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Changing Rules Governing Artificial Intelligence in Employment

February 2, 2023

by Nicholas J. Pappas

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In recent years, employers have begun to use artificial intelligence, machine learning, algorithms, and other automated systems or technologies (“AI Technologies”) to recruit and hire employees and make other employment decisions. At the same time, federal regulatory agencies and a number of localities have enacted new rules targeting how employers may use AI Technologies. As further discussed below, employers should expect increased enforcement efforts of federal, state, and local agencies (as well as private litigation) regarding their use of AI Technologies.

Most recently, on January 10, 2023, the Equal Employment Opportunity Commission (“EEOC”) issued a Draft Strategic Enforcement Plan (“SEP”) that places employment discrimination in the use of AI Technologies at the top of its strategic priorities list. Specifically, the SEP indicates the EEOC will make a concerted effort to eliminate employment discrimination in “the use of automated systems, including artificial intelligence or machine learning, to target job advertisements, recruit applicants, or make or assist in hiring decisions where such systems intentionally exclude or adversely impact protected groups.”

The SEP indicates that the EEOC plans to take a “targeted approach” in enforcing employment discrimination laws through directed investigations and litigation to “positively influenc[e] employer practices and promot[e] legal compliance.” The EEOC specifically called attention to the “lack of diversity” in the construction and “high tech” industries, “growth industries,” and industries benefitting from substantial federal investments as “areas of particular concern.”

The EEOC has already increased investigation and litigation activity related to the use of AI Technologies. For example, in May 2022, the EEOC commenced its first lawsuit related to allegedly discriminatory use of AI Technologies by an employer. EEOC v. iTutorGroup, Inc., et al., Case No. 1:22-cv-02565 (E.D.N.Y.). The age discrimination lawsuit was filed in the United States District Court for the Eastern District of New York against three integrated companies providing English-language tutoring services for allegedly programming their tutor application software to automatically reject older applicants. In the lawsuit, the EEOC is seeking back pay and liquated damages for more than 200 applicants who were allegedly denied jobs under the defendants’ application program.

The final version of the SEP (which will be issued after a public meeting on January 31, 2023, and a public comment deadline of February 9, 2023) will provide further guidance regarding the EEOC’s approach to enforcing employment discrimination laws in the context of AI Technologies going forward.

While the EEOC’s draft SEP has affirmed its commitment to enforcing all employment discrimination laws implicated by the use of AI Technologies, disability discrimination laws remain a point of emphasis and pose unique obstacles to employers’ use of AI Technologies. In May 2022, the EEOC released guidance specifically addressing how the Americans with Disabilities Act (“ADA”) applies to the use of AI Technologies in recruiting applicants and making employment decisions. In that guidance, the EEOC specifically identified potential ADA violations where: (1) an employer using AI Technologies does not provide legally required reasonable accommodations to applicants and employees with disabilities to ensure fair assessment, (2) the AI Technologies used by the employer—intentionally or unintentionally—screen out individuals with disabilities who could perform the essential functions of a job with a reasonable accommodation, and (3) the AI Technologies used by the employer violate ADA restrictions on disability-related inquiries and medical examinations. The EEOC contends that employers are generally responsible for ADA violations caused by the use of AI Technologies even when such technologies are developed and administered by a third-party vendors.

To avoid potential ADA violations arising out of the use of AI Technologies, employers should consider taking steps such as: (1) providing advance notices advising applicants and employees of the use of AI Technologies (including information about what traits or characteristics are being measured by the technology and the methods used to do so); (2) obtaining consents from applicants and employees regarding such use of AI Technologies; (3) advising applicants and employees how to contact the employer if reasonable accommodations are needed; and (4) providing adequate reasonable accommodations to applicants and employees with disabilities. Due to the plethora of physical and/or mental disabilities that exist, any required reasonable accommodations must be specifically tailored to each individual and there is no one-size-fits-all approach to the use of AI Technologies that ensures compliance with disability discrimination laws.

In addition to federal laws and guidance regarding the use of AI Technologies in employment decisions, employers must be cognizant of developments in state and local laws on this topic. Most prominently, New York City passed a local law effective on January 1, 2023, that prohibits employers from using “automated employment decision tools” to screen candidates or employees for employment decisions unless the tool has been the subject of a “bias audit” not more than one year prior to the use of the tool, among other things. The law also requires employers using automated employment decision tools to provide certain notices to candidates and employees who reside in the city regarding the use of such tools. There are a number of open questions regarding the meaning and application of this law, which the New York City Department of Consumer and Worker Protection (“DCWP”) is currently attempting to clarify through a revised set of proposed rules.  The DCWP held a second public hearing regarding its proposed rules on January 23, 2023, and is delaying enforcement of the law until April 15, 2023.

Other states and local governments have (or may in the future implement) their own laws and regulations regarding the use of AI Technologies in employment matters, leading to complex and varied requirements for employers to ensure their use of AI Technologies is legally compliant in all jurisdictions in which they operate.

In 2023 employers should work with legal counsel to: (1) assess whether their current or prospective use of AI Technologies in employment matters complies with current legal requirements and guidance, (2) create or update legally compliant policies and procedures related to the use of AI Technologies in making employment decisions, (3) respond to and defend enforcement actions and private litigation related to the use of AI Technologies in employment matters, and (4) closely monitor further legal developments that are likely to come—federally and in state and local jurisdictions—related to the use of AI Technologies in employment matters.

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FERC Denies TransAlta 202(c) Cost-Recovery Plan The Federal Energy Regulatory Commission (FERC) recently rejected TransAlta’s plan to recover $19.9 million in expenses stemming from a DOE order in which DOE prohibited TransAlta from retiring its coal-powered Centralia power plant. TransAlta had previously intended to retire the facility at the end of 2025. TransAlta’s cost recovery plan proposed spending an additional $23 million on repairs to continue operating the unit. FERC’s main objection had to do with geographic scope. TransAlta’s recovery plan called for recovering costs from California Independent System Operator (CAISO) and the Southwest Power Pool (SPP), but the DOE’s order requiring operation of the plant was designed to ensure reliability in the Northwest assessment area (Montana, Oregon, Washington, and parts of northern California and northern Idaho). 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On September 30, 2026, the Securities and Exchange Commission (the “SEC”) proposed amendments to Rule 205-3 under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), which provides an exemption from the general prohibition under Section 205(a)(1) of the Advisers Act on registered investment advisers receiving performance-based compensation (the “Proposal”) so long as performance-based compensation is limited to “qualified clients”.1 Most notably for private fund sponsors, the Proposal would expand the definition of “qualified client” to include any investors that satisfy the “accredited investor” definition under Regulation D. The Proposal may also have implications for private fund managers that rely on exemptions from investment adviser registration under state law because certain state-level investment adviser registration exemptions incorporate or otherwise reference the federal qualified client definition. 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A number of states have adopted exemptions modeled on the North American Securities Administrators Association (“NASAA”) private fund adviser exemption, which may condition relief for advisers to certain funds relying on Section 3(c)(1) on each beneficial owner satisfying the federal qualified client definition. However, state requirements vary, and any effect of the Proposal would depend on the text of the applicable state exemption and how it incorporates Rule 205-3. Many emerging private fund managers may have a larger network of accredited investor relationships than qualified client relationships during the early stages of their investment advisory business. Currently, under Rule 205-3, private fund managers may receive performance-based compensation from investors who do not satisfy the qualified client definition if those investors were admitted to their private funds prior to registration with the SEC. Following registration with the SEC, however, managers may continue to permit investors that are not qualified clients to invest in future private funds but may not receive performance-based compensation from those investors with respect to such investments. In addition, because the net worth and assets under management thresholds for qualified client status are adjusted for inflation every five years, the pool of qualified client investors may diminish over time as previously eligible investors no longer satisfy the applicable thresholds. The Proposal could provide the dual benefit of greater flexibility for private fund managers to establish and maintain relationships with accredited investors as their businesses scale and they become registered with the SEC, and greater flexibility for certain accredited investors to participate in investment strategies that historically have been restricted to much larger institutional investors. Unless and until the Proposal is adopted, investment advisers should continue to comply with the existing qualified client requirements. If the Proposal is adopted, private fund sponsors should consider whether corresponding changes are appropriate for their subscription documents, investor questionnaires, and other offering materials. Advisers that are state-registered or rely on a state-level exemption should also consult the laws and regulations of each relevant jurisdiction before changing investor eligibility standards or performance-based compensation practices, because adoption of the federal amendments may not automatically modify state requirements. Comments on the Proposal will be due 60 days after publication in the Federal Register. 1 Investment Adviser Performance-Based Compensation Modernization, Investment Advisers Act Release No. IA-7022 (Sept. 30, 2026), available at https://www.sec.gov/rules-regulations/2026/09/s7-2026-28#33-11443proposed.