When SEC Chair Gary Gensler expressed concerns last December about the possibility of reporting companies engaging in “AI-washing,” he was referring company disclosures that overstate or mislead investors as to their true AI capabilities or the extent to which the company has incorporated AI into their operations or products. Since the time of those remarks, there have in fact been several AI-washing based SEC enforcement actions (as discussed, for example, here), and even several securities class action lawsuits based on AI washing allegations (for example, here). Late last week, In the latest example of an AI- washing-based securities class action lawsuit, a plaintiff shareholder filed a securities class action lawsuit against Israeli-based cosmetics internet platform Oddity Tech Ltd., based on allegations that the company overstated the extent to which AI processes and tools enhanced its delivery of consumer services. A copy of the July 19, 2024, complaint can be found here.
Background
Oddity is an Israeli consumer tech platform focused on the beauty and wellness market. Oddity completed and IPO in the U.S. on July 19, 2023. The company portrays itself as a “disruptor” in the cosmetics industry, differentiating itself from traditional retailers by claiming that it uses proprietary AI-based technologies to target consumers needs.
On May 21, 2024, short-seller NINGI Research published a report explaining that the firm had shorted Oddity’s stock because, the firm alleged, Oddity had “completely misled investors about every critical aspect of its business, concealing a large brick-and-mortar business and sales generated by dishonest marketing tactics.”
Specifically, the NINGI report alleged, based on supposed interviews with former company employees, that Oddity’s claimed AI approach is “nothing but a questionnaire” and that Oddity’s lauded “repeat purchase rates” are attributable to “customers unknowingly entering into non-cancelable plans” that allow the company to record repeat purchases “even though the customers didn’t want the product.” The NINGI report also claimed that the firm had found “hundreds of undisclosed lawsuits alleging violation of consumer protection laws.” The subsequently filed lawsuit claims that the company’s shared declined on this news.
The Lawsuit
On July 19, 2024, exactly one year after the company completed its IPO, a plaintiff shareholder filed a securities class action lawsuit in the Eastern District of New York against Oddity and certain of its directors and officers. The complaint purports to be filed on behalf of investors who purchased Oddity securities during the period July 19, 2023, through May 20, 2024.
The complaint alleges that during the class period the defendants made false or misleading statements or failed to disclose that: “(i) Oddity overstated its AI technology and capabilities, and/or the extent to which this technology drove the company’s sales; (ii) Oddity’s repeat purchase rates and revenues were, at least in part, derived from unsustainable and deceptive sales and advertising practices; (iii) Oddity downplayed the true scope and severity of ongoing civil litigation against the Company and/or its subsidiaries; and (iv) as a result, Oddity’s public statements were materially false and misleading 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 thereafter. The complaint seeks to recover damages on behalf of the plaintiff class.
Discussion
In reading this complaint, I was struck by the extent to which this complaint is almost entirely dependent on the short-seller’s report. In prior posts, for example here, I have discussed the reasons to be wary of securities complaints prepared in reliance only upon short-sellers’ allegations. Short-sellers obviously are financially motivated to disparage the target company’s business and operations, and indeed, some courts have been – for good reason, in my view — skeptical of complaints that are heavily reliant on short sellers’ allegations. Thus, while there may be reasons to be wary of company’s efforts to try to establish their AI credentials though so-called AI washing, there are also good reasons to be wary of the allegations in this complaint.
Another thing that struck me in this complaint is the fact that even though this lawsuit was filed exactly one year to the day after the company completed its U.S. IPO, the complaint does not contain IPO-related allegations. The complaint does not allege misrepresentations in the IPO documents. It does not assert claims on behalf of investors who purchased shares in the IPO; the claims are asserted only on behalf of secondary market purchasers. The complaint does not assert Section 11 claims. A quick glance at the stock price graph for this company since the IPO revels the likely reason why; for most of the period since the IPO, the company’s shares have been trading above the offering price. (A glance at the stock price graph also suggests pretty strongly that the market actually was not all that troubled by the short seller’s supposed revelations.)
From my perspective, the most noteworthy attribute of this complaint, and the reason I am writing about it here, is that the lawsuit involves AI-related allegations. In recent months, because of all of the hype in the investment markets surrounding AI, shares of companies with a good AI story have soared. These circumstances created a context within which there is a high likelihood that companies whose AI credentials are questioned, causing a drop in the price of the company’s shares, are likely to get hit with a securities suit.
And indeed there have been a number of AI-related securities class action lawsuits filed this year, as I have discussed in prior posts (most recently here). By my count, this lawsuit is the fifth AI-related securities suit to be filed this year. As I noted in the prior post, there were in fact other AI-related securities suits filed prior to this year, as well.
Because of all of the noise surrounding AI; because of the extent to which the securities markets have been influenced by AI-related hype; and indeed because of the extent to which a lot of the assertions about the capabilities of artificial intelligence seem to be seriously overblown, it seems likely to me that there will be more AI-related securities lawsuit filed as the year progresses. Indeed, I strongly believe that the number of AI-related securities suit filings will prove to be a significant factor in the overall number of securities class action lawsuit filings during the year.
All of which does raise the question of what the right underwriting response to AI-related issues may be. At a minimum, I think underwriters will want to actively discern whether applicant companies are actively promoting their AI capabilities. Underwriters may also want to develop questions designed to determine whether the extent to which an applicant company’s claimed AI credentials are based on actual technological investments and the extent to which the AI-based claims represent only a marketing approach. There is undoubtedly a lot more that could be said on this topic, which likely will be the subject of extensive further discussion within the D&O industry in the months ahead.