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CFTC’s First Chief AI Officer & How It Can Impact AI Fraud

August 19, 2024
CFTC’s First Chief AI Officer & How It Can Impact AI Fraud

On May 1, 2024, the Commodity Futures Trading Commission (CFTC) designated Dr. Ted Kaouk as the agency’s first Chief Artificial Intelligence (AI) Officer.[1] In an expansion of his previous role as the CFTC’s Chief Data Officer and Director of the Division of Data, Kaouk will also be responsible for “leading the development of the CFTC’s enterprise data and artificial intelligence strategy to further integrate CFTC’s ongoing efforts to advance its data-driven capabilities.” Kaouk has worked across a variety of federal agencies, developing data strategies and AI platforms to improve organizational functionality in each.

As AI continues to evolve, it becomes a breeding ground for fraudsters who leverage it to their advantage. This appointment is part of the CFTC’s ongoing efforts to develop its capacity to assess and respond to the use of AI in detecting commodity fraud, especially when it may be concealed by AI.

The CFTC is Following a Federal Trend of Developing Stronger AI Capabilities

Across the federal government, agencies have been bolstering their AI capabilities–both in their internal operations and in their response strategies. The trend follows an Executive Order issued in October 2023 instructing all federal agencies to develop safe, secure, and trustworthy AI capabilities.[2] As an independent U.S. federal agency that regulates the derivatives markets, it is particularly important for the CFTC to rapidly and soundly develop its AI program. Traditional regulatory methods are often insufficient to detect and address market abuses effectively, whereas AI can greatly assist in automating complex processes, enhancing data analysis, and improving decision-making capabilities.

What Risk Does AI Pose in CFTC-Regulated Markets?

AI can be a powerful tool for regulators, but it can also be an equally powerful tool for fraudsters seeking to exploit markets with its computing powers. The technology is already being used in the markets in many ways:[3]

  • Trading (e.g., market intelligence, robo-advisory, sentiment analysis, algorithmic trading, smart routing, and transactions)
  • Risk Management (e.g., margin and capital requirements, trade monitoring, fraud detection)
  • Risk Assessments and Hedging
  • Resource Optimization (e.g., energy and computer power)
  • RegTech – Applications that enhance or improve compliance and oversight activities (e.g., surveillance, reporting)
  • Compliance (e.g., identity and customer validation, anti-money laundering, regulatory reporting)
  • Books and Records (e.g., automated trade histories from voice / text)
  • Data Processing and Analytics
  • Cybersecurity and Resilience
  • Customer Service

In a report issued in May 2024, the CFTC Technology Advisory Committee (TAC) put forth several risks and recommendations for the CFTC to develop its AI efforts. The TAC identified several risks in the use of AI in CFTC-regulated markets:[4]

  • Embedded biases in AI models due to misguided training data or bad actors can disrupt markets or prompt market instability;
  • Lack of transparency or explainability of AI models’ decision-making processes (the “black box”) prevents actors from taking full responsibility for their actions;
  • Risks related to data relied on by AI systems, including overfitting of AI models to their training data or “poisoning” real world data sources encountered by the AI model;
  • Mishandling of sensitive data;
  • Fairness concerns, including the AI system reproducing or compounding biases;
  • Concentration risks that arise from the most widely deployed AI foundation models relying on a small number of deep learning architectures, as well as the relatively small number of firms developing and deploying AI foundation models at scale; and
  • Potential to produce false or invalid outputs, whether because of AI reliance on inaccurate “synthetic” data to fill gaps or because of unknown reasons (hallucinations).
  • Where AI resembles more conventional forms of algorithmic decision-making, the risks likely include a heightened risk of market stability, and, especially when combined with high frequency trading, potential institutional and wider market instability.

The CFTC’s Efforts in Developing AI Guidance and Regulation

Even the CFTC does not know the full scope of the risks that AI may pose in these markets. In January 2024, it put out an RFC, or request for comment, asking the public for their input on how to handle regulating AI in CFTC-regulated markets.[5] The RFC reflects the agency’s commitment to doing everything within its power to effectively build up its regulatory abilities, but it also reflects that the agency is just as in the dark–if not more so–as the public when it comes to tackling AI fraud and misuse in derivatives markets.

Despite this uphill battle, the CFTC Commissioner has articulated three steps planned by the agency to combat AI fraud in CFTC-regulated markets:[6]

  • First, the CFTC plans to adopt a principles-based regulatory framework for addressing the increasing prevalence of AI-related risks in our markets. For example, certain swap traders may be required to implement a risk-management program to monitor and manage the risks of certain activities.
  • Second, it plans to have heightened penalties for those who deliberately misuse AI to engage in fraud or market manipulation. While these penalties have not been established yet, the CFTC understands that the penalties must be calculated fairly, but with enough weight that it would not be worth the risk of abusing AI when trading.
  • Third, the CFTC hopes to establish an inter-agency task force to consider the adoption of parallel, harmonized safeguards that will focus on ensuring the stability and integrity of the markets. By sharing information with other agencies, the CFTC can strengthen its own regulatory powers and strengthen AI capabilities across the entire government.

As AI grows as both an industry and as a standalone technology, it is important that all industry leaders and regulators keep up with it as well. While the CFTC and other federal agencies are just beginning to develop their AI capabilities, the use of AI in the markets has already spread far. However, as Ted Kaouk and the CFTC begin to implement a sound AI strategy, it is clear that regulators are diligently and actively working to prevent AI abuse in the financial markets. Speak to a CFTC whistleblower lawyer today to understand your rights.

[1] https://www.cftc.gov/PressRoom/PressReleases/8903-24

[2] https://www.whitehouse.gov/briefing-room/presidential-actions/2023/10/30/executive-order-on-the-safe-secure-and-trustworthy-development-and-use-of-artificial-intelligence/

[3] https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement050224

[4] https://www.cftc.gov/PressRoom/PressReleases/8905-24#:~:text=Without%20appropriate%20industry%20engagement%20and,markets%2C%20services%2C%20and%20products.

[5] https://www.cftc.gov/PressRoom/PressReleases/8853-24

[6] https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement050224

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