The SEC Takes a Strong Stance on “AI Washing”

Artificial intelligence (AI) has gained significant attention and investment to revolutionize every industry; however, is it misleading some investors? Investment advisers are eager to showcase their involvement in AI to attract customers, investments and talent. However, some organizations engage in AI washing by using the term “AI” as a buzzword without truly incorporating AI capabilities into their offering. As a result, the Securities and Exchange Commission (SEC) is ramping up its efforts to combat AI washing with a particular focus on the role of the investment adviser.

This topic took center stage at the SEC’s spring conference for the Program on Corporate Compliance and Enforcement (PCCE) on April 15, 2024. Gurbir Grewal, the SEC’s director of enforcement, stated, “While perhaps not quite yet a perfect storm, there’s certainly one brewing around AI. And it is incumbent on each of us to make sure it does not come to pass and that investors are not harmed by noncompliance with the securities laws when it comes to this new technology.” This warning follows the SEC’s action on March 18, 2024, when it charged two investment advisers for making false and misleading statements about their use of AI.

What is the SEC focused on and why?

Exaggerated, False and Misleading Claims. The use and implementation of an effective AI solution will likely enhance processes, efficiency and productivity for companies and markets who implement robust programs. In the opinion of the regulator, this enthusiasm may lead some to rush to invest with companies or firms that are first to market and/or claim to be utilizing AI. The SEC argues that some investment firms are providing misleading statements claiming to be using AI as a premise for investment — overselling their use of AI to inflate valuations or gather investments. This is similar to “greenwashing” where firms overstate environmental and social practices for marketing purposes.

One form of this is an investment adviser may claim to have AI-driven products or solutions, but upon closer examination, the AI component may be limited to basic automation or rule-based algorithms rather than true AI algorithms that can learn, adapt and make autonomous decisions. For example, the SEC fined one adviser for making claims that their advice to purchase securities was based on machine learning linked by social media, banking and other records to give an unfair investment advantage, when in fact, these capabilities were not developed or used.

Another form of this is a company may use AI-related terminology in their marketing materials without providing substantial evidence or clarity about the actual AI capabilities behind their products or services. For example, an adviser claimed to use expert AI driven forecasts and to be the first regulated AI financial adviser on its website, emails and social media posts. These claims turned out to be false, and the SEC eventually fined the firms and issued press releases describing the circumstances.

The consequences of AI washing can be detrimental. It can mislead customers into believing they are purchasing cutting-edge AI technology when they are not. This can lead to dissatisfaction, wasted resources and missed opportunities to leverage genuine AI solutions. Furthermore, AI washing can erode trust in the broader financial and AI ecosystem, making it harder for truly innovative AI companies to differentiate themselves and gain credibility.

Investment advisers play a crucial role in maintaining the integrity of the AI ecosystem by ensuring that their claims about AI are accurate and substantiated. The SEC’s stance on AI washing serves as a reminder of the importance of honesty and transparency in the financial services industry.

A Proactive Approach to AI Ethics

For investment advisers, it is crucial to be aware and focus on avoiding these types of statements to mitigate risks. Firms should regularly review their practices and procedures to ensure all marketing and disclosures regarding their use of AI are not misleading. It is additionally important for consumers, investors and industry professionals to be vigilant and critically evaluate claims made by companies about their AI capabilities. Scrutinizing the technical details, requesting evidence of AI functionality and seeking independent verification can help separate genuine AI-driven solutions from those that are merely AI-washed.

Regulatory bodies and industry associations are taking steps to address AI washing. Guidelines and best practices are being developed to promote transparency, accountability and ethical use of AI technologies. For example, the SEC proposed a rule in July 2023 to help underscore how the use of predictive data may lead to conflicts of interest. The expectation is that firms will understand their fiduciary duties and consider when analytics, algorithms, artificial intelligence and forecasts may place the interest of the firm ahead of the investors and have a process which includes policies, procedures and testing. While the proposed rule has yet to be adopted, regulators can still rely on the marketing rule and anti-fraud rules applicable to all advisers.

These efforts aim to ensure that companies accurately represent their AI capabilities and provide clear information to consumers and stakeholders.

Weaver Can Help

Weaver’s dedicated Investment Adviser Compliance practice supports advisers in navigating the evolving regulatory landscape. Let us help ensure your compliance program remains effective and adaptable with support to your policy review, testing, monitoring, communication and training.

For more information and to find out how Weaver can help advisers prepare for examinations, review disclosures, analyze compliance programs for conflicts of interest and confirm adherence to SEC requirements, contact us. Weaver has significant experience providing comprehensive audit and compliance services to funds and advisers and can assist with compliance efforts surrounding the new rules.

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