professionals.

Regulatory Obligations: Consistency Amidst Technological Evolution

FINRA’s notice emphasizes that its rules are intended to be technology-neutral, meaning that the same regulatory framework applies regardless of whether a firm uses traditional tools or advanced AI technologies. This approach aims to keep regulatory principles consistent even as technology evolves. Key areas of focus for member firms using Gen AI and other AI technologies include:

1. Supervision: Under Rule 3110, firms must have a well-designed supervisory system tailored to their business, which includes robust technology governance, model risk management, data privacy, and ensuring the reliability and accuracy of AI models.

2. Communication Standards: FINRA has reinforced that content standards for communications with the public, as defined in Rule 2210, apply equally to AI-generated and human-generated content. This includes ensuring that AI-driven communications are accurate, balanced, and not misleading.

3. Recordkeeping: Records of AI-generated/distributed correspondence and communication must be maintained according to Rules 3110.09 and 4511, or Rule 17a-4 of the Securities and Exchange Act, respectively. If an AI tool or model is not sufficiently explainable (i.e., offering necessary visibility into how and why an AI model produced a particular output), reliably documenting the source of AI-generated tables and illustrations used in communications can be particularly challenging.

Firms must evaluate Gen AI tools and other AI technologies before deployment to ensure ongoing compliance with FINRA rules and other applicable regulations. This includes considering how AI use might impact various regulatory obligations and ensuring that AI tools are integrated into existing compliance frameworks.

Challenges and Risks

While Gen AI offers numerous benefits, it also poses significant risks. These include concerns about accuracy, privacy, bias, intellectual property, and potential exploitation by malicious actors. Firms must address these risks by implementing comprehensive policies and procedures that mitigate potential negative impacts. For instance, ensuring data integrity and accuracy in AI models is crucial to prevent flawed decision-making processes.

Opportunities for Engagement and Future Directions

Recognizing the rapidly evolving nature of AI technology, FINRA encourages member firms to engage actively with regulators. Firms can seek interpretive guidance for specific AI use cases and have ongoing discussions with Risk Monitoring Analysts to navigate any ambiguities. Furthermore, FINRA invites feedback on how its rules might be updated to better accommodate emerging technologies while maintaining investor protection and market integrity.

Editorial Perspective: Balancing Innovation and Regulation

FINRA’s Regulatory Notice 24-09 underscores the critical balance between maintaining appropriate regulatory oversight and enabling innovation. The financial industry is poised to benefit immensely from AI, but these advancements must be tempered with clear compliance measures to protect investors and maintain market integrity. FINRA’s technology-neutral stance is a pragmatic approach, ensuring that regulatory principles remain relevant even as the tools and technologies evolve.

However, the onus is on individual firms to proactively integrate AI within their regulatory frameworks, continuously adapting to new developments, as AI has undoubtedly arrived and is being used by more employees and in more ways than employers are currently aware. This proactive engagement is essential to leverage AI’s potential fully while safeguarding against its inherent risks.

Conclusion

As the financial industry embraces the potential of Generative AI and Large Language Models, regulatory bodies like FINRA play a crucial role in guiding this transformation. Regulatory Notice 24-09 serves as a timely reminder of the importance of maintaining regulatory compliance amidst technological advancements. By balancing innovation with rigorous oversight, the financial sector can harness the power of AI to drive growth, efficiency, and enhanced investor experiences, ensuring a secure and equitable financial ecosystem.