AI in Investment Management: Ethics Case Study Part II
Earlier this week, I shared a case study describing use of AI technology in the investment management process and client communications and asked readers to analyze the ethical dimensions of the facts through the lens of CFA Institute’s Code of Ethics and Standards of Professional Conduct. Below is an analysis of the Standards of Professional Conduct at issue in the case.
CFA Institute Standard V(A) Diligence and Reasonable Basis requires CFA Institute members and candidates to exercise diligence and thoroughness in analyzing investments and acting. While gathering, analyzing, and interpreting big data may enable a thorough analysis of investments, in this case the accuracy and completeness of the information in the database is in question.
While the data is supposedly comprehensive data for all regions, the big data provider used formulas and algorithms to create model data for those regions in which actual data is incomplete. Use of model data calls into question the accuracy and potential bias of the information. It’s not clear from the facts that Simmons is aware of or takes account of this limitation when using the big data to analyze the investments and make recommendations to clients.
If the big data company’s disclosures relating to the database provided to Simmons do not include the fact that model data is used to fill gaps in actual observations, that would violate CFA Institute Standard I(C) Misrepresentation. This standard prohibits CFA Institute members and candidates from making any misrepresentations, including misleading omissions, relating to investment analysis or actions.
CFA Institute Standard I(E) Competence requires CFA Institute members and candidates to act with and maintain competence necessary to fulfill their responsibilities. It is clear from the facts that Simmons relies on an AI technology consultant to examine and analyze the data to identify favorable investments and then passes on the consultant’s recommendations to clients. It is not clear that Simmons understands how the consultant uses AI to conduct the analysis or make the investment recommendations.
Standard I(E) does not require members and candidates to have expertise in all aspects of the investment process. Hiring an internal team or third-party consultant to fill a knowledge and skills gap is a legitimate way to competently provide professional services to investors. But as the investment manager, Simmons must have at least a thorough, basic understanding of the methods and process for making investment recommendations. Simply passing on the recommendations of a consultant to clients without understanding how the recommendations are formed would likely not meet the competence required by Standard I(E).
Once received, Simmons’s use of the AI-assisted recommendations was also questionable. The facts state that Simmons invested in these recommended companies for all clients who have given him discretionary authority, regardless of their investment mandate. Similarly, he passed on the recommendations to all non-discretionary clients.
There is no indication that Simmons made a suitability analysis to determine whether the investment recommendations were suitable to each client’s financial situation, objectives, mandates, and constraints as required by Standard III(C) Suitability. Simmons’s distribution of the AI-assisted investment recommendations was also flawed. CFA Institute Standard III(B) Fair Dealing requires CFA Institute members and candidates to deal fairly and objectively with all clients when making investment recommendations or taking investment actions. By acting for his discretionary clients before distributing the recommendations to his non-discretionary clients, Simmons treated the latter unfairly.
Simmons’s communication with clients regarding his firm’s use of AI in the investment management process is incomplete and misleading. Simmons is concerned that his clients will not be comfortable with the use of AI to manage their investments or will question his competence or expertise if he shares that he relies on AI to help him in the investment-decision making process. He is also concerned that the use of AI will seem to contradict his claims that he takes an active role in managing client assets and will lead to questions about fees. As a result, he did not disclose the use of AI in the investment decision-making process to his clients.
CFA Institute Standard V(B) Communications with Clients requires CFA Institute members and candidates disclose to clients the basic format and general principles of the investment processes they use to analyze investments, select securities, and construct portfolios. Omitting information on the nature and extent that Simmons used AI in the investment process would likely be a violation of Standard V(B) and could also be a violation of CFA Institute Standard I(C) Misrepresentation.
The same transparency questions arise with Simmons’s use of the chatbot for communication with clients. It is not clear from the facts that clients are aware that communication from the firm when they inquire about their account or receive new investment recommendations is AI generated and not from investment personnel of the firm. Transparency dictates that clients be made aware of this use of AI technology in handling their accounts.
Another potential ethical issue with the use of the AI client communication portal is the bias toward investing in AI-recommended securities when responding to client inquiries: CFA Institute Standard III(C) Suitability. Because of Simmons’s enthusiasm for these investments, he programmed the chatbot to guide conversations to promote the securities, invariably recommending these investments to clients. This was done regardless of the suitability or appropriateness of the investments for clients.
CFA Institute Standard III(A) Loyalty, Prudence, and Care mandates that CFA Institute members and candidates exercise reasonable care and prudent judgement to act for the benefit of their clients. By interjecting bias and not incorporating safeguards into the chatbot program, Simmons may be in violation of this standard and other standards as well. If given free rein, the chatbot could violate several standards. Use of AI in communication and other aspects of the investment process requires prudence, care, and oversight to ensure compliance with the principles of the CFA Institute Code and Standards and ethical investment practices.
