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FRM Part II · FRM Exam Part II · Advances in Artificial Intelligence: Implications for Capital Markets Activities

A firm's validation team reviews a large language model used to summarise regulatory filings for portfolio managers. Testing shows 4% of summaries contain fabricated statements. Which control design best reflects proportionate governance given that managers act on the summaries?

The best design keeps human review of material claims against source filings, monitors the hallucination rate with escalation thresholds, and documents limitations. Since managers act on the summaries, a 4% fabrication rate cannot simply be accepted, concealed or answered with a disproportionate firmwide ban.

  1. AAccept the 4% error rate because summaries are not formal trading signals
  2. BRetrain the model monthly and remove all documentation of errors to avoid creating discoverable evidence
  3. CBan all AI use across the firm regardless of the use case
  4. DRequire human review of material claims against source documents, track the hallucination rate, and set escalation thresholds with documented model limitationsCorrect

Explanation

Hallucinations are an inherent limitation; proportionate governance keeps a human in the loop for decisions that matter, monitors the error rate against thresholds and documents limits. Accepting errors or concealing them is poor governance, and a blanket ban is disproportionate.

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