Businesses Should Scrub Public Statements, as the SEC Focuses on "AI Washing"
In March, the U.S. Securities and Exchange Commission (SEC) settled a pair of enforcement actions against investment advisory firms that the SEC says misled investors about their use of artificial intelligence (AI). The actions came after months of warnings from senior SEC officials that the agency intends to crack down on businesses that make unfounded claims to the public about their use of AI – a practice the agency refers to as "AI washing." The SEC will surely continue to investigate and bring actions involving suspected AI washing, and these early cases serve notice to regulated entities – investment advisers, broker-dealers, and companies that raise money from the public – that the SEC will make good on its promise to penalize those that mislead investors about their use of AI.
"One Shouldn't Greenwash and One Shouldn't AI Wash."
SEC Chair Gary Gensler hails AI as "the most transformative technology of our time, on par with the internet and mass production of automobiles" and insists that the SEC is "technology neutral." [SEC Chair Gary Gensler, Remarks Before the National Press Club, "Isaac Newton to AI" (July 17, 2023), https://www.sec.gov/news/speech/gensler-isaac-newton-ai-remarks-07-17-2023.] He worries, however, that businesses may be tempted to overstate their AI capabilities in order to "create buzz" and attract investors. "Don't do it," he warned attendees at The Messenger AI Summit in Washington, D.C., in December. "One shouldn't greenwash, and one shouldn't AI wash." See Richard Vanderford, SEC Head Warns Against 'AI Washing,' the High-Tech Version of 'Greenwashing', WSJ (Dec. 5, 2023), https://www.wsj.com/articles/sec-head-warns-against-ai-washing-the-high-tech-version-of-greenwashing-6ff60da9; Hailey Konnath, SEC Chair Warns Businesses Against AI Washing: 'Don't Do It', Law360 (Dec. 5, 2023), https://www.law360.com/articles/1773759.
"Greenwashing" refers to exaggerated or false claims about a business's Environmental, Social, and Governance (ESG) practices. SEC Commissioner Allison Herren Lee, It's Not Easy Being Green[1] : Bringing Transparency and Accountability to Sustainable Investing (May 25, 2022), https://www.sec.gov/news/statement/lee-statement-esg-052522. Examples of greenwashing might include an investment manager misleading investors about the criteria it uses to make investment decisions, or using green-sounding fund names that mislead investors about the funds' investment objectives. Greenwashing might also include public company disclosures that falsely describe a manufacturing process or products as "sustainable" or "environmentally friendly." The SEC's Division of Enforcement has been keenly focused on these sorts of embellishments in recent years; it has even created a dedicated Climate and ESG Task Force to proactively identify ESG-related misconduct, which is some cases amounts to little more than deficient policies and procedures. SEC enforcement actions targeting greenwashing include an action against an asset management firm that failed to establish reasonable policies and procedures governing the use of ESG criteria in making how investment decisions; an action against a sham company that falsely claimed to run environmentally-friendly manufacturing facilities; and an action against a mining company that failed to assess and disclose environmental risks and related financial risks to the company. See, e.g., Examples of Enforcement Actions Related to ESG Issues or Statements, available at https://www.sec.gov/securities-topics/enforcement-task-force-focused-climate-esg-issues.
"Fraud is Fraud, and Bad Actors Have a New Tool, AI, to Exploit the Public."
Like greenwashing, AI washing involves making false claims about whether, how, or the extent to which a business relies on AI technology. "We've seen time and again that when new technologies come along, they can create buzz from investors as well as false claims from [salespeople]," Chair Gensler observed in February. SEC Chair Gary Gensler, Prepared Remarks Before the Yale Law School, "AI, Finance, Movies, and the Law" (Feb. 13, 2024), https://www.sec.gov/news/speech/gensler-ai-021324. Broadly, the SEC is concerned about "false claims" from two market segments: false claims by companies (issuers) to investors, and false claims by financial services firms to their investor clients.
For companies that raise money from the public, Chair Gensler warns that their disclosures must be sufficiently clear and detailed: "Claims about prospects should have a reasonable basis, and investors should be told that basis. When disclosing material risks about AI—and a company may face multiple risks, including operational, legal, and competitive—investors benefit from disclosures particularized to the company, not from boilerplate language." Id.
Chair Gensler has given a similar admonishment to financial services firms: "Investment advisers or broker-dealers also should not mislead the public by saying they are using an AI model when they are not, nor say they are using an AI model 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." Id.
Indeed, like false statements about a company's quarterly earnings or an adviser's investing track record, false statements about a business's use of AI technology could amount to fraud. After all, Chair Gensler reckons, "[f]raud is fraud, and bad actors have a new tool, AI, to exploit the public." If you are AI washing, Gensler warns, "ya got trouble." Id.
"Neither of the Firms Had the AI Capabilities That They Claimed They Had."
In March, the SEC notched two early successes in its efforts to root out AI washing. In settled actions against Delphia (USA) Inc. and Global Predictions Inc., the SEC found that the investment advisers made false and misleading statements to investors about the firms' purported use of AI. Delphia agreed to pay a civil penalty of $225,000, and Global Predictions agreed to pay a civil penalty of $175,000, to settle fraud and other charges. SEC Press Release, SEC Charges Two Investment Advisers with Making False and Misleading Statements About Their Use of Artificial Intelligence (March 18, 2024) (Delphia and Global Predictions Press Release), https://www.sec.gov/news/press-release/2024-36.
According to the SEC's order against Delphia, the firm falsely claimed in SEC filings, in a press release, and on its website that it used AI to "predict which companies and trends are about to make it big and invest in them before everyone else." Meanwhile, the SEC's order against Global Predictions found that the firm falsely claimed on its website and on social media that it was the "first regulated AI financial advisor" and that it could provide "AI-driven forecasts." Despite these claims, SEC Enforcement Director Gurbir Grewal explained, "neither of the firms had the AI capabilities that they claimed they had. Simply put, that's called AI washing, and it hurts investors." SEC Enforcement Director Gurbir Grewal Discusses AI Washing Enforcement Cases, YouTube (March 18, 2024) (Grewal YouTube Statement), https://www.sec.gov/news/sec-videos/sec-enforcement-director-gurbir-grewal-discusses-ai-washing-enforcement-cases.
According to Grewal, the SEC is "committed to protecting [investors] against those engaged in 'AI washing.'" Delphia and Global Predictions Press Release. The Delphia and Global Predictions cases should serve as a warning to businesses that claim to use AI, Grewal says, that they must ensure that any representations about the use of AI are not false or misleading. Grewal YouTube Statement.
Regulated Entities "Should Say What They're Doing, and Do What They Say."
The same day the SEC announced charges against Delphia and Global Predictions, Chair Gensler weighed in again on the risks of AI washing. "Investment advisers or broker dealers might want to tap into the excitement about AI by telling you that they're using this new technology to help you get a better return," he said. Meanwhile, public companies "might think that they will enhance their stock price by talking about their use of AI." In either case, the SEC wants to make sure regulated entities are "telling the truth." In short, "they should say what they're doing, and do what they're saying." SEC Chair Gary Gensler, Video Transcript, Chair Gary Gensler on AI Washing (March 18, 2024), https://www.sec.gov/news/video-transcript/sec-chair-gary-gensler-ai-washing.
And the SEC is determined to ascertain whether regulated entities are accurately saying what they're doing. It has been widely reported that the SEC's Division of Examinations is conducting a "sweep" of investment advisers to gather information on firms' AI-related marketing materials, algorithmic models used in connection with portfolio management, and internal compliance training efforts, among other topics. See, e.g., Richard Vanderford, SEC Probes Investment Advisers' Use of AI, WSJ (Dec. 10, 2024), https://www.wsj.com/articles/sec-probes-investment-advisers-use-of-ai-48485279. The SEC is also investigating a number of public companies that claim to incorporate AI technology in their product offerings or services.
The SEC is casting a wide net, and the sweeps will surely result in additional cases. Indeed, Enforcement Director Grewal recently advised compliance professionals to watch for and take lessons from "future [AI-related] enforcement actions." "While perhaps not quite yet a perfect storm, there's certainly one brewing around AI," he said. SEC Enforcement Director Gurbir Grewal, Remarks at Program on Corporate Compliance and Enforcement Spring Conference 2024 (April 15, 2024), https://www.sec.gov/news/speech/gurbir-remarks-pcce-041524.
Businesses that use AI, but haven't yet received information requests from the SEC, should be on the lookout. Take this time to reevaluate past and forthcoming statements on the businesses' use of AI—financial services firms, in particular, must make sure any statements about their use of AI comply with the SEC's Marketing Rule. "The bottom line: you must ensure that your representations regarding your use of AI are not materially false or misleading." Id.
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