In any discussion these days of emerging directors’ and officers’ risks, the conversation inevitably turns to the topic of Artificial Intelligence (AI). There is a general perception that while AI presents significant opportunities, it also involves significant liability risks. The contours of the risk that AI represents have yet to develop, largely because the claims have yet to emerge. That is, until now.

Earlier this week, a plaintiff shareholder filed a securities class action lawsuit against the AI-enabled software platform company, Innodata. The plaintiff claims the company misrepresented the extent to which the company’s products and services actually employ AI technology and also the extent of the company’s investment in AI. As discussed further below, as far as I know, this case represents the first AI-related securities class action lawsuit to be filed. A copy of the plaintiff’s February 21, 2024, complaint can be found here.

Background

Innodata is a software-based data management company. The company promotes itself as providing AI-enabled software platforms and services for AI data collection and AI digital transformation. On February 15, 2024, short-seller Wolfpack Research published a report about Innodata in which the firm claimed that Innodata has misrepresented the nature and extent of its business and operations. The report claimed that Innodata’s AI Initiative was “smoke and mirrors” and that the company’s marketing claims are like “putting lipstick on a pig.”

While the company claimed to be an AI pioneer, its operations, the report claims, its products and services are actually powered by thousands of low-wage offshore workers, not proprietary AI technology. The report also claimed that the company AI R&D investment over the preceding five years amounted to only $4.4 million, with less allocated to 2023 to R&D that what, the report claims, the company spent on promoting its AI technology through press releases.

The complaint alleges that despite representing to investors that the company “develops custom AI models” that it deploys and integrates for a diverse range of industry customers, Innodata “did not have a viable AI and was not effectively developing the technology.” Because of the company’s misleading statements and omissions about its AI business and development, “investors were unaware that Innodata was not effectively operating as an AI company and that Defendants were misrepresenting its ‘AI expertise’.” The complaint alleges that on publication of the report, the price of the company’s shares declined more than 30%.

The Lawsuit

On February 21, 2024, a plaintiff shareholder filed a securities class action lawsuit in the District of New Jersey against Innodata and certain of its directors and officers. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between May 9, 2019, and February 14, 2024.

The complaint alleges that during the class period, the defendants made false and misleading statements or failed to disclose that Innodata: “(1) did not have a viable AI technology; (2) its Goldengate AI platform is a rudimentary software developed by just a handful of employees; (3) it was not going to utilize AI to any significant degree for new Silicon Valley contracts; (4) it was not effectively investing in research and development for AI; and (5) based on the foregoing, Defendants lacked a reasonable basis for their positive statements about Innodata’s business and development and related financial results, growth and prospects.”

The complaint alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.

Discussion

There has of course been prior litigation relating to AI; however, much of the prior litigation involves alleged intellectual property or privacy-related violations by AI developers as they train or deploy their AI models. The lawsuit that the New York Times filed in December 2023 against Microsoft and OpenAI alleging copyright infringement in the defendants’ use of NYT content to train its AI models is an example of this kind of lawsuit.

But while AI-related lawsuits previously have been filed, the lawsuits to date have not alleged violations of corporate or securities laws. The prior lawsuits have also not been filed by or on behalf of investors or based on allegations that investors have been misled. As I noted above, as far as I know, this lawsuit represents the first AI-related securities class action lawsuit to be filed. (Readers are encouraged to let me know if in making this statement I am overlooking something.)

The allegations in this lawsuit reflect a concern that SEC Chair Gary Gensler flagged in a December 2023 speech (as detailed here). Gensler said that as investor interest in AI surges, companies may seek to promote their use of AI when the businesses are in fact using only a small amount of AI, or even none at all. Gensler implied that in the current environment, companies may be tempted to throw around the term AI when the company may not have in fact have incorporated true AI processes or functions in its operations. With a nod to is now known as “greenwashing” (as companies seek to burnish their ESG credentials or tout the extent of their sustainability efforts), Gensler referred to this concern that some companies may misrepresent their AI credentials as “AI washing.” What the plaintiff has alleged here clearly represents an example of Gensler referred to as “AI washing.”

This lawsuit has only just been filed and it remains to be seen how it will fare. In reading the complaint, the extent to which the plaintiff relies almost exclusively on the allegations in the short-seller report is striking. There are of course obvious reasons to be wary of claims in a report of a financially motivated short seller (as discussed in detail in a recent guest post on this site, here). While courts’ treatment of short seller reports has been mixed (as discussed here), recently courts have been skeptical of securities lawsuit complaints based exclusively or largely on the reports of short sellers.

For example, as discussed here, in January 2023, the district court presiding over the securities class action lawsuit field against DraftKings, and largely based on allegations from a short seller report, granted the defendants’ motion to dismiss, saying the allegations from the short seller report were based on “unsourced or anonymously sourced allegations.” The court criticized the “threadbare sourcing and the conclusory quality” of the allegations. The defendants will likely seek to raise the same arguments about the short seller report-based allegations here.

While this new complaint apparently is the first AI-related securities class action lawsuit to be filed, it almost certainly will not be the last. I suspect there will be AI-related SEC enforcement claims to come as well. We likely will see further “AI washing”-type claims, like the one filed here. I suspect that there will also be claims in which companies adopting AI-enabled tools or processes are alleged to have failed to disclose the risks involved. I also suspect we will see claims filed against corporate boards alleging that the directors failed to monitor the company’s deployment of AI-enabled processes.

To be sure, these various claims I am speculating we will be seeing would not represent new forms of claims. In many ways, these claims about which I am speculating will take very familiar forms – just as, for example, this new lawsuit the plaintiff filed against Innodata is in many ways just a plain vanilla securities lawsuit. The only difference – arguably the only thing that makes the new suit noteworthy – is that the alleged misrepresentations involve AI. In other words, while we may be about to see many new AI-related lawsuits, the suits themselves are likely to be familiar, conventional kinds of claims. To the extent the forthcoming claims are just traditional lawsuits with AI-related allegations, existing indemnification and insurance tools are likely to respond in the conventional way.

Some readers may object that there is an awful lot of speculation here. I freely concede that my crystal ball is no better than anyone else’s. I will say though that this new lawsuit is exactly the kind of lawsuit I was expecting we would see, and it arrived almost exactly when I expected we would see it. Predictions are of course always tricky, especially about the future, but I don’t think I am going out on a limb here that before all is said and done, we will be seeing more (perhaps a lot more) AI-related corporate and securities litigation – and SEC enforcement activity, as well.