SEC Cracks Down on AI Washing: What Investment Managers Need to Know

The SEC recently issued significant fines, cracking down on what it terms 'AI washing' – misleading claims by investment managers about their artificial intelligence usage. The regulator fined two investment advisors $400k for these deceptive practices, signaling heightened scrutiny on the role of AI in investment management.

The SEC's Director of Enforcement stated, “As today’s enforcement actions make clear to the investment industry – if you claim to use AI in your investment processes, you need to ensure that your representations are not false or misleading.” This strong message sets a precedent for future SEC enforcement regarding AI claims.

Key Enforcement Cases

Based on the press release, the merits of both cases appear straightforward.

Delphia claimed it used "AI and machine learning that incorporated client data in its investment process." It also stated its AI would become "smarter so it can predict which companies and trends are about to make it big and invest in them before everyone else." Such phrases, implying guaranteed success or an unfair advantage, are often red flags for SEC enforcement.

Global Predictions, conversely, faced issues stemming from multiple failings. It asserted itself as the "first regulated AI financial advisor." Using "regulated" to imply official approval from the regulator is a significant concern. The order also cited other non-AI misrepresentations.

Broader Implications for Investment Management

The larger question is the impact on the investment industry. Does the SEC intend to police every AI usage claim in investment management? Will it define what constitutes AI?

Governments globally view AI as an area ripe for new regulation. Both the US and the EU have recently passed AI legislation. The EU proudly proclaimed its achievement of creating "the first comprehensive regulation on AI by a major regulator anywhere in the world." Regardless of whether this warrants boasting, rule-making for the industry has begun.

So far, most AI regulation targets technology companies that build foundational models, such as Google, Amazon, and Microsoft. This regulation focuses on data usage, privacy protection, and generally adopts an inclusive approach.

The SEC's actions, however, differ. They target AI applications rather than the underlying models. They implicitly initiate a discussion on what qualifies as AI in investment management. Is it acceptable for an investment advisor claiming AI use to employ a regression model? An older neural network? What model parameters are necessary for something to be considered AI? This 'AI washing' crackdown forces clarity.

These actions might be a warning shot, indicating the SEC is watching. Alternatively, it could mark the beginning of a new era of AI regulation in investment management. This era may finally provide answers regarding whether a regression model can be classified as AI.