AI Washing: From Marketing Hype to Regulatory Crackdowns

The Concept of AI Washing

There is a lot of buzz about artificial intelligence (AI) and this makes sense as it could very well be the most transformative technology of our time, right in line with the internet. It’s already being used in finance, insurance, healthcare, to name a few, and many companies are exploring ways to harness its many potentials. However, whenever a new technology comes along, we have seen instances of false claims by those claiming to use those new technologies in order to tap into public excitement. Director of the SEC’s Division of Enforcement, Gurbir Grewal, stated it succinctly, “history teaches us that as AI continues to develop, firms will rush to capitalize on investor interest by promoting their supposed use of AI, but some of these claims may come before the firms actually develop the technology or strategy, or maybe they’ll fail altogether to follow through on implementing the technology or strategy after announcing it.” This is called AI washing.

AI washing, also known as “AI hype” or “algorithm washing,” refers to a practice where companies or organizations misleadingly rebrand their products or services as involving artificial intelligence to capitalize on the AI buzz, even when these offerings do not truly use advanced AI capabilities. This can involve exaggerating the role of AI in products that largely rely on simpler or traditional technologies, or declaring AI capabilities that are non-existent. AI washing typically occurs for a few reasons:

Marketing Advantage: In a tech-driven market, AI has a trendy and cutting-edge appeal. Companies may claim their solutions are AI-powered to attract more customers or investors, who may perceive AI as a sign of innovation and future-readiness.

Competitive Edge: As businesses in various sectors rush to announce their AI integration, others may feel pressured to do the same, even if their actual use of AI is minimal or irrelevant. This can create a competitive illusion that everyone is leveraging AI, thereby pushing more companies to engage in AI washing.

Investment Attraction: AI startups and projects can attract significant investment. Organizations might label their offerings as AI-related to secure funding from investors who are keen to back technologically advanced ventures.

As SEC Chairman, Gary Gensler, put it in an educational video on the practice of AI washing, broker-dealers “might want to tap into the excitement about AI by telling [investors] that they’re using this new technology to help [investors] get a better return,” and public company executives “might think that they will enhance their stock price by talking about their use of AI.”

Enforcement Actions

AI washing is one area that the regulators are keeping an eye on. In March 2024, SEC charged two different advisers, Delphia (USA) and Global Predictions, with making false and misleading statements about their use of AI technology in violation of the Investment Advisers Act rules governing marketing and compliance policies and procedures. According to the SEC’s investigations, the firms advertised that they used AI in their investment processes when, in fact, they didn’t. For example, Delphia represented that it used artificial intelligence and machine learning to analyze its retail clients’ spending and social media data to inform its investment advice when, in fact, no such data was being used in its investment process. Global Predictions claimed on its public website that its technology incorporated “[e]xpert AI-driven forecasts,” when in fact it did not. Global Predictions also claimed to be the “first regulated AI financial advisor” on its public website, in emails to current and prospective clients, and on various social media sites and, in turn, could not produce documents to substantiate this claim. Both firms agreed to settle charges with the SEC and were ordered to pay civil money penalty of $225,000 and $175,000, respectively.

In SEC’s press release following these enforcement actions, Grewal emphasized that the SEC is committed to protecting investors from AI washing as “more and more investors consider using AI tools in making their investment decisions or deciding to invest in companies claiming to harness its transformational power.” If investment firms claim to use AI in their investment processes, they must ensure those representations are not false or misleading.

While the actions above specifically targeted investment advisers, recent regulatory activities, both at the state and federal levels, show that regulators are closely scrutinizing and, where appropriate, penalizing firms for enticing investors with false claims about their AI capabilities. For example, Connecticut regulators ordered an investment firm to pay a civil penalty of $700,000 for fraudulently promising massive returns with its AI trading system that “operates 24 hours a day, so you never lose money.”

Similarly, the Commodity Futures Trading Commission’s (CFTC) Office of Customer Education and Outreach issued a customer advisory (AI Won’t Turn Trading Bots into Money Machines) warning the public about AI scams. The advisory explains how the scams use the potential of AI technology to defraud investors with false claims that entice them to hand over their money or other assets to fraudsters who misappropriate the funds and deceive investors.

Relatedly, on February 14, 2024, the DOJ also turned its attention to AI. Deputy Attorney General, Lisa Monaco, has stated on her remarks at the University of Oxford on the Promise and Peril of AI, that AI may be the “sharpest blade yet” in the long history of technology as a double-edged sword, and warned that “[g]oing forward, where Department of Justice prosecutors can seek stiffer sentences for offenses made significantly more dangerous by the misuse of AI, they will.”

Other Regulatory Frameworks

Outside of the investment industry, there are established regulatory frameworks that prohibit false claims in advertising, which would include AI washing. This includes Unfair or Deceptive Acts or Practices (UDAP) under Section 5 of the Federal Trade Commission Act (FTC Act), Unfair, Deceptive, or Abusive Acts or Practices (UDAAP) pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), and Telemarketing Sales Rule (TSR). UDAP protects consumers from damages in a wide range of industries while UDAAP specifically defends a consumer’s rights when seeking services from financial service providers. TSR specifically targets telemarketing activities.

On the topic of TSR, on April 18, 2024, the FTC adopted amendments to the TSR that, among other things, prohibit material misrepresentations and false or misleading statements in business to business (B2B) telemarketing calls. The amendments are effective May 16, 2024. However, compliance with certain aspects of the amendments is not required until October 15, 2024.

TSR prohibits deceptive or abusive telemarketing practices, such as misrepresenting several categories of material information or making false or misleading statements to induce a person to pay for a good or service. The original TSR generally excluded B2B calls, except those involving selling office and cleaning supplies. In the current amendments, the TSR’s prohibitions against misrepresentations will now apply to B2B telemarketing, i.e., telemarketing directed at businesses. We will explore the amendments in detail in next week’s Insights. However, we recommend reviewing the amendment if it’s applicable to your firm assuming you have not already done so.

Key Takeaways

Implement or review policies and procedures. Implement policies and procedures or review, and as appropriate, update existing policies and procedures to ensure that advertisements that are published, circulated, or distributed are accurate and do not contain misleading or untrue statements. The policies and procedures should include activities conducted through social media.

Transparency: Accurately represent and disclose the specifics of the AI technology in communications with investors and others who are expected to rely on those representations to make a decision, and accurately convey how the AI technology works.

Review and approval process. Implement a clear advertising review and approval process, either in policies and procedures or otherwise, that would enable personnel involved in the process to understand their respective roles and responsibilities in that process. Marketing materials, sales scripts and other marketing communications should be carefully reviewed to confirm that material representations are accurate and unambiguous. When in doubt, ask the product team for a demonstration of the representations being made before approving the communication.

Training refresher. Provide refresher training to relevant personnel on your marketing/advertising/social media policies and procedures, their expected roles and responsibilities, and the importance of adherence.

Ongoing monitoring. Periodically monitor social media posts to ensure representations being made by personnel about the firm’s products and services are accurate.

Thought Leadership

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