SEC charges advisors over misleading AI claims

The Securities and Exchange Commission charged two different investment advisors who both were accused of severely overstating how much they used AI for their insights, even though neither made use of the technology despite fervent marketing materials stating otherwise.

One case involved investment advisor Delphia which, starting in 2019, began making statements in its marketing materials about how it generates insights using client data fed into a predictive algorithmic model. Using this data, Delphia said it could use artificial intelligence and machine learning to analyze its retail clients' spending and social media data to inform its investment advice. When the SEC dug further into these claims, however, they quickly fell apart.

"During an examination, the Division of Examinations discovered the various misleading statements outlined above," said the SEC complaint. "In a response to SEC staff's questions, Delphia admitted to the Division of Examinations in July 2021 that it had not used any of its clients' data and had not created an algorithm to use client data."

Afterward, the company amended some of its previous statements to make clear it does not use client data to inform decisions. It would also review all current marketing and regulatory disclosure documents and take action to correct any false and misleading statements regarding the use of client data. Despite this, according to the SEC, Delphia kept making statements to clients saying its data was helping train their algorithm, that it would pool everyone's data together to power the algorithm, referred to its "proprietary algorithm" using client data to make stock selections, and which "uses the data being invested by our members, so we can make stock selections across thousands of publicly traded companies up to seven financial quarters in the future." In a press release, it claimed its algorithm could make predictions across thousands of publicly traded companies up to two years into the future.

"Each of these statements was false and misleading because Delphia had not developed the represented capabilities," said the SEC complaint. It added that the company also failed to develop policies to make sure it does not make such statements in the future.

The other company, Global Predictions Inc., had a similar issue. It touted itself as "the first regulated AI financial advisor" that offered "expert AI-driven forecasts." The SEC, however, said it could not produce any documentation substantiating these statements.

Beyond AI, the company was also accused of offering tax loss harvesting services that could save customers "thousands of dollars" when it did not, in fact, offer this service. The company also said it had more than $6 billion of assets on its platform, when in fact Global Predictions did not have or report any regulatory assets under management. The SEC also faulted the company for saying its predictive models outperform International Monetary Fund forecasts by 34% when it could, once again, not produce documentation substantiating this claim. There were also conflicts of interest in some of its customer testimonials.

"For example, two persons giving testimonials had outside business relationships with Global Predictions' Chief Executive Officer and one of those persons had previously been retained by Global Predictions as an independent contractor, while a third person giving a testimonial was a close family member of Global Predictions' Chief Executive Officer," said the SEC complaint.

The SEC also said the company made unilateral changes to its advisory contracts without adequately informing customers and furthermore the language in these changes contained misleading statements, such as claiming the company "do[es] not give financial or investment advice or advocate the purchase or sale of any security or investment" when its marketing materials said the exact opposite. The agency also pointed to the insertion of liability disclaimer language that purported to relieve Global Predictions from liability for "any claim or demand" regardless of the theory of liability, and purported to cause the client to broadly indemnify and hold Global Predictions harmless from any third-party claim or demand arising out of the client's use of Global Predictions' services.

"The hedge clauses in Global Predictions' advisory contract with retail clients were inconsistent with Global Predictions' fiduciary duty because the hedge clauses could have misled retail clients into not exercising their non-waivable legal rights," said the SEC complaint.

Without admitting or denying the SEC's findings, Delphia and Global Predictions consented to the entry of orders finding that they violated the Advisers Act and ordering them to be censured and to cease and desist from violating the charged provisions. Delphia agreed to pay a civil penalty of $225,000, and Global Predictions agreed to pay a civil penalty of $175,000.

While the SEC has not focused much on artificial intelligence so far, as the technology proliferates it's likely there will be more enforcement actions involving it. Prior to these two cases, the last announced enforcement action regarding AI involved an online instructor who encouraged his students to invest in the Rockwell Fund, a hedge fund that he claimed he would launch, and which would use cutting-edge technologies like artificial intelligence and trading strategies involving crypto assets to generate returns for investors. Despite receiving approximately $1.2 million from 15 students, he never launched the fund nor executed the trading strategies he advertised to investors, instead holding onto the invested money in bitcoin. The complaint further alleges that the bitcoin was eventually stolen when his digital wallet was hacked and looted.

Prior to that, the last announced enforcement action was in 2021 and involved a mother-son team who raised more than $12 million from at least 277 retail investors, who were told their money would be invested in securities trading and cryptocurrencies based on recommendations made by an "artificial intelligence supercomputer" that consistently generated enormous returns. However it turned out to be more of an old fashioned Ponzi scheme where over 90% of the funds came not from any sort of supercomputer but from investors. The company was said to actively encourage investors to use money from retirement funds and home equity, and target investors looking to build educational funds for their family. 

SEC Chair Gary Gensler said cases like this represent what he called "AI washing."

"We find that Delphia and Global Predictions marketed to their clients and prospective clients that they were using AI in certain ways when, in fact, they were not," said Gensler in a statement. "We've seen time and again that when new technologies come along, they can create buzz from investors as well as false claims by those purporting to use those new technologies. Investment advisers should not mislead the public by saying they are using an AI model when they are not. Such AI washing hurts investors."

In January, the SEC released an alert regarding the rising use of AI use in investment fraud, in terms of both overstated claims and utilization in various scams.