SEC Settles Charges with Advisers for Marketing Rule Violations Related to AI Washing

Who may be interested: Investment Advisers

Quick Take: The SEC recently settled charges with two investment advisers, through separate orders, relating to each adviser’s alleged violations of Rule 206(4)-1 under the Advisers Act (the Marketing Rule) for making false and misleading statements concerning their purported use of artificial intelligence (AI), so-called “AI washing.” The SEC’s orders follow the SEC’s recent proposal that would govern an adviser’s use of AI, and offer insight into how the SEC is reviewing “AI Washing” under current regulations.

According to the SEC’s first order, one adviser made multiple false and misleading claims over a period of approximately four years. Claims made by the adviser through advertisements and client communications, generally represented that the adviser used AI and machine learning to analyze its clients’ spending and social media data and that the adviser used such analysis in a predictive algorithmic model for selecting investments for such clients. The SEC’s order found that each of the claims the adviser made concerning its use of AI and machine learning were false and misleading as the adviser had not actually developed or implemented the capabilities it represented with respect to AI and machine learning. The order also noted that the adviser failed to adopt and implement policies necessary to ensure that its advertisements were accurate and not misleading.

According to the SEC’s second order, another adviser made false and misleading statements concerning its use of AI. The adviser claimed on its website that it was the “first regulated AI financial adviser,” despite not being able to produce documents to substantiate the claim. The adviser also claimed that its technology incorporated “expert AI-driven forecasts” and that it offered tax-loss harvesting services, although it did neither of those activities. The SEC’s order further noted that the adviser failed to implement its policies and procedures relating to the adviser’s marketing activities, that the adviser’s advisory contracts contained misleading liability disclaimer language (frequently referred to as a hedge clause), and that the adviser misstated the level of its assets under management in its Form ADV disclosures.

The SEC orders found that both advisers violated Section 206(2) of the Advisers Act, the Marketing Rule and Rule 206(4)-7 under the Advisers Act. Without admitting or denying the findings set forth in the SEC’s orders, the advisers agreed to cease-and-desist orders, censures, and to pay civil penalties of $225,000 and $175,000, respectively.

Of note, the fund is a Maryland corporation governed by the Maryland General Corporation Law. By contrast, the closed-end funds that recently received no-action relief were Massachusetts business trusts. In the latter instance, the Staff’s determination permitting the funds to exclude a shareholder proposal to declassify its board was based on provisions in Massachusetts law and in the governing documents of the funds.

The SEC’s press release and links to the orders can be found here.