Consumer Groups Warn AI Sandbox Could Bypass States
Consumer protection advocates are speaking out against a provision in Congress’s proposed cryptocurrency legislation, claiming it would allow financial firms to sidestep state oversight of artificial intelligence.
In a letter last week to U.S. Sens. John Thune (R-SD) and Chuck Schumer (D-NY), 78 groups urged lawmakers to oppose a proposed “sandbox” provision of the CLARITY Act that would grant broad waivers to participating financial firms testing AI tools, potentially insulating them from some state regulatory mandates. The signees spanned numerous industries, including investor protection organizations such as Americans for Financial Reform, the Consumer Federation of America and the Public Investors Arbitration Bar Association.
In a Wealth Management interview with Joe Wojciechowski, PIABA president and partner with Stoltmann Law Offices, said the protections offered by the sandbox were all the more worrisome in the context of a Washington regulatory environment “more in the mode of rubberstamping as opposed to truly enforcing regulations.”
“It’s one thing to call it a sandbox,” he said. “But that sandbox better have a 10-foot ironclad fence with those sharp spikes on top to make sure that nothing escapes out of that sandbox, and to make sure there’s no misapplication of the technology.”
The CLARITY Act is intended as a regulatory framework for the crypto sector, specifying which agencies, including the Securities and Exchange Commission and the Commodity Futures Trading Commission, would be responsible for oversight. The proposed legislation details the potential sandbox in which firms must submit an application to federal regulators (and must employ no more than 25 employees, with gross revenues below $10 million per fiscal year).
The law would allow participants “to test innovative activities,” defining ‘innovative’ as “new or emerging technology, or a novel application of technology, including artificial intelligence.” The SEC and CFTC would have 360 days after the law’s passage to “establish a CFTC-SEC Micro-Innovation Sandbox,” according to the bill’s language. In the section’s language, lawmakers wrote that “participation in the Sandbox” could “supersede any state securities or commodities law requiring registration, qualification or licensing as a condition of engaging in an approved activity or otherwise regulating that activity.”
However, the bill also states that the language shouldn’t be “construed to prohibit any state securities or commodities regulator … or any state law enforcement agency” from bringing enforcement actions related to fraud, deceit or “any state law of general applicability,” including those relating to “banking, consumer protection, contracts, property or criminal conduct.”
According to CFA Director of Investor Protection Corey Frayer, the rule could create a situation in which firms could establish AI chatbots offering investment advice that would otherwise be covered by the SEC’s Regulation Best Interest or federal fiduciary duties, and would “preempt state law to be able to do anything about that.”
Both Frayer and Wojciechowski argued that the provision couldn’t be viewed in isolation from what they saw as the SEC’s increasing deregulatory posture, with Wojciechowski noting the agency’s significant staff cuts since the start of the Trump administration.
According to Wojciechowski, the sandbox’s greatest risk comes in ensuring proper data protection, particularly if an AI testing model uses a firm’s account applications, forms and questionnaires to build the model’s institutional knowledge.
“Once that aggregation happens, this thing becomes a gold mine of information for bad actors,” he said. “How they access it, whether there is a leak of the AI platform in some form or fashion, are all questions that can only be answered with rigorous walls and digital safety. And I think AI is outpacing that in real, material ways.”
Numerous consumer advocacy groups, as well as state securities regulators, have already come out against some proposed versions of crypto market structure legislation, warning that it could encroach on states’ ability to police alleged violations within their jurisdictions.
The Senate Banking Committee released its language for the CLARITY Act in May, after the House passed its own version last year. Republican senators (and President Donald Trump) have been pushing for passage, but the bill’s progress has slowed amid negotiations among lawmakers; Democrats are calling for stronger ethics provisions in light of Trump’s (and his family’s) deep involvement in the crypto sector.
The Senate failed to pass the bill before breaking for the summer until September, and several legislators admitted the move dimmed the likelihood that the legislation would pass. Senate Majority Leader Thune has scheduled a procedural vote for the bill for when the Senate returns from its recess, according to Reuters.
According to Ben Winters, the CFA’s director of data privacy, the provision’s caps on employment and revenue could create an incentive for firms to deliberately remain small, or for large entities to spin off specific projects into separate (but connected) companies to qualify for the sandbox.
To Wojciechowski, it wasn’t an accident that an AI sandbox proposal appeared in legislation otherwise focused on crypto market structure. From his perspective, crypto firms believe AI innovation is “integral” to growing their businesses.
“It’s hard to have 365-day, 24/7 trading of all assets on the blockchain unless you are enabling AI to handle it, because there are not enough people to do it,” he said. “Tokenization is going to lead to a ‘brave new world’ of finance. Without AI, it’s going to be hard to do it.”
