Watch out "AI Washing" in Finance Investment Scam

In 1957, the Tony Award-winning musical The Music Man introduced audiences to the charismatic con artist, Professor Harold Hill, who dupes the town of River City, Iowa, into purchasing musical instruments with promises of forming a children’s band. Decades later, the essence of this story has unsettling similarities to developments in financial markets, especially when new technologies, such as artificial intelligence (AI), create a buzz.

Just like Hill’s grand promises, AI has generated immense excitement, leading to exaggerated claims in finance. While AI undoubtedly holds transformative potential, it also poses risks, especially when firms misuse the hype to mislead investors. This practice of overinflating AI’s capabilities has even led to the coining of a term, "AI washing," akin to greenwashing in environmental claims. 

The U.S. Securities and Exchange Commission (SEC) has observed a growing trend of public companies and investment advisors making AI-related disclosures. But the SEC stresses the importance of sticking to the fundamentals: any claims, especially those related to AI, must be truthful and backed by a reasonable basis. Investors have the right to accurate information, grounded in fair disclosure, to make informed decisions.

When companies tout the use of AI, it is essential for them to clearly define what they mean by AI, how it is being implemented, and whether it is developed internally or sourced from third parties. Misrepresentations, whether intentional or not, can mislead investors and raise significant legal issues. For instance, if AI plays a crucial role in a company’s operations or earnings calls, companies should consider whether this information is "material" under securities law, necessitating disclosure.

Investment advisors and broker-dealers, too, must avoid claiming to utilize AI when they do not, or misleading the public about the way AI is being applied. This kind of "AI washing" not only damages trust but may also lead to violations of the law.

Just as River City’s residents found themselves at risk of being duped by Professor Hill’s musical promises, investors today must be vigilant. The SEC warns that if companies and advisors engage in AI washing, they will face legal repercussions, emphasizing that truthful, clear disclosures are paramount in a technology-driven market.

As the SEC Chair quipped, echoing The Music Man: “If you’re AI washing, you’ve got trouble.”