Gensler warns advisors and BDs about AI washing ... again

SEC Chair Gary Gensler gave a warning last week to investment advisors and broker-dealers about “AI washing,” the latest sign that the regulator may be cracking down on that area.

“As we've seen an increase in the disclosures around artificial intelligence by SEC registrants, public companies as you know them, it's important that companies making these disclosures remember that the basics of the securities laws still apply,” Gensler said in one of his “Office Hours” videos posted on YouTube.

“Companies should ask themselves some basic questions, such as if we're discussing artificial intelligence in our earnings calls or having extensive discussions with our board of directors, maybe this information is potentially material to our business and to investors,” he said. “Investment advisors, broker-dealers also should not mislead the public by saying they're using AI when they're not, nor say that they're using it in a particular way and not do so.”

AI washing could violate securities laws, he noted.

That message follows at least three cases the SEC has filed this year against companies over alleged AI washing, including two against financial services companies. In March, the SEC settled charges against two investment advisors – Delphia and Global Predictions – for $400,000. Those firms allegedly mischaracterized or made untrue statements to clients about their use of AI.

Then in June, the SEC announced another case, that one against defunct hiring startup Joonko as well as its CEO, Ilit Raz. That case, which has a much wider range of charges, alleges that Raz and the firm defrauded investors of at least $21 million, misleading them about the company’s customers, prospects, and revenue.

“We allege that Raz engaged in an old school fraud using new school buzzwords like ‘artificial intelligence’ and ‘automation,’” said Gurbir Grewal, director of the SEC’s Division of Enforcement, in a statement at the time. “As more and more people seek out AI-related investment opportunities, we will continue to police the markets against AI-washing and the type of misconduct alleged in today’s complaint.”

The cases against Delphia and Global Predictions represented “the first shot across the bow,” several Ropes & Gray lawyers wrote in the Harvard Law School Forum on Corporate Governance.

“Investment advisors should not only ensure that their marketing and other materials convey information about AI that is consistent with their actual use of such technologies but should also maintain documentation of their support for any such claims,” the post read. “Advisors and investment firms need to coordinate internally to ensure the consistent description of any AI tools in a manner aligned with their actual use by investment professionals.”

The SEC is also in the process of reviewing comments submitted in response to a rule it proposed last year on the use of predictive data analytics by broker-dealers and investment advisors. That proposed rule would require that firms address conflicts of interest that arise through the use of those analytics “and similar technologies,” that could otherwise put the firms’ interests ahead of those of clients’, the SEC wrote.

The clock is ticking for that rule, like others, that the regulator might hope to finalize before the end of the year, given that anything passed too close to inauguration day could be reversed by the next president. In June, the SEC discussed the proposed rule at its Investor Advisory Committee, indicating that it could be closer to a final version.

Still, the use of AI in a highly regulated industry like financial services might not be as prevalent as some might think, and many actually want rules for how AI is used. Results of a survey published last month by the CFA Institute found that 85 percent of respondents said they see a need for industrywide standards and ethical guidelines for AI use in investment roles. Further, 82 percent said they thought the lack of clear standards is hampering the use of AI or Generative AI.