SEC Targets Misleading AI Claims: Enforcement Actions and Key Takeaways
In recent years, the use of Artificial Intelligence (“AI”) has surged across multiple industries, with many financial services institutions either actively integrating AI into their operations or claiming to do so. Alongside this growth, regulatory scrutiny around “AI washing”—the practice of overstating or misrepresenting a firm's use of AI to attract investors—has also intensified. Much like "greenwashing," where companies overstate their environmental initiatives, the Securities and Exchange Commission (“SEC”) has now honed in on AI washing, as reflected by public warnings and two recent enforcement actions.
The SEC’s Recent Focus on “AI Washing”
In late 2023, SEC Chair Gary Gensler underscored the Commission’s concerns about AI washing, delivering a stark warning: “[d]on’t do it . . . I don't know how else to say it.” Shortly thereafter, in January 2024, the SEC issued an investor alert highlighting investment fraud schemes involving the alleged use of AI and other emerging technologies. This included firms falsely portraying themselves as AI-driven to attract investments.
The SEC's Division of Enforcement has also been vocal about these risks. In a speech last month, Director Gurbir Grewal warned companies that representations about AI use must not be “materially false or misleading.” He pointed to two enforcement actions from March 2024, further emphasizing that AI misrepresentation poses significant risks not only for private firms but also for public companies.
Recent SEC AI Enforcement Actions
On March 18, 2024, the SEC settled with two investment advisers—Delphia (USA) Inc. and Global Predictions, Inc.—for violations of the Investment Advisers Act of 1940 (the “Advisers Act”). These settlements highlighted false claims regarding the use of AI, with Delphia agreeing to pay a $225,000 penalty and Global Predictions facing a $175,000 penalty.
The Delphia Case
Delphia, a robo-adviser that developed algorithms for managing retail portfolios, claimed its AI-powered models were bolstered by data collected from clients, such as their social media and banking information. However, during an SEC examination in July 2021, Delphia admitted it had never used client data or developed an algorithm for such purposes. Although Delphia updated its disclosures in 2021, it continued to make misleading claims about its AI capabilities in subsequent marketing efforts.
The SEC found Delphia’s representations to be materially misleading, particularly as it positioned itself as distinct from other advisers due to its purported AI-driven insights. Delphia’s failure to adopt appropriate policies and procedures to prevent these violations, particularly in social media advertisements, further contributed to its breaches of Sections 206(2) and 206(4) of the Advisers Act and related rules.
The Global Predictions Case
Global Predictions, a San Francisco-based investment adviser, similarly misled clients about its AI capabilities, including falsely claiming to be the “first regulated AI financial advisor.” Additionally, it presented hypothetical performance data without proper disclosures and posted unverified testimonials on its website. Inconsistencies between Global Predictions’ advisory contracts and its Form ADV disclosures further compounded the firm's regulatory issues.
As with Delphia, the SEC found Global Predictions violated Sections 206(2) and 206(4) of the Advisers Act, along with related rules, including those governing marketing materials and compliance procedures. The firm was required to retain a compliance consultant to address these deficiencies.
Key Takeaways for Firms
In light of the SEC’s increasing focus on AI washing, financial services firms and publicly traded companies should consider the following steps:
Assess AI Risks: Companies should evaluate the risks associated with their use of AI, including potential conflicts of interest, and consider establishing board-level oversight similar to cybersecurity risk management frameworks.
Conduct AI Audits: Undertake a comprehensive review of AI-related programs and services. Ensure all marketing and advertising materials accurately reflect the capabilities and limitations of the AI technologies being utilized.
Enhance Compliance Measures: Implement or strengthen policies to ensure marketing claims, particularly about AI, are accurate and comply with regulatory standards. This is particularly important for investment advisers subject to the requirements of Rule 206(4)-7.
Disclosure Accuracy: Ensure all public disclosures related to AI, including risks and potential conflicts, are accurate and complete. This may include detailing the limitations of AI models and the impact they may have on client services.
Diligence for AI Claims: For investment firms, it is crucial to perform thorough due diligence on potential portfolio companies' AI claims, including verifying whether AI contributes to profitability or operational improvements.
Cybersecurity and AI Overlap: Consider the intersection of AI and cybersecurity, particularly the need for appropriate disclosure controls in case of incidents or breaches. An effective incident response plan should involve external counsel and forensic experts, as needed.
Conclusion
As the SEC’s actions against Delphia and Global Predictions show, misrepresenting the use of AI can lead to significant regulatory consequences. Firms must ensure that their use of AI is accurately represented in all public materials and that proper compliance measures are in place to prevent misleading statements.
For more information on navigating SEC enforcement actions or for guidance on compliance with AI-related regulatory issues, please contact Anderson P.C.’s Securities Enforcement and Regulatory team.
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