An SEC-registered investment adviser uses an AI model to generate personalized portfolio recommendations for retail clients. The firm's compliance team is reviewing disclosure obligations under the Investment Advisers Act of 1940 and SEC guidance on AI. Which disclosure scenario would MOST likely trigger an SEC enforcement action for inadequate AI-related disclosure?
Select an answer to reveal the explanation.
Short Explanation and Infographic
The SEC has made it crystal clear: calling your AI 'proprietary quantitative models' while burying conflicts of interest is not adequate disclosure — it's a violation waiting to happen. The SEC's 2023 AI-related enforcement actions and proposed rules hit exactly this pattern: vague, generic language that obscures AI's role and hides that the model might be optimizing for the firm's wallet, not the client's retirement. Option A is the enforcement magnet.
Full explanation below image
Full Explanation
The SEC has pursued an active enforcement agenda around AI and algorithmic disclosures in investment advisory contexts. The Investment Advisers Act of 1940 Section 206 prohibits fraudulent or deceptive conduct, and Form ADV Part 2A requires advisers to provide full and fair disclosure of material facts, including conflicts of interest.
In 2023, the SEC charged two investment advisers (Delphia and Global Predictions) for making misleading statements about their use of AI—specifically claiming to use AI capabilities they did not actually have. More broadly, SEC staff guidance and proposed rulemaking have signaled that 'generic' disclosures such as 'quantitative models' are insufficient when AI systems are making or materially influencing client recommendations, and when those AI systems embed conflicts of interest (e.g., models that optimize for the firm's revenue rather than client best interest).
Option A describes exactly the scenario the SEC targets: (1) materially misleading language ('proprietary quantitative models' rather than 'AI') that fails to convey the nature of the technology, and (2) omission of a material conflict of interest—that the AI may prioritize firm revenue over client suitability. This combination violates the adviser's fiduciary duty under Sections 206(1) and 206(2) of the Advisers Act.
Option B describes adequate disclosure. The firm has used plain language, disclosed AI use, and noted human oversight—meeting best-practice standards for client communication.
Option C describes detailed, substantive disclosure that goes beyond minimum requirements and would not trigger enforcement.
Option D describes material change notification, which aligns with SEC expectations for maintaining current and accurate disclosures. Annual updates for material model changes are consistent with SEC staff guidance on ongoing AI disclosure obligations.
CFIA candidates should understand that the SEC applies a technology-neutral fiduciary standard: the form of technology (AI vs. spreadsheet) does not reduce disclosure obligations. If anything, AI systems with opaque decision logic and embedded optimization objectives require more, not less, disclosure.