SEC Takes a Stand Against Artificial Intelligence (“AI”) Washing: Two Investment Advisories That Exaggerated AI to Attract Investors Settled For Making Deceptive Claims
With their promise of revolutionizing investment strategies and decision-making processes, it’s no wonder that AI-powered models are attractive to both companies and investors. In fact, certain investment advisers realized that they could benefit from AI without even possessing the technology; simply pretending that their investment strategies were driven by a proprietary deep-learning model was enough to create buzz and attract new clients.
But the U.S. Securities and Exchange Commission (“SEC”) has made clear that it will not tolerate “AI washing”—a deceptive marketing tactic where companies exaggerate or fabricate their development or implementation of AI technology. In March 2024, two investment advisers, Delphia (USA) Inc. and Global Predictions Inc., settled the SEC’s charges related to AI washing and agreed to pay $225,000 and $175,000, respectively, in civil penalties, without admitting or denying the SEC’s findings.
The SEC had charged these firms with falsely claiming advanced AI capabilities and thus misleading their clients and potential investors. Delphia, for example, claimed that its AI analyzed vast amounts of data and could predict emerging market trends before anyone else—a claim that was, in reality, unsubstantiated. Global Predictions went even further, falsely declaring itself the "first regulated AI financial advisor" and boasting of "expert AI-driven forecasts." These assertions were not only misleading but entirely unfounded, as neither firm possessed the AI-powered technology it advertised.
While touting one’s use of AI certainly piques the interest of prospective clients and investors, companies, particularly those in regulated industries such as investment advisers, should be careful in making statements that are untrue. Notably, investment advisers are subject to the “Marketing Rule.” Rule 206(4)-1 of the Investment Advisers Act of 1940 ("Advisers Act") prohibits investment advisers from including in their advertising “any untrue statement of a material fact” or stating “information that would reasonably be likely to cause an untrue or misleading implication or inference to be drawn concerning a material fact relating to the investment adviser,” among other things.
Even for private companies and those in non-regulated industries, however, there is still a not-so-fine line between exaggerating your firm’s (non-existent) AI capabilities and fraud, as Ilit Raz, the CEO and founder of Joonko, a now-defunct AI recruitment startup, learned last June after the SEC charged her with defrauding investors of at least $21 million through a series of fraudulent claims. Gurbir S. Grewal, the Director of the SEC’s Division of Enforcement, stated “We allege that Raz engaged in an old school fraud using new school buzzwords like ‘artificial intelligence’ and ‘automation.’”
Is AI washing 2024’s new flavor of old school fraud? At the start of this year, the SEC issued an Investor Alert regarding the growing prevalence of fraudulent investment schemes that exploit the excitement, coupled with the general lack of understanding, around AI. Warning investors about unregistered platforms and promoters touting AI-driven trading systems that make unrealistic claims, such as "guaranteed stock winners" or "can't lose" systems, the bulletin advises investors that, apart from checking that the firm is registered, they should think twice if something sounds too good to be true. This warning to investors, taken together with the SEC’s recent enforcement actions, shows the SEC’s commitment to protecting investors from being misled by those touting AI methods in financial technology. And the take-away for companies? While it sounds like everyone has jumped on the AI bandwagon, and it may be enticing to overhype your own firm’s use of AI, perhaps it is best to keep in mind that the cost of AI washing will likely outweigh the perceived benefits.
