(Article from Registered Funds Regulatory Update, April 2024)
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The SEC settled charges against two registered investment advisers for making false and misleading statements about their use of AI, which the SEC refers to as “AI washing.” By analogy, the SEC has pursued “greenwashing” cases in connection with false and misleading statements about ESG, which has been anticipated to provide a playbook for the SEC to pursue AI-related perceived disclosure failures.
According to the SEC’s Order, one RIA made false and misleading statements regarding its use of AI in its Form ADV Part 2A brochures, in a press release, and on its website, a sampling of which is as follows:
- That the RIA’s advice was “powered by the insights it makes when individuals . . . connect their social media, banking, and other accounts . . . or respond to [RIA] questionnaires” which make its investment decisions “more robust and accurate”;
- That client data was used in “a predictive algorithmic model” for the selection of investments;
- That the RIA “uses machine learning to analyze the collective data shared by its members to make intelligent investment decisions”; and
- That the RIA puts “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.”
The Order alleged that the RIA had not developed the stated capabilities and noted that in 2021, the RIA had conceded during an examination that it had not created an algorithm to use client data nor otherwise used the client data. The Order detailed post-examination remediation undertaken by the RIA, including corrective disclosure, onboarding a compliance manager, and retaining compliance consultants. However, the Order found that the RIA continued to make false and misleading statements in email communications, on social media, and in a press release through August 2023, as follows:
- That client data was helping train the RIA’s “algorithm for pursuing ever better returns” and was pooled “to power [the RIA’s] algorithm”;
- That the RIA’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”; and
- That the RIA’s “proprietary algorithms combine the data invested by its members with commercially available data, to make predictions across thousands of publicly traded companies up to two years into the future.”
The second settlement involved an RIA that was an internet investment adviser to retail clients, on similar conduct (as well as other conduct unrelated to statements concerning AI). The Order found that the RIA made false and misleading statements on social media, on its website, and in emails to current and prospective clients, with certain AI-related statements as follows:
- That the RIA’s technology incorporated “expert AI-driven forecasts;” and
- That the RIA was the “first regulated AI financial advisor.”
The Orders found that the RIAs violated both the anti-fraud provisions and the Marketing Rule of the Advisers Act. Without admitting or denying the SEC’s findings, the RIAs each agreed to the entry of an order finding that they violated the Advisers Act, a cease-and-desist order, a censure, and a civil monetary penalty with combined penalties of $400,000.
In the SEC press release accompanying the two settlements, SEC Chair Gary Gensler commented that the two RIAs “marketed to their clients and prospective clients that they were using AI in certain ways when, in fact, they were not. We’ve seen time and again that when new technologies come along, they can create buzz from investors as well as false claims by those purporting to use those new technologies. Investment advisers should not mislead the public by saying they are using an AI model when they are not. Such AI washing hurts investors.” Enforcement Director Gurbir Grewal gave a similar warning in the press release, stating that “if you claim to use AI in your investment processes, you need to ensure that your representations are not false and misleading.”
While the settlements involved retail investors, and focused on fairly straightforward disclosure failures, the SEC’s current focus on AI is expansive and extends beyond advisers to retail clients. SEC officials have stated publicly that they are scraping registrants’ publicly available statements (e.g., Form ADVs, websites) about their use of AI and that AI is going to be a larger part of the examination program this year—and such commentary is not limited to advisers to retail clients. Also, notably, though these settlements did not involve public issuers, Grewal’s press release comments included the following warning to those entities: “And public issuers making claims about their AI adoption must also remain vigilant about similar misstatements that may be material to individuals’ investing decisions.”
In the Matter of Delphia (USA) Inc., SEC Admin. File No. 3-21894 (Mar. 18, 2024), available at: https://www.sec.gov/files/litigation/admin/2024/ia-6573.pdf.
In the Matter of Global Predictions Inc., SEC Admin. File No. 3-21895 (Mar. 18, 2024), available at: https://www.sec.gov/files/litigation/admin/2024/ia-6574.pdf.