Category Archives: Securities Fraud

AI for IAs: How Artificial Intelligence Will Impact Investment Advisers

by Michael McDonald

Photo of the author

Photo courtesy of Davis Wright Tremaine LLP

The use of artificial intelligence and machine learning technology solutions (“AI”) is becoming increasingly common in all industries, including the registered investment adviser (“RIA”) space. A recent survey by AI platform Totumai and market research firm 8 Acre Perspective found that 12% of RIAs currently use AI technology in their businesses and 48% plan to use the technology at some point, which means there is a realistic expectation that 60% of RIAs will be using AI in the near future. Among other use-cases, AI has the potential to be used by RIAs for portfolio management, customer service, compliance, investor communications, and fraud detection. While regulators are not likely to prohibit the use of AI in the industry, they are likely to closely monitor and regulate specific applications and use cases which is why it is essential for RIAs to understand these emerging rules and regulatory frameworks so they can appropriately leverage the many benefits of AI while ensuring their business remains compliant with these new rules of the road. DWT has recently launched a series of webinars entitled, “AI Across All Industries” available here, that has gone in-depth on the legal issues surrounding the use of AI.

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Preparing for AI Whistleblowers

by Charu A. Chandrasekhar, Avi Gesser, Arian M. June, Michelle Huang, Cooper Yoo, and Sharon Shaji

Photos of the authors

Top row: Charu A. Chandrasekhar, Avi Gesser, and Arian M. June
Bottom row: Michelle Huang, Cooper Yoo, and Sharon Shaji
(Photos courtesy of Debevoise & Plimpton LLP)

As artificial intelligence (“AI”) use and capabilities surge, a new risk is emerging for companies: AI whistleblowers. Both increased regulatory scrutiny over AI use and record-breaking whistleblower activity has set the stage for an escalation of AI whistleblower-related enforcement. As we’ve previously written and spoken about, the risk of AI whistleblowers is rising as whistleblower protections and awards expand, internal company disputes over cybersecurity and AI increase due to a lack of clear regulatory guidance, and public skepticism mounts over the ability of companies to offer consumer protections against cybersecurity and AI risks.

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Supreme Court Holds That “Pure Omissions” Are Not Actionable Under Rule 10b-5(b)

by Elliot Greenfield, Matthew E. Kaplan, Maeve O’Connor, Benjamin R. Pedersen, Jonathan R. Tuttle, Anna Moody, Brandon Fetzer, and Mark D. Flinn

Top left to right: Elliot Greenfield, Matthew E. Kaplan, Maeve O’Connor, and Benjamin R. Pedersen.
Bottom left to right: Jonathan R. Tuttle, Anna Moody, Brandon Fetzer, and Mark D. Flinn. (Photos courtesy of Debevoise & Plimpton LLP).

On April 12, 2024, in a highly anticipated decision, the Supreme Court held in Macquarie Infrastructure Corp. v. Moab Partners, L.P.[1] that pure omissions are not actionable in private litigation under Rule 10b-5(b). Resolving a circuit split, the Court held that Rule 10b-5(b) does not support a “pure omissions” theory based on an alleged failure to disclose material information required by Item 303 of SEC Regulation S-K (Management’s discussion and analysis of financial condition and results of operations, or MD&A). Instead, a “failure to disclose information required by [MD&A] can support a Rule 10b-5(b) claim only if the omission renders affirmative statements made misleading.”[2] While the decision arose in the context of Item 303, which requires disclosure of “known trends and uncertainties” that have had or are “reasonably likely” to have a material impact on net sales, revenues or income from continuing operations,[3] the decision stands for the broader principle that Rule 10b-5(b) does not support pure omissions theories based on alleged violation of any disclosure requirement. Such claims remain viable, however, under Section 11 of the Securities Act of 1933. This ruling provides welcome clarity to issuers and eliminates the risk of pure-omission claims under Rule 10b-5(b) based on the judgment-based requirements of MD&A.

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Implications of the SEC’s “Shadow Trading” Verdict

by John F. Savarese, Wayne M. Carlin, and David B. Anders

Photos of the authors

From left to right: John F. Savarese, Wayne M. Carlin, and David B. Anders (photos courtesy of Wachtell, Lipton, Rosen & Katz).

Last week, a jury in San Francisco returned a verdict in SEC v. Panuwat, finding that a corporate executive engaged in insider trading when he learned about an impending acquisition of his employer and then traded in the securities of an unrelated company in the same industry. The case has widely been described as “novel” but, in bringing this case, the SEC did not seek to extend existing law. Panuwat simply applied well-established principles of insider trading law to a new fact pattern. Yet in doing so, this action may well have implications for corporate trading policies. 

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AI Enforcement Starts with Washing: The SEC Charges its First AI Fraud Cases

by Andrew J. Ceresney, Charu A. Chandrasekhar, Avi Gesser, Arian M. June, Robert B. Kaplan, Julie M. Riewe, Jeff Robins, and Kristin A. Snyder

Photos of authors

Top (left to right): Andrew J. Ceresney, Charu A. Chandrasekhar, Avi Gesser, and Arian M. June
Bottom (left to right): Robert B. Kaplan, Julie M. Riewe, Jeff Robins, and Kristin A. Snyder (photos courtesy of Debevoise & Plimpton LLP)

On March 18, 2024, the U.S. Securities and Exchange Commission (“SEC”) announced settled charges against two investment advisers, Delphia (USA) Inc. (“Delphia”) and Global Predictions Inc. (“Global Predictions”) for making false and misleading statements about their alleged use of artificial intelligence (“AI”) in connection with providing investment advice. These settlements are the SEC’s first-ever cases charging violations of the antifraud provisions of the federal securities laws in connection with AI disclosures, and also include the first settled charges involving AI in connection with the Marketing and Compliance Rules under the Investment Advisers Act of 1940 (“Advisers Act”). The matters reflect Chair Gensler’s determination to target “AI washing”—securities fraud in connection with AI disclosures under existing provisions of the federal securities laws—and underscore that public companies, investment advisers and broker-dealers will face rapidly increasing scrutiny from the SEC in connection with their AI disclosures, policies and procedures. We have previously discussed Chair Gensler’s scrutiny of AI washing and AI disclosure risk in Form ADV Part 2A filings. In this client alert, we discuss the charges and AI disclosure and compliance takeaways.

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Recent Regulatory Announcements Confirm Increased Scrutiny of “AI-Washing”

by Tami Stark, Courtney Hague Andrews, Maria Beguiristain, Joel M. Cohen, Daniel Levin, Darryl Lew, and Marietou Diouf

Photos of authors

Top (left to right): Tami Stark, Courtney Hague Andrews, Maria Beguiristain, and Joel M. Cohen
Bottom (left to right): Daniel Levin, Darryl Lew, and Marietou Diouf (Photos courtesy of White & Case LLP)

In December 2023, we published an alert concerning US Securities and Exchange Commission (“SEC”) Chair Gary Gensler’s warning to public companies against “AI washing” – that is, making unfounded claims regarding artificial intelligence (“AI”) capabilities.[1] It is no surprise that since then regulators and the US Department of Justice (“DOJ”) have repeated this threat and the SEC publicized an AI related enforcement action that typically would not get such emphasis.

In January 2024, the SEC’s Office of Investor Education and Advocacy issued a joint alert with the North American Securities Administrators Association and the Financial Industry Regulatory Authority warning investors of an increase in investment frauds involving the purported use of AI and other emerging technologies.[2] Similarly, the Commodity Futures Trading Commission Office of Customer Education and Outreach issued a customer advisory warning the public against investing in schemes touting “AI-created algorithms” that promise guaranteed or unreasonably high returns.[3]

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AI in the 2024 Proxy Season: Managing Investor and Regulatory Scrutiny

by William Savitt, Mark F. Veblen, Kevin S. Schwartz, Noah B. Yavitz, Carmen X. W. Lu, and Courtney D. Hauck

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Top from left to right: William Savitt, Mark F. Veblen, and Kevin S. Schwartz.
Bottom left to right: Noah B. Yavitz, Carmen X. W. Lu, and Courtney D. Hauck. (Photos courtesy of Wachtell, Lipton, Rosen & Katz)

Corporate disclosures concerning artificial intelligence have increased dramatically in the past year, with Bloomberg reporting that nearly half of S&P 500 companies referenced AI in their most recent annual reports. And some investors are clamoring for even more, using shareholder proposals to press public companies for detailed disclosures concerning AI initiatives, policies, and practices — including, most recently, an Apple shareholder proposal that attracted significant support at a meeting last week. Regulators, meanwhile, have signaled increasing scrutiny of AI-related corporate disclosures, including in a February speech by SEC Chair Gensler cautioning against “AI washing” — the practice of overstating or misstating corporate AI activity. For the 2024 proxy season and beyond, public companies will need to balance the competing demands of regulators and investors, in order to craft effective, responsive strategies for engaging with their stockholders on AI topics. 

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Paying Criminal Whistleblowers: DOJ Announces A Program to Pay For Tips, and the SFO Is Considering Doing So Too

by Joshua A. Naftalis, Matt Getz, and Tracey Dovaston

From left to right: Joshua A. Naftalis, Matt Getz, and Tracey Dovaston. (Photos courtesy of Pallas Partners LLP).

In the past two weeks, the U.S. Department of Justice (DOJ) and the U.K. Serious Fraud Office (SFO) each made announcements about paying financial bounties to whistleblowers.  On March 7, 2024, U.S. Deputy Attorney General Lisa Monaco announced a new DOJ whistleblower program that will compensate individual whistleblowers for reporting corporate or financial misconduct previously unknown to DOJ.  This announcement followed a February 13, 2024 speech by SFO Director Nick Ephgrave, who said that he supported the idea of paying whistleblowers.    

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White-Collar and Regulatory Enforcement: What Mattered in 2023 and What to Expect in 2024

by John F. Savarese, Ralph M. Levene, Wayne M. Carlin, David B. Anders, Sarah K. Eddy, Randall W. Jackson, and Kevin S. Schwartz

Photos of Authors

Top left to right: John F. Savarese, Ralph M. Levene, Wayne M. Carlin, and David B. Anders.
Bottom left to right: Sarah K. Eddy, Randall W. Jackson, and Kevin S. Schwartz. (Photos courtesy of Wachtell, Lipton, Rosen & Katz)

This past year was yet another notable and intensely active one across the entire range of white-collar criminal and regulatory enforcement areas. We heard continued tough talk from law enforcement authorities, especially concerning the government’s desire to bring more enforcement actions against individuals and on the need to keep ramping up corporate fines and penalties. The government largely lived up to its talking points about increasing the numbers of individual prosecutions and proceedings, particularly with respect to senior executives in the cryptoasset industry. But there were some notable stumbles. The most striking example of this was DOJ’s failure to secure convictions in cases where it attempted to extend criminal antitrust enforcement in unprecedented areas, such as no-poach employment agreements and against certain vertical arrangements—neither of which has historically been viewed as involving per se violations of the federal antitrust laws. And, as in years past, many state attorneys general remained active throughout 2023, using broad state consumer-protection statutes to bring blockbuster cases across a wide array of industries, from ridesharing and vaping to opioids and consumer technology offerings.

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Cryptoasset Developments: Observations on the Thawing Crypto Winter

by Kevin S. Schwartz, Rosemary Spaziani, David M. Adlerstein, Samantha M. Altschuler, and Sabina M. Beleuz Neagu

Photos of the authors

Left to right: Kevin S. Schwartz, Rosemary Spaziani, David M. Adlerstein, Samantha M. Altschuler and Sabina M. Beleuz Neagu (Photos courtesy of Wachtell, Lipton, Rosen & Katz)

The U.S. cryptoasset industry just rang in the new year with the watershed SEC approval of the first spot ETFs for a digital asset.  With the approval of the first bitcoin Spot ETFs, making possible a path for millions of Americans to have direct bitcoin exposure in retirement and other traditional investment accounts, it is an appropriate time to reflect on significant recent developments that may shape the crypto industry in the year to come.

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