The Problem with “Whitewashing” Investment Processes: Lessons from SEC Enforcement 

In a recent enforcement action, the SEC charged Inspire Investing, LLC for falsely representing its investment processes as automated and data-driven when, in reality, they were largely manual and inconsistent. This case is part of a growing trend where advisers exaggerate the sophistication of their operations, especially by claiming the use of artificial intelligence (AI) or other automated systems. However, the issue of 'whitewashing' extends beyond AI and can apply to any process that an adviser discloses but does not actually implement as claimed.

The Case Against Inspire Investing

Inspire Investing marketed its approach as a scientifically rigorous, rules-based methodology , particularly in its 'Biblically Responsible Investing' strategy. Inspire claimed to rely on data science and proprietary algorithms to analyze companies and ensure investments aligned with specific values. However, as the SEC found, Inspire's actual process was largely manual , relying on a small team to conduct research by cross-referencing company names with lists of organizations associated with specific business practices. This process was not automated or data-driven and was inconsistent, allowing investments in companies that should have been excluded based on Inspire's stated criteria.

In short, Inspire promised an investment process grounded in objectivity and data science but failed to deliver on those promises. The SEC cited this as a violation of both the Investment Advisers Act and the Investment Company Act and imposed penalties on the firm.

The Rise of AI Whitewashing in Investment Management

Inspire's case is far from unique. In the rush to capitalize on trends like AI and automation, many investment advisers are tempted to overstate their use of these technologies. Firms may claim their strategies are powered by sophisticated algorithms when, in fact, much of the process is manual or semi-automated. This kind of 'whitewashing' has profound implications.

Why This Matters:

1. Misleading Investors : Investors make decisions based on disclosed strategies. When those strategies are not implemented as described, they can mislead clients and undermine trust in the market.
2. Regulatory Risk : The SEC has clarified that it will enforce compliance where firms misrepresent their processes, mainly when those representations involve AI or automation that is not fully integrated.
3. Operational Gaps : Falsely claiming automation can mask significant operational risks. Manual processes are more prone to error, leading to inconsistent application of investment criteria and potentially damaging portfolios.

The Broader Issue: Disclosing 'Ideal' vs. Current State

The problem of whitewashing extends beyond AI. Many advisers present an ideal version of their processes rather than the reality. They might disclose a future state they hope to achieve—such as full automation or AI-driven decision-making—but fail to clarify that these capabilities are not yet fully implemented.

The SEC's message is clear: advisers must disclose their current investment processes, not their aspirational goals. Advisers should avoid making promises about their methods unless they are in place and operational today. Misleading investors, even unintentionally, about the true nature of a firm's operations can lead to significant penalties, as seen in Inspire's case.

Best Practices for Advisers

To avoid similar enforcement actions, advisers should adhere to the following best practices:

1. Accurately Represent Your Processes : Only describe the processes that are currently in place. If automation or AI is in development but not fully implemented, this should be made clear to investors.
2. Regularly Review and Update Disclosures : Ensure that all marketing materials, Form ADV brochures, and prospectuses accurately reflect the current state of operations. If any part of the process changes, update your disclosures immediately .
3. Adopt Robust Compliance Policies : Inconsistent or manual processes should have strong oversight and compliance policies to implement them correctly. Inspire's failure to have such policies was critical to the SEC's action.
4. Train Staff on Disclosure Obligations : Your team, especially those involved in marketing and investor communications, should understand the legal implications of misleading disclosures.

Conclusion

The Inspire case highlights a crucial lesson for investment advisers: disclosures must reflect reality, not aspirations. Whether you claim to use AI, automation, or other advanced systems, ensure these processes are fully operational before marketing them to investors. The SEC's enforcement actions remind advisers that they must be transparent about their methodologies and that misrepresenting them can lead to significant regulatory and reputational damage.

For investment advisers, accuracy in disclosures isn't just good practice— it's the law.

If your firm needs help reviewing its compliance policies or updating its disclosures to reflect current operations, consulting with legal professionals is crucial to avoid the fate that befell Inspire. For more information, contact FinTech Law | Securities Lawyers (fintechlegal.io).