A US-based robo-advisory platform uses an AI-driven portfolio construction model to manage $12 billion in retail client assets. The SEC's 2023 cybersecurity and AI risk disclosure rules, combined with the Investment Advisers Act of 1940 obligations, most likely require the firm to take which of the following steps regarding its AI model?
Select an answer to reveal the explanation.
Short Explanation and Infographic
The SEC treats your AI like any other adviser — it can't hide behind algorithms to dodge fiduciary duty. Disclosing how the model works, its conflicts, and its limitations in Form ADV is the core obligation. Answer B gets this right.
Full explanation below image
Full Explanation
The SEC has consistently applied the Investment Advisers Act of 1940 and its fiduciary framework to robo-advisors and algorithm-driven investment platforms. The 2017 IA Release 4776 ('Guidance on Robo-Advisors') clarified that AI-driven advisers owe clients the same fiduciary duty as human advisers — the duty of loyalty and duty of care — regardless of whether recommendations are generated by a human or a machine.
For Form ADV Part 2A (the brochure clients receive), the SEC expects robo-advisors to clearly explain: how the algorithm constructs portfolios and what inputs it uses; any conflicts of interest embedded in the model (for example, if the model preferentially selects proprietary funds or products that generate higher revenue for the firm); and the material limitations of the algorithmic approach, such as inability to account for client-specific tax situations not captured in onboarding questionnaires.
Option A is incorrect: the SEC does not require source code or training data filings. Option C fabricates a FINRA AI Supervisory Framework and an AUM threshold for pre-approval — neither exists as described. Option D is a fundamental misunderstanding; the fiduciary duty under the Advisers Act applies to the investment adviser entity, not to any individual human making decisions. Automation does not negate the duty.
The SEC's 2023 predictive data analytics (PDA) proposed rule (if finalized) would add further requirements around conflicts of interest embedded in AI optimization objectives. CFIA candidates should monitor SEC rulemaking in this area while anchoring exam answers in existing guidance.