As Dave noted last week, the SEC continues to pay attention to “AI washing” by public companies. Over on “The D&O Diary,” Kevin LaCroix points out that the plaintiffs’ bar has also been watching. A recent complaint shows how they are scrutinizing statements about AI opportunities. If those opportunities are delayed or fail to materialize, they are alleging that the statements were materially misleading. Here’s an excerpt from Kevin’s summary:
The complaint alleges that these statements about the company’s AI-related initiatives “created the false impression that” the company “possessed reliable information pertaining to the Company’s ability to develop and incorporate AI throughout the software development cycle in order to optimize code generation thereby increasing market demand.” In truth, the complaint alleges, there was “weak market demand for the Company’s touted AI features,” and the company was incurring increased expenses involving its China joint venture.
The complaint alleges that “the truth emerged” on March 4, 2024, when the company released its first fiscal quarter 2024 earnings report. Among other things, the company announced that it needed more time to build its pipeline and close deals on new products. The company also lower its 2025 guidance. The complaint alleges that the company’s share price declined 21% on this news.
This is far from the first AI-related securities lawsuit. Kevin shared another example just a few months ago. He notes that the rise in AI-related litigation – including newer claims based on “AI washing” – is one of the top D&O trends for 2024. Companies should be aware of this risk when making any public statements about their AI opportunities.
As we emerge from “AI summer” – and take stock of the heightened interest of the SEC and the plaintiffs’ bar in corporate AI disclosures – it’s a good time to revisit the Board’s role in overseeing the unique risks that companies may face in this brave new world of artificial intelligence (and the regulations that will apply to its use).
This Skadden memo provides a good starting point for that exercise. It summarizes key risks (based on the NIST framework), how they may vary across different industries, and the current regulatory landscape in the U.S. and Europe (which many U.S.-based companies will have to contend with). The memo offers these “guiding principles” for AI corporate governance:
1. Understand the company’s AI risk profile. Boards should have a solid understanding of how AI is developed and deployed in their companies. Taking stock of a company’s risk profile can help boards identify the unique safety risks that AI tools may pose.
2. Be informed about the company’s risk assessment approach. Boards should ask management whether an AI tool has been tested for safety, accuracy and fairness before deployment, and what role human oversight and human decision-making play in its use. Where the level of risk is high, boards should ask whether an AI system is the best approach, notwithstanding the benefits it may offer.
3. Ensure the company has an AI governance framework. The board should ensure that the company has such a framework to manage AI risk, and then reviews it periodically to make sure it is being properly implemented and monitored, and to determine the role the board should have in this process.
4. Conduct regular reviews. Given the rapid pace of technological and regulatory developments in the AI space, and the ongoing discovery of new risks from deploying AI, the board should consider implementing regular reviews of the company’s approach to AI, including whether new risks have been identified and how they are being addressed.
5. Stay informed about sector-specific risks and regulations. Given how quickly the technology and its uses are evolving, boards should stay informed about sector-specific risks and regulations in their industry.
You can find details on all of the latest AI developments in our “Artificial Intelligence” Practice Area. AI developments will also be on the agenda for our “2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences.” For example, we have a panel titled “In-House Insights: Governing and Disclosing AI,” which will feature Kate Kelly of Meta, Erick Rivero of Intuit and Derek Windham of Tesla to discuss how AI is being utilized in the in-house legal functions at public companies. If you can’t make it to the Conferences in person, we also offer a virtual option. Register today by visiting our online store or by calling us at 800-737-1271.
Okay, we’ve established a few guiding principles for board oversight of AI. But how do you actually put those principles into action – for artificial intelligence and technology more generally? This Deloitte memo suggests that, for some boards, it may be helpful to cover some of the issues outside of regular meetings of the full board. For example:
– Audit committee meetings. Given that audit committees are focused on tracking major risks and compliance issues, it’s one place where technology is often discussed. “With the boards I serve on, technology is always in the conversation since there’s so much going on. We’re always discussing technology—if not in the primary board then in the audit committee meetings,” says Wong.
– Board strategy workshops. Smaller, less formal groups may also create opportunities for in-depth technology discussions. “During one of our quarterly board meetings, we had the board spend six hours with the extended senior leadership team in workshopping sessions where each breakout explored a different theme, like technology strategy,” says Burkey. “Being part of that process was great. You weren’t having that 12-minute conversation around the board table; you were really participating in a very meaningful and productive exchange.”
– Compensation committees. Today, compensation committees have responsibilities that extend beyond just overseeing a company’s compensation and benefit policies. They are increasingly focused on the overall talent experience, retention rates, and skills gaps, as well as coordinating succession planning with the nominating committee. One technology executive from a vehicle retailer recommended these committees look at progress against transformation goals when discussing leadership compensation, especially given the technology function’s capacity to transform businesses and corporate strategies: “Besides talent, how boards construct their compensation and reward system for management, and how they hold them accountable, can be tied to overall business transformation goals. Having a business transformation goal could be one of the parameters to determine compensation.”
The memo reports that 38% of surveyed executives say that their company has some form of “technology committee” to oversee tech-related issues. It also suggests questions that board members can ask their CIO or CTO to help ensure they’re getting the right information, including:
– How can our organization mitigate potential technological blind spots?
– What is our technology talent bench strength?
– What incremental, technology “easy wins” are possible if resources are unconstrained?
See Meredith’s blog a few weeks ago for even more suggestions…
Over the course of the past weekend, the California legislature passed Senate Bill 219, which contemplates amendments to the Climate Accountability Package, including extending the rulemaking deadline from January 1, 2025, to July 1, 2025. SB 219 differs from Governor Newsom’s proposed amendments to the California climate requirements that John had discussed back in July, which did not go anywhere in the California legislature. This WilmerHale alert notes:
At the close of California’s legislative session, on August 31, 2024, the state legislature passed Senate Bill 219, which proposes several amendments to the Climate Accountability Package, including extending the rulemaking deadline from January 1, 2025, to July 1, 2025. If these amendments are passed, details about disclosure obligations under SB 253 may not become available until July 1, 2025. SB 219 differs from Governor Newsom’s proposed amendments to the Climate Accountability Package, outlined in a budget trailer bill, which did not advance in the legislature. Governor Newsom’s trailer bill would have delayed SB 253’s emissions disclosure requirements by two years. Instead, SB 219 maintains that a reporting entity, starting in 2026, or another set date to be determined by the California Air Resources Board (CARB), as the first year for reporting entities to begin publicly disclosing their scope 1, 2 and 3 emissions.
In addition, SB 219 would require CARB to prepare a schedule for disclosure of scope 3 emissions, rather the current timeline requiring scope 3 emissions disclosure no later than 180 days after scope 1 and 2 emissions disclosure. Finally, SB 219 would expressly allow a covered entity to consolidate emissions disclosure reports at the parent company level, relieving the subsidiaries of any requirement to submit a separate report.
SB 219 would eliminate the filing fee requirements for corporations when filing their GHG emissions disclosure report for SB 253 and SB 261. Finally, SB 219 would authorize, rather than require, CARB to contract with a climate reporting organization to develop a program through which the required disclosures would be made public.
Governor Newsom has until September 30, 2024, to sign or veto SB 219. If signed, the bill will take effect on January 1, 2025
It looks like we might remain in a climate disclosure holding pattern for a little while longer in California.
Recently, PwC published its latest analysis of Staff comment letters for the annual period ended June 30, 2024. The number of comment letters issued by the staff was down slightly overall as compared to the prior period, while the overall themes remained very much on par with years past. The PwC analysis presents sample comments in the following topic areas:
– Non-GAAP measures
– Management’s discussion and analysis
– Segment reporting
– Business combinations
– Revenue recognition
– Inventory and cost of sales
– Goodwill and other intangibles
– Debt, quasi-debt, warrants and equity
– Fair value measurement
– Disclosure controls and ICFR
In my experience, the most difficult comments to resolve with the Staff deal with non-GAAP financial measures that involve individually tailored accounting principles. The Staff has applied the individually tailored accounting principles guidance in an ever-widening range of circumstances, and issuers must often go several rounds with the Staff to address the comments, with the result often being that issuers must eliminate the measure.
The clock is loudly ticking for those issues who are required to disclose resource extraction payments on Form SD by the upcoming September 26, 2024 due date. You can find the latest guidance of the resource extraction disclosure requirements in the July-August 2024 issue of The Corporate Counsel and in our “Resource Extraction” Practice Area. In addition, a number of resource extraction issuers have filed their Form SD early, so there are examples on EDGAR of how issuers have approached the payments disclosure.
One element to not forget when preparing the Form SD filing is that the information presented in Item 2.01 to the Form SD must be tagged using standard XBRL, and not the Inline XBRL that we have all become used to in most other filings. If a resource extraction issuer is submitting an alternative report, that report will also need to be tagged using XBRL. To assist with this task, the SEC published a “Resource Extraction Payments (RXP) Taxonomy Guide” back in June 2023 to facilitate tagging the Item 2.01 exhibit. It includes a number of examples of resource extraction payments disclosure and how it should be tagged.
Given that this is the first go-round for these Form SD reports, filers should build in some extra time to get the XBRL tagging done prior to filing.
SEC Chair Gary Gensler addresses the topic of AI washing by public companies in his latest “Office Hours” video, picking up again on a topic that he discussed in a video back in March. He specifies the ways in which public companies should be addressing AI developments in a manner that provides full, fair and truthful disclosure. He notes:
Well, as we’ve seen an increase in the disclosures around artificial intelligence by SEC registrants, public companies as you know them, it’s important that companies making these disclosures remember that the basics of the securities laws still apply.
You see, any claims about prospects should have a reasonable basis and investors should be told that basis. And when disclosing material risk about artificial intelligence and a company may face multiple risks, including operational, legal, competitive, investors benefit from disclosures that are particular to the company, not just boilerplate language.
Companies should ask themselves some basic questions, such as if we’re discussing artificial intelligence in our earnings calls or having extensive discussions with our board of directors, maybe this information is potentially material to our business and to investors. If so, disclosure may be required under the securities laws.
Further, companies may be required to define for investors what they mean when referring to AI. How and where is it being used at the company? Is it being developed by the company or supplied by others?
Investment advisers, broker dealers also should not mislead the public by saying they’re using AI when they’re not, nor say that they’re using it in a particular way and not do so.
Such AI washing, whether it’s by companies raising money or by financial intermediaries like investment advisers and broker dealers, may violate the securities laws.
Chair Gensler and the SEC Staff have clearly been focused this year on how public companies are addressing AI developments in their public disclosures, and we do not foresee that focus shifting anytime soon.
Well, it is “back to school” time, and the inevitable question is sure to come up, “what did you do over the summer?” The answer, of course, is “be bombarded by artificial intelligence developments.” I think it goes without saying that generative AI developments have been in “fast and furious” mode of late, so I thought it might make sense to review the bidding for what we observed over the course of this summer:
– At its June meeting, the SEC Investor Advisory committee addressed the regulation of AI.
– We reviewed the evolving AI disclosures of S&P 500 companies (in part 1 and part 2), and a recent report noted how disclosure of AI risks has soared.
– The PCAOB reported on the integration of generative AI in audits and financial reporting and is considering further action.
– The Standing Committee on Ethics and Professional Responsibility of the ABA published an opinion providing guidance on the ethical use of generative AI tools by legal professionals.
– The Center for Audit Quality released its guide “Audit Committee Oversight in the Age of Generative AI.”
You can find details on all of the latest AI developments in our “Artificial Intelligence” Practice Area. AI developments will also be on the agenda for our “2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences.” For example, we have a panel titled “In-House Insights: Governing and Disclosing AI,” which will feature Kate Kelly of Meta, Erick Rivero of Intuit and Derek Windham of Tesla to discuss how AI is being utilized in the in-house legal functions at public companies. If you can’t make it to the Conferences in person, we also offer a virtual option. Register today by visiting our online store or by calling us at 800-737-1271.
We are just a little over a month away from the 2024 Proxy Disclosure Conference, and for our “Game Show Lightning Round: All Star Feud” segment, I still have not decided whether I will be channeling Richard Dawson or Steve Harvey as the host. In any event, I look forward to having some fun with the SEC All-Stars and hopefully entertaining the audience for a few minutes. In order to make this game show a success, we need your participation! Please take a moment to respond to the latest anonymous poll. We’ll gather and rank responses by popularity. Responses will be hidden, so you will have to join day 1 of our Conferences to hear whether your response made the “most popular” list.
If you have not done so already, today is a great day to sign up for our “2024 Proxy Disclosure & 21st Annual Executive Compensation Conferences,” which are taking place on October 14th & 15th in San Francisco. There is also a virtual option if you are unable to attend in person. You can register by visiting our online store or by calling us at 800-737-1271.
One of the hottest topics in boardrooms these days is “what do we do about ESG?” Facing an ESG backlash movement that appears to be in full swing, boards are facing increasing pressure to reevaluate ESG programs and the overall approach to managing ESG risks.
As Zach Barlow notes in the PracticalESG.com blog, companies are still facing a variety of ESG risks, notwithstanding the accelerating ESG backlash. The blog notes:
Recently we’ve seen the appetite for ESG waning as investors back off of ESG proposals and some companies abandon or scale back ESG programs. However, choosing not to engage with ESG doesn’t make ESG risks disappear, it just reduces their visibility. A recent survey from Supplier .io looked at 214 publicly traded companies from across various industries. The findings indicate that most companies face ESG risks in various areas. The survey states that:
– “An overwhelming majority of companies, 73%, are exposed to material risks from greenhouse gas (GHG) emissions. This statistic underscores the pervasive and escalating threat climate change poses to businesses.
– Our analysis unveiled a range of social risks, with diversity, equity, and inclusion (DEI) standing out as the most critical. 71% of companies face material risks related to DEI issues; the risk extends beyond corporate boundaries, impacting supply chains and local communities.
– When examining governance risks, supply chain management emerged as a significant concern, with 45% of companies facing material exposure. Our members can find more information on climate commitments here.”
These results shine an interesting light on recent ESG walkbacks. Companies aren’t scaling back on ESG because the problems have been solved and there is no more need to manage them. ESG risks are just as present as they’ve always been, perhaps even more so. Companies slashing ESG may be blinding themselves to threats posed by ESG issues and are hampering their ability to identify and manage those issues. ESG risks aren’t likely to let up anytime soon. Taking climate change as an example, there is no end to extreme weather events in sight leading to persistent and increasing physical risk. Additionally, new emissions reporting regulations are creating substantial compliance risks globally. ESG practitioners are a company’s first line of defense against a rapidly changing world, those who bury their heads in the sand do so at their own risk.
This area of focus will no doubt continue to evolve, particularly as we go into the 2025 proxy season.
