top of page

Fiduciary Duty and AI: What Investors Need to Know

As artificial intelligence increasingly makes its way into the investment world, questions arise regarding how AI systems can uphold fiduciary duties owed to investors. Fiduciary duty refers to the legal and ethical obligations owed by financial and investment firms to their clients and beneficiaries. This article explores key considerations around fiduciary duty as related to AI in investment management.

What Does Fiduciary Duty Entail?

At its core, fiduciary duty requires that financial advisors, money managers, and other investment professionals act solely in the best interests of their clients when providing investment advice or making investment decisions. Key elements include:

  • Duty of care: Investment managers must exercise appropriate diligence, care, and skill when investing assets. This includes thoroughly researching investments, diversifying client portfolios, and regularly monitoring investments.

  • Duty of loyalty: Financial advisors must put client interests ahead of personal or company interests when providing recommendations or advice. They should make full disclosures regarding potential conflicts of interest.

  • Duty to inform and report: Investment advisors have an obligation to fully inform clients regarding strategies, risks, fees, and other material facts. They must provide regular, accurate reporting on investment performance and account status.

How Do AI Systems Uphold Fiduciary Duties?

As AI tools take on increasing responsibilities in areas like portfolio management, algorithmic trading, and personalized financial planning, questions arise if and how they can uphold critical fiduciary duties:

  • AI transparency: To evaluate an AI system's prudence and loyalty, investors need transparency into the data and logic underlying recommendations. Firms should provide details on development, testing, capabilities, and limitations.

  • Accountability mechanisms: Even if an AI system is initially unbiased, it can produce unintended outcomes. Having accountability systems like algorithmic auditing and human oversight in place is key to monitoring recommendations and detecting issues like data or model drift over time.

  • Expert validation: Before full deployment, firms should rigorously backtest AI tools on historical data and have industry experts evaluate planned uses to ensure suitability to a fiduciary standard of care and skill.

Ongoing Evaluation of AI Systems

Fiduciaries looking to utilize AI should remember that initial testing and validation of these tools is just the beginning when it comes to upholding duties to investors. There must be ongoing governance processes to continually evaluate AI systems and detect any deviations from expected behavior or outcomes over time. Concept drift occurs when the statistical properties of the data input change such that the predictions and outputs from an AI model deteriorate in accuracy. This is a risk even with a properly designed system. As such, governance steps should include:

  • Continuous monitoring of inputs and outputs to flag anomalies

  • Regular audits by both internal team members as well as independent outside experts to assess ongoing suitability

  • Implementing channels for those impacted by an AI system's outputs to provide feedback to human reviewers

  • Willingness to pull back or shut down AI systems completely if glaring issues emerge, with humans stepping in to fill the gap

Additionally, as markets fluctuate or new types of data become relevant to investment processes, the AI models will need retraining and updating to incorporate these shifts. Outright replacing legacy systems with AI tools without such vigilance can compromise fiduciary duties.

Investor Recourse

Even with the most stringent governance practices in place, issues can still occur with AI technologies. In such cases, investors should examine what legal recourse they may have should losses or subpar performance occur due to deficiencies in an AI system. While laws around liability for AI systems are still evolving, misrepresentation, breach of contract, and negligence claims may feasibly apply in certain situations. Additionally, the SEC and other regulators have indicated willingness to prosecute fiduciaries should AI implementations clearly conflict with duties owed to investors.

As AI capabilities progress in finance, upholding fiduciary obligations remains paramount. A combination of ex-ante validation and ongoing governance, monitoring, and accountability will enable investors to realize AI’s benefits while still preserving and enforcing this necessary investor protection.

17 views0 comments


bottom of page