How to Avoid "AI Washing" and SEC Scrutiny

The SEC has a new target: firms that exaggerate their AI capabilities. In March 2024, the Commission charged two investment advisers with making false and misleading statements about their use of AI. The message is clear: if you claim to use AI, you better be able to prove it.

What Is "AI Washing"?

AI washing is the practice of overstating or misrepresenting your firm's use of artificial intelligence to attract clients or appear more sophisticated than you actually are.

Common examples include:

• Claiming to use "AI-powered portfolio management" when you're really just using basic algorithms
• Marketing "machine learning-driven insights" that are actually manual analyst reports
• Touting "proprietary AI technology" that's just a third-party tool with your branding
• Advertising "AI-enhanced due diligence" when AI plays a minimal or non-existent role

The SEC's enforcement actions make one thing clear: marketing hype without substance is fraud.

The SEC's 2024 Enforcement Actions

In March 2024, the SEC charged Delphia (USA) Inc. and Global Predictions Inc. with making false and misleading claims about their AI capabilities.

What They Did Wrong

Delphia:

• Claimed to use AI and machine learning to manage over $20 million in client assets
• Reality: The AI features were not operational for the investment strategies they marketed
• Penalty: $225,000 settlement

Global Predictions:

• Advertised an "AI-Powered Equity ETF" as the "first regulated AI financial advisor"
• Reality: The AI tools were not used as described in marketing materials
• Penalty: $175,000 settlement

The SEC's Message

SEC Division of Enforcement Director Gurbir S. Grewal stated:

"We've observed a growing trend of firms using AI-related terms to describe their services in ways that may be false or misleading... As we've said before, using buzzwords to attract investors is a violation of the federal securities laws."

Translation: If you say you use AI, you better actually use AI—and be able to prove it.

Common AI Washing Red Flags

The SEC is watching for these warning signs:

1. Vague or Exaggerated Claims

Red Flag:

• "Our AI-powered platform delivers superior returns"
• "Proprietary machine learning algorithms optimize your portfolio"
• "AI-driven insights give you an edge"

Why It's Risky: These claims are vague, unsubstantiated, and suggest capabilities you may not have.

Better Approach: Be specific about what AI actually does in your process and avoid performance claims you can't back up.

2. Marketing That Doesn't Match Reality

Red Flag: Your website says "AI-powered portfolio management," but your actual process involves a human analyst using Excel and a third-party screening tool.

Why It's Risky: This is misrepresentation. If a regulator or client asks you to demonstrate your AI capabilities and you can't, you're exposed.

Better Approach: Only market AI features that are actually operational and material to your process.

3. Using "AI" as a Catchall Term

Red Flag: Calling every automated process "AI"—from basic if/then rules to simple data sorting.

Why It's Risky: Not every algorithm is AI. The SEC knows the difference, and they expect you to as well.

Better Approach: Use accurate terminology. If it's automation, call it automation. If it's AI, be prepared to explain how it qualifies.

4. No Documentation or Oversight

Red Flag: You claim to use AI but have no written policies, no vendor due diligence, and no oversight process.

Why It's Risky: If you can't document how AI is used, how it's monitored, and who's responsible for it, your claim isn't credible.

Better Approach: Treat AI like any other material business process—document it, oversee it, and be ready to explain it.

How to Use AI Claims Responsibly

1. Be Specific and Accurate

Instead of vague claims, describe exactly what AI does in your process.

Weak: "We use AI to enhance portfolio management."

Strong: "We use natural language processing to analyze earnings call transcripts and identify sentiment trends that inform our research process."

2. Distinguish Between AI and Automation

Not every automated process is AI. Be honest about what you're using.

Automation: Rule-based systems, scheduled tasks, basic algorithms
AI/Machine Learning: Systems that learn from data, adapt over time, or make predictions

Example:

• Automated rebalancing based on fixed thresholds = automation
• A model that learns from market data to predict optimal rebalancing timing = AI

3. Disclose Limitations

If you use AI, be transparent about what it can and cannot do.

Example: "Our AI tool analyzes historical market data to identify patterns. It does not predict future performance, and all recommendations are reviewed by our investment team before implementation."

4. Document Everything

Create a paper trail that proves your AI claims:

• Vendor contracts and due diligence records
• Internal policies on AI use
• Training materials for staff
• Audit logs showing AI tool usage
• Examples of AI-generated output and human review

5. Avoid Performance Implications

Don't suggest that AI gives you a performance edge unless you have data to back it up—and even then, be cautious.

Risky: "Our AI-powered strategy outperforms the market."

Safer: "Our investment process incorporates AI-driven data analysis to support our research efforts."

What to Do If You've Over-Claimed

If you realize your marketing materials exaggerate your AI capabilities, act quickly:

Step 1: Conduct an Internal Audit

Review all client-facing materials (website, pitch decks, Form ADV, social media) and identify any AI-related claims that are inaccurate or unsupported.

Step 2: Correct the Record

Update your materials to reflect reality. If you've made claims to clients that were inaccurate, consider proactive disclosure to avoid future liability.

Step 3: Strengthen Your Compliance Framework

Implement policies to ensure all marketing claims are reviewed and substantiated before publication.

Step 4: Consult Legal Counsel

If you're concerned about potential exposure, consult with securities counsel to assess your risk and determine next steps.

The Bottom Line

The SEC is serious about AI washing. They're not trying to discourage innovation—they're trying to prevent fraud. If you use AI, say so accurately. If you don't, don't pretend you do.

Key Takeaway: Honesty is your best defense. Use AI claims that are specific, accurate, and defensible. Avoid hype, avoid exaggeration, and avoid suggesting capabilities you don't have. The SEC is watching, and the penalties for AI washing are real.

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Next Steps:

1. Audit your marketing materials for AI-related claims
2. Verify that every AI claim is accurate and substantiated
3. Update your compliance manual to address AI marketing risks
4. Train your team on responsible AI communication

Need help ensuring your AI claims are compliant? Book a free 30-minute assessment call to discuss your firm's marketing and compliance posture.