SEC Enforcement Director Addresses PCCE Conference on AI Risks and Proactive Compliance

The Perfect Storm of Risk: A Recurring Theme in Financial Scandals

For a decade, the PCA conference has convened academics, regulators, and industry professionals to discuss important issues relating to compliance, corporate misconduct, and the pursuit of justice. As we celebrate this milestone, it is worth reflecting on the lessons learned and leveraging these lessons to effect better compliance in the future.

One of the recurring themes found in many of the financial scandals of the past decade is that they often share a combination of factors that create a "perfect storm" of risk. This includes situations where there is an charismatic leader, strong investor interest, noncompliance, weak controls, or under-empowered gatekeepers. These scandals have resulted in significant investor harm and underscore the importance of compliance and good corporate governance.

Recently, these perfect storms have ravaged the crypto markets with the collapses of FTX and Terraform, where the principals were sentenced to 25 years in prison and found liable for misleading investors, respectively. These events and others highlight the danger of individuals or corporations attempting to capitalize on FOMO, or the "fear of missing out," around new technologies or offerings, and the resulting risk for regulators and compliance professionals.

Looking ahead, a potential perfect storm of risk is brewing in the AI space, where there is immense investor and market interest. AI is being rapidly adopted and marketed by companies, and investors are incorporating AI into their investment strategies and using it to analyze and recommend investments. As a result, there is a risk of elevated investor harm from noncompliance with securities laws, and it is important to address these potential risks.

AI Risks and Investor Protection

As the SEC has investigated and addressed misconduct relating to ESG and other investment strategies, it has also prosecuted cases involving false or misleading statements about AI integration. Last month, the SEC announced settled charges against two registered investment advisers for making false and misleading statements about their purported use of AI.

The advice included making false statements about their AI capabilities and the use of AI in their investment processes. This "AI-washing" is a violation of federal securities laws and puts investors at risk. The SEC's enforcement actions in this area put the industry on notice and should encourage companies to ensure that any representations regarding AI capabilities are not materially false or misleading.

Proactive Compliance for AI Disclosures

Proactive compliance requires education, engagement, and execution. Companies and industry professionals should educate themselves about emerging and heightened AI risk areas, engage with personnel inside the company's different business units, and execute any necessary updates to policies and procedures and internal controls. It is not enough to generate an AI policy with a AI tool; companies must ensure that their representations regarding AI are not materially false or misleading and take reasonable steps to implement effective compliance measures.

Finally, the SEC will continue to prioritize enforcement of AI-related disclosures and liability, with a focus on protecting investors while harnessing the benefits of AI. By learning the lessons of prior financial scandals and working together to implement proactive compliance measures, we can avoid the perfect storm of risk and foster the beneficial development and use of AI.

Read more