SEC Brings First Ever Enforcement Cases Concerning Artificial Intelligence

Background:

On March 18th, 2024, the Securities and Exchange Commission charged two investment advisers with misrepresenting their usage of artificial intelligence¹.
Both investment advisers were charged with violations of the SEC Marketing Rule, SEC Compliance Rule, and Section 206 of the Investment Advisers Act.
These cases could set precedent and create a roadmap for future similar enforcement actions.

Key Allegations:

Misleading Statements: Both investment advisers made a series of misleading statements in their marketing materials and regulatory filings which touted capabilities that did not exist. The table below highlights key information about each manager’s violations:

Analysis: The circumstances described in the order were exacerbated by the fact that (a) the managers served retail clients; (b) AI was key to each manager’s investment strategy raising the materiality of statements about AI; (c) the misstatements were repeated and pervasive; and (d) there were other violations of the marketing rule making the bringing of these cases more interesting.

Takeaways:

Disclosure-Based Approach: Unlike some other enforcement cases, these matters revolve around “meat and potatoes” disclosure-based violations. The enforcement orders clearly describe the misstatements and lay out the case that those misstatements were material. This case is a reminder to investment managers that investor disclosure is still one of the primary risks about employing AI in any investment program.
Potentially Precedent Setting Cases: While most of the misstatements highlighted in these cases are not groundbreaking, these cases do establish precedent for the notion that statements about a firm’s use of AI are material facts. In addition, these cases demonstrate the types of situations that may violate the general prohibitions and other more technical aspects of the SEC’s Advertising Rule. Finally, this is the second case to highlight the improper use of hedge clauses in a retail setting as a potential enforcement matter.
Reviews of Marketing Materials as Pretext: While the SEC’s rules do not require all marketing materials to be reviewed, both of the matters in question highlight the lack of effective marketing material reviews as a possible cause of the underlying compliance violations. The first manager did not implement any policies requiring marketing reviews while the second manager had review policies that it did not follow.

¹ In the Matter of Delphia, Administrative Proceeding File No. 3-21894; In the Matter of Global Predictions Inc, Administrative Proceeding File No. 3-21895