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Is “-washing” the securities fraud equivalent of “-gate” for political scandals? First we had greenwashing, then diversity-washing, and now we have AI-washing—a topic that, as discussed in the SideBar below, SEC officials made a lot of noise about last year. And this recent action by the SEC certainly seems to allege just that—even though the SEC doesn’t actually use the term. In mid-January, the SEC announced “settled charges against Presto Automation Inc., a restaurant-technology company that was listed on the Nasdaq until September 2024, for making materially false and misleading statements about critical aspects of its flagship artificial intelligence (AI) product, Presto Voice. Presto Voice employs AI-assisted speech recognition technology to automate aspects of drive-thru order taking at quick-service restaurants.”  However, as alleged in the Order, the AI technology used in the product was not developed by Presto—at least not until September 2022; rather, the company deployed speech recognition technology owned and operated by a third party.  But, the SEC charged, Presto failed to disclose in its SEC filings that it used the third party’s AI technology, rather than its own, to power all of the Presto Voice units it deployed commercially during that time period.  What’s more, once Presto did begin to use its own  proprietary technology in the Presto Voice units, the SEC alleged, the company “misrepresented the capabilities of the product by claiming that it eliminated the need for human order taking.” Not the case, the SEC alleged; “substantial human involvement” was actually required. The SEC charged that Presto made materially misleading statements in violation of the Securities and Exchange Acts and failed to maintain adequate disclosure controls; however, in light of its financial condition and remedial actions, the SEC imposed only a cease-and-desist order and no civil money penalty.

SideBar

Last year, SEC officials were raising lots of red flags in speeches about “AI-washing.”  In January last year, in remarks at an event hosted by Public Citizen reported by law.com, then-SEC Chair Gary Gensler cautioned companies to be careful about making false claims about their use of AI: “Companies should be ‘truthful about what they’re saying about their claims’….They should also ‘talk about the risks’ of using AI ‘and how they manage their risk,’” Gensler said.  And in February, in remarks at Yale Law School, Gensler observed that, whenever there is a buzzy new technology, there are also often false claims about its use. But if “a company is raising money from the public,” Gensler cautioned, the company “needs to be truthful about its use of AI and associated risk.” He noted that “[s]ome in Congress have proposed imposing strict liability on the use of AI models.”  He continued:

“As AI disclosures by SEC registrants increase, the basics of good securities lawyering still apply. Claims about prospects should have a reasonable basis, and investors should be told that basis. When disclosing material risks about AI—and a company may face multiple risks, including operational, legal, and competitive—investors benefit from disclosures particularized to the company, not from boilerplate language. Companies should ask themselves some basic questions, such as: ‘If we are discussing AI in earnings calls or having extensive discussions with the board, is it potentially material?’ These disclosure considerations may require companies to define for investors what they mean when referring to AI. For instance, how and where is it being used in the company? Is it being developed by the issuer or supplied by others? Investment advisers or broker-dealers also should not mislead the public by saying they are using an AI model when they are not, nor say they are using an AI model in a particular way but not do so. Such AI washing, whether it’s by companies raising money or financial intermediaries, such as investment advisers and broker-dealers, may violate the securities laws.” (See this PubCo post.)

Similarly, in April remarks at a Program on Corporate Compliance and Enforcement, then-SEC Enforcement Director Gurbir Grewal cited several statistics showing the immense importance that investors were attributing to AI: “according to a recent survey, 61% of investors believe that faster adoption of AI is very, or extremely, important to a company’s value. That jumps to 85% when including investors who believe it is moderately important.” As a result, there may well be a “perfect storm…brewing around AI.” The staff’s experience with ESG could be instructive he suggested:  when institutional investors began to indicate interest in companies with ESG strategies, “companies had meaningful financial incentives to exaggerate, or make misleading statements about, their supposed ESG activities or products. After all, saying that you have an investment strategy or business plan that incorporates ESG considerations is pretty easy; creating one and sticking to it is another matter.” In recent years, the SEC brought several enforcement actions against this type of misconduct.

And the SEC has begun to see similar misleading statements with regard to AI and has brought an action against two registered investment advisers for making false and misleading statements claiming AI capabilities that, the SEC charged, they did not have. Grewal suggested that advisers “[t]ake a step back, and ask yourselves: do these representations accurately reflect what we are doing or are they simply aspirational? If it’s the latter, your actions may constitute the type of ‘AI-washing’ that violates the federal securities laws.” And the same may well apply to public companies that disclose AI-related information. In that case, he advises, companies must ensure that their disclosures are not materially false or misleading, particularly as AI-related disclosures by public companies are increasing. He advised companies and their advisors to adhere to general principles of “proactive compliance”: educate themselves about emerging and heightened AI risk areas as they relate to their businesses; engage with personnel inside the company “to learn how AI intersects with their activities, strategies, risks, financial incentives, and so on”; and execute by updating policies and procedures and internal controls specific to the company and effectively implementing those policies and procedures.

Background. Presto, a “restaurant technology company offering enterprise-grade digital solutions to the restaurant hospitality industry,” went public through a SPAC transaction in September 2022. In connection with the SPAC transaction, Presto received offering proceeds of approximately $49.8 million in a PIPE.  Presto also filed a Form S-8 and raised $9.5 million in a private placement.  Presto traded on Nasdaq until Nasdaq suspended trading in August 2024. Presto then traded OTC and filed a Form 15 in September 2024 to terminate the registration of its securities. The Form 15 became effective in December 2024.   

As described in the Order, in anticipation of the SPAC merger, “Presto sought to position itself in the public markets as a technology company with substantial growth potential in the very large and growing market for AI-assisted restaurant drive-thru products.”  However, as of 2021, Presto “had not yet developed its own voice AI technology that could be commercially deployed at restaurant drive-thrus” and instead, licensed from “Supplier A” its voice AI technology to be installed at certain customer restaurant locations as part of Presto Voice-branded units.  That technology allowed orders to be accepted through automated voice interaction at the drive-thru, which could then be integrated into the restaurant’s point-of-sale system.  According to the SEC, “Presto’s executives understood that Supplier A’s voice AI solution was supported by human agents to some extent.” From at least November 2021 to September 2022, the Presto Voice units that Presto commercially deployed—all of which were deployed at the restaurants of Presto’s largest customer—used voice AI technology and components owned and operated by Supplier A.    

As alleged, beginning in early 2022, Presto began development of its own proprietary voice AI technology, similar to the technology of Supplier A, for use in Presto Voice, and began to commercially deploy Presto Voice units powered by its proprietary voice AI at new customers in September 2022. Pilot versions of a more advanced Presto Voice using proprietary technology were introduced in June 2023.

The SEC charged that, from at least November 2021 to September 2022, Presto made misleading statements about the technology powering Presto Voice because it failed to adequately disclose that the voice AI technology that powered all Presto Voice units was actually owned and operated by Supplier A. For example, in the de-SPAC S-4 and other registration statements, the SEC alleged, Presto “referred to Presto Voice (powered by Supplier A’s technology) as, variously, ‘Presto’s speech recognition technology,’ ‘Presto’s Voice product,’ and ‘our technology,’ without adequately disclosing the “extent of Presto’s reliance on Supplier A to power Presto Voice units deployed at restaurant locations of Presto’s largest customer.” Not until Presto learned of the SEC investigation in October 2023 did it disclose its reliance on Supplier A’s technology.

Moreover, the SEC charged, Presto “also made materially false statements about the purported capabilities of Presto Voice units powered by its own proprietary voice AI technology to reduce reliance on humans in the drive-thru ordering process,” claiming in registration statements that “Presto Voice ‘eliminat[es] human order taking.’”  But in fact, the SEC alleged, Presto Voice “relied heavily on humans to complete drive-thru orders at customer locations.” According to the Order, the original version of Presto’s proprietary voice AI technology “required human agent intervention, including entering the order, in all instances”; the more advanced pilot version “required a human agent to enter the orders approximately 70% of the time during the time period of June 2023 through at least December 2023.”  Similarly, in public filings and investor presentations furnished on Form 8-K, Presto used terms that the SEC alleged created a misleading impression, such as describing 95% rates of “reported ‘automated order completion’ and ‘non-intervention,’” which actually “referred to rates at which drive-thru orders were completed without restaurant staff involvement (but not without any human involvement).” As alleged, Presto was well aware of the need for human intervention, but did not correct the false statements until Presto learned of the SEC investigation in October 2023.  Although “certain Presto executives identified the potential for these terms to create confusion and misunderstanding among Presto investors and customers,” the SEC charged, “Presto took no steps to correct the misleading statements identified above until it provided clarity, after learning of the Commission’s investigation.”

Once Presto became aware that the SEC staff was investigating, it disclosed additional information in its public filings, including in a Form 10-K, Form 8-K and a prospectus supplement, explaining the “extent of the company’s relationship with Supplier A and its reliance on humans to complete orders placed through Presto Voice units powered by Presto’s proprietary technology.” The SEC charged that “[r]easonable investors would have considered the false and misleading statements…to be material in making investment decisions concerning Presto’s securities during the relevant time period,” citing as an example an analyst who “understood Presto’s statements about ‘automated order completion’ and ‘nonintervention’ rates to refer to rates of any human intervention in the order taking process, not just restaurant staff intervention.  The analyst would have considered this information to be material in assigning a rating to Presto’s stock.” Similarly, an asset manager complained to a Presto employee that “Presto ‘need[s] to be front and center that you have only one commercial deployment of [Presto Voice], that it is a very small percentage of the company’s revenue and that you have no patented technology.  Anyone who starts to do work on the company and has to find those things out after speaking to the company will be very unlikely to be an investor now or later.’”

In addition, the SEC alleged that, from “September 2022 through December 2024, Presto failed to design, implement, or maintain disclosure controls and procedures to ensure that the information disclosed by Presto in Commission filings was accurate and not materially misleading.  During this time period, Presto had no established process for drafting, reviewing, or approving periodic or current reports required to be filed with the Commission.”  As a result, “no one at Presto was formally responsible for ensuring that the information disclosed in Presto’s Commission filings was accurate.”

Violations.  The SEC charged that Presto violated Section 17(a)(2) of the Securities Act (untrue statements in connection with offer or sale of securities), Section 13(a) of the Exchange Act and related Rule 13a-1(periodic and current reports) and Rule 13a-15(a) under the Exchange Act (disclosure controls and procedures). As noted above, in light of Presto’s financial condition and remedial acts, the SEC imposed only a cease-and-desist order with no civil money penalty.

Posted by Cydney Posner

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