AI Provisions in Client Agreements: What Advisers Should include in Client Agreements on AI use

Artificial intelligence (“AI”) has quickly become part of the daily operations of many organizations, and registered investment advisers are no exception. Whether it is used to summarize meetings, organize research, draft communications, or improve internal workflows, AI can help firms operate more efficiently and devote more time to serving clients.

As its use becomes more commonplace, advisers should also consider whether their client agreements adequately describe how these AI tools are used and the safeguards put in place to protect client information.

The Securities and Exchange Commission (“SEC”) has not adopted rules requiring AI-specific provisions in advisory agreements as of yet.  However, advisers remain subject to their fiduciary obligations under the Investment Advisers Act of 1940. Those obligations include providing clients with full and fair disclosure of material facts relating to the advisory relationship.[1]

Explain How Your Firm Uses Artificial Intelligence

One of the first questions an adviser should address is simply how does the firm utilize AI both within the firm for daily operations and to service its clients. AI can be used as a tool to assist investment advisers to support their investment advice decisions, in addition to assisting with administrative or operational functions. Some examples include:

• Preparing meeting summaries
• Organizing research
• Drafting routine correspondence
• Reviewing large volumes of documents
• Automating repetitive tasks

Explaining the firms’ use of AI helps clients understand where technology fits into the advisory relationship without creating the impression that investment advice is being delegated to a machine.  Ultimately the investment advisers remain fully responsible for any advice provided whether AI was used to assist in the process or not.

Clarify That AI Does Not Replace Professional Judgment

Investment advisers also need to explain that they are not using AI for client sensitive investment and financial planning activities.  Investment recommendations, portfolio management decisions, and financial planning advice should continue to be based on the professional judgment of qualified personnel. It is important to emphasize to clients that AI does not replace the adviser’s independent analysis or their fiduciary responsibilities to the client. The SEC has consistently emphasized that advisers owe clients a duty of care that cannot be delegated to technology.[2]

Address Data Security and Confidentiality When Using AI

Client agreements should also address the firm’s commitment to protecting confidential information. Many AI applications process data submitted by users, making it important for firms to establish appropriate safeguards before incorporating these tools into their operations. Advisers should consider explaining that they use commercially reasonable security measures designed to protect client information, such as enterprise-grade AI platforms, encryption where appropriate, multifactor authentication, access controls, and policies restricting the use of public AI applications for confidential information.

These disclosures should align with the firm’s obligations under Regulation S-P, which requires advisers to adopt written policies and procedures designed to safeguard customer records and information.[3]  If an adviser does use third-party AI providers, they must make sure all vendors are subject to appropriate due diligence and ongoing oversight consistent with the firm’s overall compliance program.

Document AI Governance

Advisers should also consider including a brief discussion of their internal AI governance practices. Clients generally do not need to know every detail of a firm’s compliance program, but they often appreciate knowing that the technology is not being used without oversight. A simple statement explaining that employees receive training on the firm’s AI policies, that AI-generated work product is reviewed before being relied upon, and that the firm periodically evaluates its AI tools can reinforce the firm’s commitment to responsible use.

This type of governance is consistent with Rule 206(4)-7 under the Advisers Act, which requires registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the federal securities laws. As AI becomes increasingly integrated into advisory operations, regulators will likely expect firms to address its use within their broader compliance framework.

Manage Client Expectations and Avoid AI Washing

Investment advisers must also manage client expectations regarding the capabilities of AI. AI can improve efficiencies, but it can also hallucinate.  Assuring clients that all AI output is reviewed by qualified personnel helps to reinforce that professional judgment always remains the center of the client and adviser relationship.

Finally, advisers should avoid making broad marketing claims about their use of AI that cannot be substantiated. In March 2024, the SEC announced its first “AI washing” enforcement actions against two investment advisers that allegedly made misleading statements about their use of artificial intelligence.[4]  Those actions serve as an important reminder that disclosures regarding AI should be accurate, balanced, and consistent with the firm’s actual practices.

AI Client Agreement Provisions Help Build Trust and Support Compliance

Artificial intelligence will continue to expand and will remain an important part of the investment advisory industry. Firms that use these technologies thoughtfully and explain that use clearly to their clients will be better positioned to demonstrate transparency, strengthen client trust, and meet their existing regulatory obligations. A carefully drafted AI provision in an advisory agreement is not simply about acknowledging new technology; it is another opportunity to show clients that innovation and fiduciary responsibility can, and should, go hand in hand.

[1] Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Advisers Act Release No. IA-5248 (June 5, 2019); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963)

[2] See Advisers Act Release No. IA-5248

[3] See 17 C.F.R. Part 248

[4] In the Matter of Delphia (USA) Inc., Advisers Act Release No. 6562 (Mar. 18, 2024), and In the Matter of Global Predictions Inc., Advisers Act Release No. 6561 (Mar. 18, 2024)

Author: Kathryn Konzen, Esq. is the Director of Operations and Counsel, at Jacko Law Group, PC (“JLG). With over 15 years of experience in the legal profession, she brings a diverse range of expertise in areas such as operations, eDiscovery consulting, business development, recruiting, and more. Her practice focuses on working closely with clients, assisting them with their Cybersecurity and AI legal needs. 

JLG works extensively with investment advisers, broker-dealers, investment companies, private equity and hedge funds, banks and corporate clients on securities and corporate counsel matters. For more information, please visit www.jackolg.com.

The information contained in this article may contain information that is confidential and/or protected by the attorney-client privilege and attorney work product doctrine. This email is not intended for transmission to, or receipt by, any unauthorized persons. Inadvertent disclosure of the contents of this article to unintended recipients is not intended to and does not constitute a waiver of attorney-client privilege or attorney work product protections.

The Risk Management Tip is published solely based off the interests and relationship between the clients and friends of the Jacko Law Group P.C. (“JLG”) and should in no way be construed as legal advice. The opinions shared in the publication reflect those of the authors, and not necessarily the views of JLG. For more specific information or recent industry developments or particular situations, you should seek legal opinion or counsel.

You hereby are notified that any review, dissemination or copying of this message and its attachments, if any, is strictly prohibited. These materials may be considered ATTORNEY ADVERTISING in some jurisdictions.