Last week, when I wrote about two recent AI-related SEC enforcement actions, I noted that the SEC’s public statements when it announced the enforcement action settlements not only underscored the SEC’s AI-related concerns but also illustrated the kinds of issues that could lead to private securities litigation brought by investors who claim they were misled by companies’ AI-related disclosures. In the latest example showing how company disclosures relating to artificial intelligence can lead to securities litigation, a plaintiff shareholder has filed a securities suit against a security screening company alleging that the company’s public statements about its AI-enabled products and services were misleading. A copy of the March 25, 2024, complaint can be found here.

Background

Evolv Technologies Holdings, Inc. describes itself as a “leader in Artificial Intelligence (AI)-based weapons detection for security screenings.” Its products and services are used as an alternative to traditional metal detectors at schools and other public locations. Evolv became a publicly traded company as a result of its July 21, 2021, merger with Newhold Investment Corp., a special purpose acquisition company (SPAC).

In describing its products and services, Evolv said that “unlike conventional metal detectors, our products use advance sensors, artificial intelligence software, and cloud services to reliably detect” weapons. In various filings and statements, the company allegedly said that its products and services had been independently and reliably tested, rated, and verified. In various disclosure disclosure, the company described in its risk factor statements the risk to the company if its products or services were to fail to detect weapons that are subsequently used to cause harm, the company could face claims and reputational damage.

Beginning in November 2022, several press reports and other publications raised a series of allegations against the company and its products and services. Among other things, the company was accused of colluding with an ostensibly independent testing services to hide test results, particularly with respect to the ability of the company’s products and services to detect knives. A series of BBC articles also questioned the company’s products and services, particularly with respect to knives.

A May 2023 BBC report reported that the company’s systems, used in hundreds of US schools, allegedly may have failed to detect a knife that was sued in anattack on one school’s students. Among other things, the BBC article said that “Evolv claims its system uses cutting-edge AI technology to find weapons. However, its critics say not enough is known about how the system works – or how effective the technology is in finding different types of weapons.”

On October 25, 2023, IPVM, a ratings organization for security technology, issued a report “Why We Believe Evolv Express Is Not Actually Intelligent.” The article states that the organization does not believe that Evolv Express is “actually intelligent” because “it struggles to differentiate small knives from cell phones … capabilities we believe are basic to being an ‘intelligent’ weapons detector.” The report also said the company’s description of its products’ capabilities has “deceived the public and competes unfairly against rivals, causing public schools to spend far more on its systems than rivals.”

On October 12, 2023, the company announced in a filing on Form 8-K that the U.S. Federal Trade Commission had “requested information about certain aspects of its marketing practices.” On February 20, 2024, the company also announced on a filing of Form 8-K that it had been advised by the SEC that the agency was conducting a “confidential non-public, fact-finding inquiry.”

The Lawsuit

On March 25, 2024, a plaintiff shareholder filed a securities class action lawsuit in the District of Massachusetts against Evolv; certain of its directors and officers; and certain former directors and officers of the predecessor SPAC (one of which individuals also continues to serve as a director of Evolv). The complaint purports to be filed on behalf of a class of investors who purchased Evolv securities between June 28, 2021, and March 13, 2024.

The complaint alleges that during the class period, the defendants made false and/or misleading statements and/or failed to disclose that: “(1) Evolv materially overstated the efficacy of its products; (2) lacked the effectiveness of Evolv’s products with respect to detecting knives and guns led to an increased risk of undetected weapons entering locations such as schools; (3) Evolv deceived the general public, its customers, and its investors regarding the effectiveness of its products; and (4) as a result, Defendants’ statements about its business, operations, and prospects, were materially false and misleading and/or lacked a reasonable basis at all relevant times.”

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 class.

Discussion

The complaint never uses the expression “AI washing,” but, at least based on my reading, that is pretty clearly what the complaint is getting at. The complaint alleges that the company used AI-related claims about its products to try to convince both customers and investors of the products’ superior capabilities, while allegedly overstating the extent to which AI actually produced superior results (including, in particular, with respect to its system’s ability to detect knives).

The unproven allegations in the complaint, if substantiated, underscore one of the great dangers in the current overhyped AI atmosphere – that is, that companies, knowing the general overzealous enthusiasm for all things AI-related, seek to distinguish themselves and their products by highlighting the extent to which their products and services are AI-enhanced, while in the meantime overstating the AI-related benefit. That was certainly the basis of the two SEC AI-related enforcement actions on which I reported last week.

This is not the first time that these kinds of allegations have resulted in AI-related securities class action lawsuit filings. As I noted in a post last month (here), investors brought an AI washing-related securities lawsuit against the software platform company Innodata alleging that 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.”

Although I said at the time the Innodata lawsuit was filed that I thought it was the first AI-related securities lawsuit, I have subsequently learned that there have been prior AI-relate securities suits. For example, in May 2022, plaintiff shareholders brought a securities class action lawsuit against Upstart, which claimed to be a cloud-based artificial intelligence lending platform. Among other things, the plaintiffs alleged that the defendants misrepresented the extent of its AI platform to adequately account for interest rates and other macroeconomic factors.

In addition, in November 2021, a plaintiff shareholder launched a securities class action lawsuit against the online real estate firm Zillow, in which the plaintiff alleged, among other things, that the company misrepresented the capabilities of its Zillow Offers tool. The company allegedly claimed that it used the tool to allow consumers to buy or sell houses quickly. Zillow allegedly said that its tool’s neural networks used artificial intelligence capabilities to map millions of data points, providing predictive power. However, the plaintiffs allege, the tool was unable to accurately predict home prices, and eventually the company had to shut it down. The Zillow case is currently set for trial in June 2025.  

These various lawsuits, taken collectively, clearly show that AI-related securities litigation is not only already a thing, it is also an important emerging trend. It seems probable that in the months ahead, we will see increased numbers of AI-related corporate and securities lawsuits, either based, like this one, on alleged exaggerations of a company’s AI-enabled capabilities, or based on companies’ alleged failure to disclose the risk to the company from its attempts to adopt AI.

It is worth noting that this case not only represents an example of the AI-related litigation trend, it also represents an example of another trend – that is, SPAC related securities litigation. The complaint not only includes references to the company’s July 2021 merger with a SPAC, but several of the former SPAC directors and offices are named as defendants in the lawsuit.

As I noted in yesterday’s post discussing another recent SPAC-related securities lawsuit filing, SPAC-related litigation has been one of the important securities litigation trends in recent years. Since January 1, 2021, there have been a total of 70 SPAC-related securities class action lawsuits filed, including four so far this year. As I also mentioned in yesterday’s post, although I had thought as we headed into 2024 that the SPAC-related litigation phenomenon likely had played out, it is clear that these cases are continuing to be filed. Increasingly, these lawsuits are what I previously have described as “two-fers” – that is, they not only reflect the SPAC-related securities litigation, but also other litigation filing phenomena, such as, for example, COVID-related litigation, or supply chain-related litigation. This lawsuit also is a two-fer, representing both AI-related litigation trends and SPAC-related litigation trends.

I will say this, whether the SPAC-related securities filing litigation trend is or is not about to wind down, the one thing I know for sure is that the AI-related securities litigation filing trend is just getting started. Hold on to your hats.

Ninth Circuit Affirms COVID-Related Securities Suit Dismissal: As I alluded to above, one of the significant securities litigation filing phenomena in recent years was the number of COVID-19-related securities suits. Plaintiffs’ attorneys filed these lawsuits in significant numbers, including even this year, even though by and large the cases overall did not fare particularly well.

Among the many companies hit with one of these COVID-related securities suits is Sorrento Therapeutics, which, as discussed here, was in May 2020 hit with a securities suit after a short-seller published a report questioning various statements company officials allegedly made about the effectiveness of a coronavirus antibody the company was developing. As happened in so many of these COVID-related securities lawsuits, the district court granted the defendants’ motion to dismiss, as discussed here. The plaintiff appealed the dismissal to the Ninth Circuit.

On March 25, 2024, in an opinion of a three-judge panel written by Judge Consuelo Callahan the Ninth Circuit affirmed the dismissal. The appellate court’s opinion can be found here. The Court said that while the statements were “enthusiastic,” they did not amount to fraud. “While defendants’ enthusiasm for STI-1499 might have been overblown, in context, their statements were not materially misleading,” Judge Callahan said, stating that “defendants did not promise an immediate 100% cure to COVID-19.”