Compliance September 19, 2023

Scope of AI Conflicts Proposal Finds New Opponents on the Hill

Members of both parties have criticized the SEC’s definition of ‘covered technology’ when it comes to using AI in financial services.

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Members of both parties criticized the scope of the Securities and Exchange Commission’s proposal on artificial intelligence technology and conflicts of interest in the financial services sector at a Congressional hearing Tuesday.

The proposal would require registered investment advisers to eliminate conflicts of interest in their use of predictive AI technology. Advisers are typically only required to mitigate and disclose conflicts, rather than eliminate them entirely.

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The hearing was held by the Capital Markets Subcommittee of the House Committee on Financial Services, with testimony from William Birdthistle, director of the SEC’s division of investment management. Most of the criticism levelled at Birdthistle by policymakers was focused on the scope of the proposal, which opponents in the investment industry have previously said has a “lack of discernible boundaries” concerning which technologies are applicable.

Representative Ann Wagner, R-Missouri, the chair of the subcommittee, said the proposal is a “one-size-fits-all” approach and will “lead to a decline in retail investor participation” in securities markets.

Representative Wiley Nickel, D-North Carolina, also expressed concern about the breadth of the proposal. He said “the proposal is very broad” and will limit the market of financial advisers for retail investors. Nickel also suggested that concerns about artificial intelligence should already be covered by SEC Regulation Best Interest, and a new proposal should not be necessary.

In many instances, Birdthistle said the scope of the proposal is something being considered closely during the public comment period, which closes on October 10, and that the Representatives’ concerns were well taken.

Birdthistle explained that the “scope of the rule is restricted to machine learning, AI, predictive data analytics […] that puts [the adviser’s] interest ahead of investors,” and that this “cabins in” the scope of the proposal.

The technologies covered by the proposal, as described in the SEC’s proposal, would include any “analytical, technological, or computational functions, algorithms, models, correlation matrices, or similar methods or processes that optimize for, predict, guide, forecast, or direct investment-related behaviors or outcomes of an investor.”

Though Birdthistle indicated the rule is not as sweeping as many of its critics fear, or at least is not intended to be, he repeatedly insisted that reviewing the scope of the proposal and comments that remark upon it are key priorities for the SEC as it prepares to finalize the rule.

At a separate hearing last week held by the Senate Committee on Banking, Housing and Urban Affairs, Senator Mike Rounds, R-South Dakota, described the proposal as a “restrictive regulatory regime that will govern any analytics tool and is inconsistent with decades of legal and commission precedent regarding the handling of conflicts of interest.”

Deals & People September 19, 2023

Carlyle Makes Growth Investment in CAPTRUST

Equity from Carlyle will be used to advance CAPTRUST’s M&A strategy in both wealth management and retirement, says CAPTRUST president.

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CAPTRUST Financial Advisors announced a minority growth investment from funds managed by the global investment firm Carlyle Group Inc., adding to private equity investment the advisory aggregator has received from lead investor GTCR.

With the addition of Carlyle, CAPTRUST’s valuation exceeds $3.7 billion, while its equity value increases from $2 billion to more than $3 billion, according to the announcement. Carlyle’s growth capital will allow CAPTRUST to continue pursuing growth opportunities through acquisitions, of which it has made five this year. The firms declined to provide the amount of the investment.

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“At a high level, [the investment] means that we have the ability to continue to grow in a way in which we have for some quite some time,” says Ben Goldstein, president of CAPTRUST. “We think there’s great opportunity in the future, as our space consolidates, while growing at the same time.”

Goldstein noted that Carlyle will bring a “large stable of resources” available to its portfolio companies that CAPTRUST will be able to leveragte to get an unbiased view on areas ranging from the implementation of artificial intelligence to talent management.

Carlyle, based in Washington D.C., has $376 billion in assets under management.

M&A, Continued

In 2020, CAPTRUST added its first institutional capital partner, private equity firm GTCR, at a valuation of $1.25 billion. Since then, the Raleigh, North Carolina-based registered investment advisory has added 29 firms to its practice. As part of the new transaction, neither GTCR nor any of CAPTRUST’s executive leadership teams will be selling secondary shares, according to the announcement. Carlyle and GTCR will be minority investors in CAPTRUST, both individually and collectively. 

“The culture at CAPTRUST is driven by unity,” Fielding Miller, co-founder and CEO of CAPTRUST, said in a statement. “Our shareholder program is one of the ways that we show our people just how important they are to the success of our organization.”

Miller will continue to lead the firm, and he remains the largest individual shareholder. Currently, more than half of CAPTRUST employees participate in one or more of the firm’s equity programs. 

Goldstein notes that CAPTRUST began moving from organic growth to strategic acquisitions in 2006, with a focus on retirement plan advisements. In 2020, the firm shifted to opportunities in wealth management. The Carlyle funding will continue to fuel that growth in a way Goldstein says is both strategic in terms of footprint and in finding firms that are a good fit for CAPTRUST’s model of integrating advisories.

Since CAPTRUST is an acquirer that fully integrates firms, Goldstein says the RIA’s first filter when it comes to acquiring is “culture.” Beyond that, CAPTRUST looks at areas such as the acquiree’s size, business line specialties, ages of its advisers and growth rates.

But location also plays a role as well, he says. The RIA “has a strategic desire to be in the 55 major markets with business lines working synergistically together, and we’re probably in 33 today,” Goldstein says, noting that even in those regions, they may not have all business lines.

Retirement and Wealth

Despite the push toward further wealth management acquisitions, Goldstein said the firm remains interested in both lines of business and wants to keep growing through them, along with its outsourced chief investment officer business. But while CAPTRUST will still consider retirement plan advisement additions, the wealth management space is much more robust in terms of growth potential.

“The maturation of the wealth management industry [has occurred] in terms of being identified as an attractive investment, largely for private equity firms, but others as well, due to the fundamentals like recurring cash flow, contracted revenue, high-client retention rates, high margins and other things that are well chronicled,” Goldstein says.

He points to CAPTRUST’s ability to provide financial wellness and education to retirement plan participants through its plan sponsor practice as a key connector, and selling point, for investors.

“Retirement is a challenge in this country, and those participants need some help,” he says. “Plan sponsors will hire us to help their participants, and we love doing that; we have the capability to do it. That engagement leads to natural opportunities to provide wealth management services to those individuals, either with their money outside the plan or, ultimately, when they’re retired.”  

Ardea Partners LP served as exclusive advisor to CAPTRUST. Alston & Bird LLP served as CAPTRUST’s legal counsel. J.P. Morgan served as lead adviser to Carlyle. Simpson Thacher & Bartlett LLP served as Carlyle’s legal counsel. Kirkland & Ellis LLP served as legal adviser to GTCR.

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