A Wave of AI ‘Washing’ or ‘Drift’ Litigation May Be Coming

Are your clients at risk for AI washing or AI drift litigation? It seems common practice for tech-enabled firms to almost boast about their use of new AI-based technologies in their day-to-day operations. If those boasts turn out to be less than truthful, or if the AI drifts or suffers from AI hallucinations and generates incorrect results then investors, customers, and regulators may take action. This is an emerging threat, but Costero helps clients prepare.

What Is AI Washing?

AI washing describes the practice of overstating AI capabilities, whether through exaggeration, misleading statements, or outright lies. Since many people are impressed with new AI capabilities, companies want to look like they’re using cutting-edge tools to attract customers and investors. However, if the claims prove to be deceptive, companies may be held accountable for misleading customers and investors.

What Is AI Drift?

AI model drift occurs when the real-world data model encounters deviates from the data it was trained to recognize or handle.

AI hallucinations are incorrect or misleading results that AI Models generate. These errors can be caused by a variety of factors, including insufficient training data, incorrect assumptions made by the model, or biases in the data used to train the model.

The First AI Washing Fines

The U.S. Securities and Exchange Commission (SEC) has settled charges against two investment advisers over AI washing.

According to the SEC announcement, Toronto-based Delphia Inc. was accused of making false and misleading statements in its SEC filings, in a press release, and on the company website regarding its use of AI and machine learning. Delphia claimed to be using collective data to power an AI tool that predicted which companies and trends were about to become big. However, the SEC found that Delphia did not have these capabilities. The SEC also found that Delphia was violating the Marketing Rule and ordered the company to pay $225,000.

The announcement also mentions San Francisco-based Global Predictions, which was accused of making false and misleading statements on its website and social media about its use of AI. Global Predictions claimed to be the first regulated AI financial advisor and said its platform provided AI-driven forecasts – claims the SEC found to be false. The SEC also found that Global Predictions violated the Marketing Rule by falsely claiming that it offered tax-loss harvesting services and by including an impermissible liability hedge clause. It ordered Global Predictions to pay $175,000.

Lastly, the SEC has issued an investor alert on AI and investment fraud. This warns investors that some unregistered and unlicensed investment platforms are claiming to use AI that guarantees good returns, when, in fact, they are running investment schemes.

The EU AI Act of Jan 2024

This new piece of EU legislation called the AI Act imposes significant sanctions for non-compliance, which can include fines of up to 7% of global annual turnover per violation for the most serious infringements – or up to 35 million euros, whichever amount is higher.

More Action May Be Coming

According to SEC Chair Gary Gensler, AI washing by financial intermediaries or companies raising money from the public may violate securities laws. “Public companies should make sure they have a reasonable basis for the claims they make and yes, the particular risks they face about their AI use, and investors should be told that basis,” he said in a statement on AI washing.

Consider the SEC actions against Delphia and Global Predictions to be a warning. The hype over AI has exploded in recent years. However, companies that make unfounded claims to leverage this excitement may be hit with regulatory action and lawsuits, as has already happened with greenwashing. Even companies that aren’t deliberately deceiving customers and investors may face accusations of AI washing if they exaggerate their claims and fail to disclose risks.

How Can Costero Help Their Clients?

Whenever new risks emerge, brokers can help their clients in two ways:

• Raising awareness. Although the recent SEC actions against AI washing have received considerable attention, some business leaders may be unaware of what’s happening. Brokers should share information on all AI trends and encourage clients to assess whether they can back up their claims regarding AI with solid facts. The securities actions are most relevant to financial advisors and companies raising money from the public. However, since other companies could face lawsuits from customers who feel deceived by AI claims, they should also consider their exposures.
• Discuss insurance coverage. Although preventing claims is always ideal, it’s still important to obtain insurance in case a claim does occur. This is important even when companies are confident, they are not violating any rules. If AI washing litigation surges, some companies may face unfounded claims. Insurance will help them defend themselves against such claims.

Costero has access to specifically tailored AI insurance products offered globally that can provide first and third-party liability cover against AI-related claims including AI washing, AI drift, and a warranty product for purchases of AI software.

To access these creative insurance solutions, please contact Jamie Webb at jwebb@costerobrokers.com or Contact us.