As in most industries, private fund sponsors are increasingly assessing and beginning to adopt artificial intelligence-powered tools to rapidly analyze large volumes of data, identify trends and patterns and to generally make more informed decisions both in connection with internal operations and management of their funds and for enhancing efficiencies at their portfolio companies. AI technology’s ability to process information from disparate sources, such as financial reports, news articles and social media, and to purportedly predict market movements and inform portfolio allocations, is an area of particular interest in the private fund community.
Such processing and analytic capacity, along with developments in generative AI, are touted as enabling succinct and readily usable outputs. Some sponsors have adopted AI-based technology to enhance deal sourcing strategies, conduct competitor analyses, automate and expedite certain components of the due diligence process for prospective investments and streamline day-to-day operational tasks (thereby freeing time for professionals to engage in higher value tasks). AI technology adoption is expected to accelerate in portfolio valuation use cases, which proponents suggest is likely to result in more frequent valuations being conducted, thus enhancing the accuracy of utilized valuations.
In 2023, the SEC conducted a sweep of investment advisers, requesting information and documents regarding how they use artificial intelligence. Some requests made in connection with the sweep included production of documents and information related to potential AI-linked conflicts of interest, contingency plans for system failures in the event of an AI-related failure, reporting on AI systems that caused regulatory or legal issues and examples of advertising that mentions AI. Gary Gensler, chair of the SEC until he stepped down, effective Jan. 20, periodically expressed concerns about investment advisers’ use of AI and its implementation across the financial sector in general during his tenure, noting that overreliance on a small number of AI providers could result in financial instability and “drive us off an inadvertent cliff.” Gensler also expressed concerns about AI-washing, which occurs when, for example, a sponsor or investment adviser makes false or misleading claims about its competence with artificial intelligence, how it uses such technology internally or how it is used by a fund’s portfolio companies and, in each case, the purported results of such use.
The SEC’s 2025 examination priorities (released while Gensler was still chair of the agency) included assessing the use of AI when an investment adviser leverages it in advisory processes and the accuracy of any representations made about AI, along with the appropriateness of controls implemented in connection with it. Further, the SEC’s 2023 proposed rule for broker dealers and investment advisers would prevent firms from using predictive data analytics (including artificial intelligence) in a manner that creates a conflict of interest that places the firm’s interests ahead of those of its customers and clients.
The fate of the proposed rule is unclear, and it received significant industry pushback, with commentors noting it could require full cessation of operations in some circumstances due to the mandate to assess all potential conflicts of interest that could arise in connection with utilization of AI, as opposed to the requirements of existing securities laws, which are focused predominantly on full and fair disclosure of conflicts of interest.
The power and potential benefits of artificial intelligence are gaining traction with and piquing the interest of private fund sponsors (including investment advisers) and their investors, but uncertainty around how the SEC will ultimately assess, further regulate, or take enforcement actions regarding AI utilization and related practices warrants careful consideration prior to deployment of AI technology.
Gensler’s departure from the SEC and the Trump administration’s announcement the next day that it would invest $500 billion in AI infrastructure, along with President Trump’s general proclivity for reduced regulation and his revocation (on the premise that it stifled private innovation) of President Biden’s 2023 executive order targeted at reducing AI-related risks to U.S. citizens and national security potentially indicate a more favorable outlook for AI utilization in the private funds space. But material uncertainty remains.
Past SEC enforcement actions make it clear that private fund sponsors should carefully disclose their use of AI to investors in numerous circumstances, and it is imperative that such disclosures are fulsome, accurate and clear. In addition to such compliance with existing securities law requirements regarding full and fair disclosure, careful consideration of the SEC’s past practices generally and past and forthcoming guidance is advised in considering when and how to adopt and integrate AI-based technology into ordinary course operations or investment decision-making — at the portfolio company level or otherwise.
