SEC Dings Investment Advisors for AI Washing; Are Public Companies Next?

You’ve heard of greenwashing and sports-washing. Let us introduce you to AI washing.

In what is believed to be a first for the Securities and Exchange Commission, the agency recently settled charges against a pair of investment advisors for allegedly glamming up their expertise in artificial intelligence. Apparently, the SEC took exception to a claim by investment firm Global Predictions that it was the “first regulated AI financial advisor.” The firm also got dinged for touting “expert AI-driven forecasts,” which regulators weren’t buying. The SEC reprimanded Toronto-based firm Delphia (USA) Inc. as well for falsely claiming that its “smarter” AI capabilities could use client data to predict which companies and trends were poised to “make it big” so investors could reap benefits “before everyone else.”

Although the SEC did break new ground with the enforcement actions, leadership at the agency has indicated for months that it had so-called “AI washing” on its radar. And regulators have made clear that their focus will not be limited to investment advisors; public companies should expect increased scrutiny as well.

In comments to New York Bar Association members in October 2023, an SEC staff member said the agency was reviewing claims made by publicly traded companies and investment advisers that certain products were incorporating AI when they actually were not. “AI is a buzzword these days,” said Tejal Shah, an associate regional director in the SEC’s New York office.

Several weeks later, SEC Chair Gary Gensler cautioned companies against making misleading AI claims and likened AI washing to greenwashing, the practice of companies making false claims about their environmental bonafides. “Don’t do it,” Gensler said at a December conference on AI. “One shouldn’t greenwash and one shouldn’t AI wash.” He added that public statements – including those about AI capabilities – are subject to federal securities laws and therefore require companies to provide “full, fair and truthful” disclosures that “accurately describe the material risks.”

In a follow-up to those remarks, Gensler in a speech at Yale Law School in February even used a tortured – and low-tech – metaphor involving a character from the musical The Music Man to illustrate his concerns about con artists appealing to gullible investors with fantastical claims about AI-driven investment models.

Referencing Professor Harold Hill, a traveling salesman in the musical who cons a town into purchasing musical instruments for their children, Gensler warned that the allure of shiny new objects can be misleading. “We’ve seen time and again that when new technologies come along, they can create buzz from investors as well as false claims from the Professor Hills of the day,” Gensler said. “If a company is raising money from the public, though, it needs to be truthful about its use of AI and associated risk.”

Gensler said investment advisers and broker-dealers should not “mislead the public” by saying they are using an AI model when they are not, or allege they are using one in a particular way but not do so. “Such AI washing, whether it’s by companies raising money or financial intermediaries, such as investment advisers and broker-dealers, may violate the securities laws,” he said.

And to those touting their AI capabilities, Gensler offered a final warning in his Yale Law School address: “If you are AI washing, as ‘Professor’ Hill sang, ‘Ya Got Trouble.’”