The Securities and Exchange Commission (SEC) has sent clear signals that it will pursue companies for “AI washing” — touting the use of artificial intelligence in ways that are false or misleading. The SEC has imposed fines on two investment advisors for AI washing, and Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, has publicly warned of the risks that AI washing poses.
Enforcement Actions Against Delphia (USA) Inc.
In a March 18, 2024 order, the SEC found that Delphia (USA) Inc., a former registered investment adviser, had made numerous false and misleading statements regarding its purported use of AI and machine learning that incorporated client data in its investment process. For example, Delphia claimed that its advice was:
“Powered by the insights it makes when individuals … connect their social media, banking, and other accounts … or respond to Delphia’s questionnaires” which make its investment decisions “more robust and accurate[.]”
Delphia’s website stated that Delphia “turns your data into an unfair investing advantage” and that Delphia “put[s] collective data to work to make our artificial intelligence smarter so it can predict which companies and trends are about to make it big and invest in them before everyone else.” In fact, Delphia had not developed these capabilities. The SEC warned Delphia against making false and misleading statements, but the company continued to make such unsupported statements, claiming in a social media post that the firm’s “proprietary algorithm uses the data being invested by our members, so we can make stock selections across thousands of publicly traded companies up to seven financial quarters in the future.” Further, Delphia failed to adopt and implement policies and procedures reasonably designed to ensure its advertising claims were accurate and prevent violations of the Investment Advisers Act.
SEC Penalties for Delphia
The SEC concluded that Delphia’s AI washing was false and misleading and violated several provisions of the Investment Advisers Act, and as a result, the SEC censured the Toronto-based firm and imposed a monetary penalty of $225,000.
In a similar order on the same day, the SEC censured Global Predictions, Inc. and fined Global Predictions $175,000. On its website, the San Francisco-based firm stated that its technology incorporated “[e]xpert AI-driven forecasts” and claimed to be the “first regulated AI financial advisor.” In addition to these false statements regarding its use of AI, Global Predictions was unable to provide support for its claim that its model outperformed “IMF forecasts by 34%.” And it did not help that Global Predictions’ retail client advisory contracts included an impermissible “hedge” clause that purported to waive non-waivable rights.
Director Grewal’s Warning
On April 15, 2024, SEC Enforcement Director Gurbir Grewal touched on AI washing during his remarks at the 10th Annual Program on Corporate Compliance and Enforcement in New York City. Director Grewal argued that AI poses a major risk because “elevated investor interest in rapidly developing technology or offerings often leads to elevated investor risk.” The high-profile AI revolution has created an environment in which companies have significant incentives to overstate the extent to which they utilize AI to capture investors’ attention and dollars. Director Grewal analogized the situation to greenwashing, when companies exaggerate their ESG engagement. And although the Delphia and Global Predictions penalties were relatively modest, a Deutsche Bank subsidiary paid a $19 million penalty after the SEC charged that it had falsely inflated its ESG engagement, claiming that ESG was in its “DNA.”
Prohibition Against False Statements
Near the end of his speech, Director Grewal summed up his advice succinctly: “The bottom line: you must ensure that your representations regarding your use of AI are not materially false or misleading.” Put this way, although AI may be cutting edge, the securities laws apply as they always have, and prohibit companies from making false and misleading statements. And that prohibition isn’t limited to investment advisers. Public companies must make certain that statements that they make about AI in their Exchange Act filings are supportable, and private companies must do the same in documents that they use to solicit investment.
Future Enforcement Efforts
We are confident that Delphia and Global Predictions are just the beginning of the SEC’s AI-washing enforcement efforts, and that the next penalty may well have more zeros behind it. For more information, please contact Andrew Wilber (AJW@kjk.com; 216.736.7298) or Christopher Hubbert (CJH@kjk.com; 216.736.7215) or another member of our Corporate & Securities practice group.