On March 18, 2024 the US Securities and Exchange Commission
(“SEC” or the “Commission”) announced that it
had settled charges in separate actions against two investment
advisers, Delphia (USA) Inc.
(“Delphia”) and Global Predictions,
Inc. (“Global Predictions”) for making false or
misleading statements regarding their use of artificial
intelligence (“AI”). These enforcement actions are the
SEC’s first explicit AI-related actions against investment
advisers.
The SEC charged both advisers with violations of Section 206(2)
and Section 206(4) of the Investment Advisers Act of 1940 (the
“Advisers Act”). In addition, the Commission charged both
advisers with violations of Investment Advisers Act Rule 206(4)-1
(the “Marketing Rule”), for disseminating advertisements
that included untrue statements of material fact or otherwise
omitted material facts necessary to make the advertisements not
misleading under the circumstances.1 The Commission also
charged the advisers with violations of Advisers Act Rule 206(4)-7
(the “Compliance Rule”), for failure to implement written
policies and procedures reasonably designed to prevent the Advisers
Act and Marketing Rule violations. The SEC ordered Delphia and
Global Predictions to pay civil penalties of $225,000 and $175,000,
respectively.
The interest of the SEC and its staff in AI, or “predictive
data analytics,” has been growing for some time. In late 2023,
the Commission began an AI sweep, requesting information from
various investment advisers on AI-related topics. These inquiries
correlated with the Commission’s 2024 Examination
Priorities report, which states that a main focus will be on
emerging financial technology, including AI. In addition, on July
26, 2023, the SEC proposed an Advisers Act
rule that would specifically require SEC-registered investment
advisers to eliminate or neutralize the effect of conflicts of
interest associated with their use of covered predictive data
analytics in providing advisory services to clients, and adopt
written compliance policies and procedures regarding the same. To
date, that rule has not been adopted. The enforcement actions
against Delphia and Global Predictions, however, show that the
Commission is ready, willing and able to use current federal
securities laws to address at least certain of the regulator’s
concerns regarding the use of AI by investment advisers.
Ultimately, the SEC’s concerns are nothing new, although the
technology is. In addition to consistent regulatory interest in
conflicts of interest, the SEC and its staff historically have
scrutinized whether investment advisers are managing client assets
in a manner consistent with their advertisements and disclosures,
particularly where the claimed strategies are new and otherwise
trendy. Notable examples in recent years include heightened
regulatory interest—including enforcement actions—in
investment advisers’ claims regarding ESG (including so-called
“green-washing”), “robo,” quantitative and
similar algorithmic-based strategies and services.2 In
each case, the bottom line for the Commission and its staff was
that the advisers’ statements to investors and clients about
their strategies were not consistent with the manner in which the
advisers were actually managing their assets. Whether it is
AI-washing, green-washing or quant-washing, the regulatory message
is the same—say what you do and do what you say, as further
demonstrated by these two recent enforcement actions, which are
summarized below.
Delphia
Delphia is a Toronto-based investment adviser that offers
robo-adviser portfolio management services to retail
clients. In August 2019, Delphia began claiming in its Form
ADV, Part 2A brochure, on its website and in a press release that
it used AI (including machine learning) in its advisory algorithms
and that it also collected client data and incorporated it into
these algorithms. For example, the press release stated, among
other things, that Delphia used machine learning to “analyze
the collective data shared by its members to make intelligent
investment decisions.” In another example, from November 2020
to August 2023, Delphia’s website stated that the adviser puts
client data to work to make its AI smarter, “so it can predict
which companies and trends are about to make it big and invest in
them before anyone else.”
During an examination, the SEC’s Division of Examinations
“discovered” the various statements described, and in
response to SEC staff questions, Delphia admitted to the staff in
July 2021 that it had not used any client data, and that it did not
have an algorithm to use client data. Shortly thereafter, in
August, Delphia updated its brochure to reflect that it did not in
fact use client data to make investment decisions.3
Delphia also informed the staff in October 2021 that it would
review all current marketing and regulatory disclosure documents,
and take action to correct any false and misleading statements
regarding the use of client data. Delphia also created the role of
Compliance Manager for its compliance team and retained two outside
compliance consulting firms. Additionally, in communications with
certain investors, Delphia noted that client data was not being
used as a data source for its algorithms because it had not yet
collected enough client data to provide meaningful
insights.
Nonetheless, through August 2023, Delphia continued to make
statements to investors in emails and press releases claiming to
incorporate client data into its algorithms to make investment
decisions. For example, a November 2022 press release stated that
“Delphia’s proprietary algorithms combine the data
invested by its members with commercially available data, to make
predictions across thousands of publicly traded companies up to two
years into the future.” In emails to new clients during 2021
and 2022, Delphia stated that the clients’ data was
“helping [Delphia] train [its] algorithm for pursuing ever
better returns” and that Delphia “will pool your data
with everyone else’s to power our algorithm.” In addition,
a 2022 social media post (which remained until 2023) said that
Delphia’s “proprietary algorithm 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.” While Delphia did collect some client
data intermittently between 2019 and 2023, it never incorporated it
into any AI or machine learning technology or otherwise used that
data in any way as inputs into its investing algorithms. The SEC
found these additional statements, like the ones noted in the 2021
examination, to be false and misleading because Delphia simply did
not possess the capabilities it claimed to have.
In terms of compliance program failures, the SEC said that while
Delphia did have “some” advertising policies and
procedures, it lacked policies and procedures relating to social
media. Further, Delphia had a number of employees and consultants
involved in their advertising review-and-approval process. Delphia
failed to lay out a clear advertising review and approval process,
either in its policies and procedures or otherwise, that would
enable its personnel and consultants to understand their respective
roles and responsibilities in that process. The SEC thought that
this was the reason that, even though Delphia corrected certain
false and misleading statements regarding the use of client data
after the SEC examination, Delphia continued to misrepresent its
use of client data in other communications.
The SEC imposed a civil penalty of $225,000, noting
Delphia’s cooperation in this matter. In addition to
Delphia’s AI and data usage claims, the regulatory interest of
the SEC and its staff in Delphia was likely also heightened
because, among other things, Delphia’s clients were retail
clients, the advisory service was a “robo”
service,4 and Delphia made promises to the examination
staff that were not fulfilled.
Global Predictions5
Similar to Delphia, Global Predictions, a San Francisco-based
internet investment adviser, offered advisory services to retail
clients through an interactive online platform, which makes
investment allocation recommendations to clients. The adviser
claimed that the platform made non-discretionary recommendations
utilizing algorithms. The platform allows clients to interface with
a chatbot that communicates investment recommendations but the
chatbot does not itself generate the recommendations.
From its date of registration on August 14, 2023, Global
Predictions disseminated advertisements claiming use of AI
technologies. For example, the adviser stated on its website that
its technology “incorporated [e]xpert AI driven
forecasts,” even though it did not. In client emails and on
social media posts and websites, Global Predictions claimed to be
the “first regulated AI financial advisor,” but could not
produce documents to substantiate this claim.
The SEC imposed a $175,000 civil penalty, and recognized the
adviser’s cooperation as well as the remedial steps it had
taken, including, in relevant part, its removal of violative
advertisements, retention of a compliance consultant to review its
marketing materials, and compliance training undertaken by its
employees. Similar to Delphia, in addition to Global
Predictions’ AI claims, the regulatory interest of the SEC and
its staff in Global Predictions was likely also heightened because,
among other things, its clients were retail clients and the
advisory service at issue was a “robo” advisory
service.
Conclusion
While the Delphia and Global Predictions settlements are
certainly attention-grabbing as the SEC’s first cases on
“AI-washing,” investment advisers may be somewhat
comforted in the understanding that—at least in these
instances—there is no new “rulemaking by
enforcement” at work here, but more simply the tried-and-true
axiom of “say what you do, and do what you say” applied
in a new context.
That said, investment advisers can and should use this as a
reminder—and an opportunity—to review and hone
statements regarding an adviser’s use of technology in the
provision of its advisory services. Advisers are certainly not
immune to broader commercial and economic trends, and while the AI
boom may have more staying power than the blockchain craze from
just a few years ago (or the dot-com boom from longer still),
advisers are subject to stricter “truth in advertising”
obligations than many other market participants. Advisers should
scrutinize marketing materials and other communications that
contain terminology relating to AI (e.g., “machine
learning,” “deep learning,” “neural
networks,” “large language models,” “natural
language processing,” or “generative pre-trained
transformers” (“GPT”)) or the use of quantitative or
algorithmic investment strategies. Further, investment advisers
should take steps to ensure that these communications accurately
describe the adviser’s actual investment strategy and related
process, and appropriately disclose conflicts of interest and
material risks associated with the adviser’s use of that
technology (particularly where third-party vendors/licensors are
involved).
As with almost anything related to marketing (or anything else
an investment adviser does in a fiduciary capacity), in order for
compliance and legal personnel to implement reasonably designed
policies, procedures and internal controls—and to effectively
and substantively review the material and identify and address
risks and conflicts—they must truly understand both the
technology and the manner in which the adviser uses it. Thus, it is
crucial that compliance and legal personnel become educated on both
of these topics, and continue that education as technology, and the
adviser’s use of it, changes over time.6
Footnotes
1. See also SEC Sweep
into Marketing Rule Violations Results in Charges Against Nine
Investment Advisers; SEC Charges
Five Investment Advisers for Marketing Rule Violations; and US
SEC Brings First “Marketing Rule” Action: A Return To
Rulemaking By Enforcement?.
2. See, e.g., 2011 Quant Adviser
Enforcement Action, 2018 Quant Related
Enforcement Action, 2023 ESG
Enforcement Action, 2022 Robo-Adviser
Enforcement Action, SEC Charges
Robo-Adviser with Misleading Clients, February 2017 Guidance
Update,
Investor Bulletin: Robo-Advisers, and
Observations from Examinations of Advisers that Provide Electronic
Investment Advice.
3. However, as the SEC noted, Delphia did
not identify the new disclosures in its summary of material changes
section of the brochure even though the change related to a core
part of its retail advisory program.
4. See also footnote 2 above.
5. Although this discussion focuses on AI
matters, the SEC’s statements in this enforcement action
regarding the Marketing Rule, as well as regarding certain terms
and conditions that the adviser had included in its investment
advisory contracts with retail investors, are very instructive.
Regarding marketing for example, the adviser represented on its
public website that it offered tax-loss harvesting services that
could save users “thousands of dollars,” when it did not
in fact offer any tax-loss harvesting services; on its public
website and in a press release, the adviser claimed that it had
more than $6 billion of assets on its platform, although it does
not have or report any regulatory assets under management on its
Form ADV; included hypothetical performance on its public website
(rather than to a particular intended audience) without providing
any disclosures along those lines (see also footnote 4 above); and
included testimonials on its public website without disclosing
material conflicts of interest (e.g., two persons giving
testimonials had outside business relationships with the
adviser’s Chief Executive Officer, one of which had previously
been retained by the adviser as an independent contractor, and a
third person giving a testimonial was a close family member of the
Chief Executive Officer). The retail client advisory contracts
permitted the adviser to change the terms of the contract
unilaterally without advance notice to clients, and required
clients to periodically visit the adviser’s website and review
the contract themselves for any changes (in fact, after the adviser
changed its contract, it sent a form email to clients informing
them that the contract had changed, with a link to the updated
terms of service, but without identifying what changes had been
made or providing a mechanism for clients to provide or withhold
informed consent to the change prior to it becoming effective);
included statements that were inconsistent with other
representations (e.g., the contract inaccurately stated that the
adviser “do[es] not give financial or investment advice or
advocate the purchase or sale of any security or
investment.”); and included a “hedge clause” that
purported to relieve the adviser from liability for “any claim
or demand”(regardless of the theory of liability) and cause
the client to broadly indemnify and hold the adviser harmless from
any third-party claim or demand arising out of the client’s use
of the adviser’s services (see also Commission
Interpretation Regarding Standard of Conduct for Investment
Advisers).
6.See also a recent speech, “Remarks
at Program on Corporate Compliance and Enforcement Spring
Conference 2024,” from the SEC’s Director of the
Division of Enforcement, echoing many of the above sentiments.
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