Oversold and Underdelivered: SEC Charges Former Startup CEO with “AI Washing” Securities Fraud

Founded in 2016, Joonko purported to use artificial intelligence (“AI”) technology to assist commercial customers with meeting hiring goals related to Diversity, Equity, and Inclusion initiatives (“DEI”).¹ Essentially, Joonko would use AI to find and develop of pool of “silver medalist” job candidates — diverse applicants who made it to the final stages of a company’s hiring process, but were not offered the position — and then match those candidates with employment opportunities at its customer companies, thereby aiding its customers in fulfilling DEI hiring goals.² Joonko’s services claimed to work by:

• Connecting with the applicant tracking systems of companies withing the “Joonko ecosystem” to identify pre-qualified candidates and recommend them to other Joonko customers;
• Facilitating candidates who got to the final stage interview with a company, but did not ultimately get hired, to be sourced by other Joonko customer companies; and
• Targeting U.S. companies with at least 500 employees and 30 job openings at any given time to gain diverse candidates through increasing Joonko’s customer base.³

In 2021 and 2022, Joonko, through Raz’s solicitation, conducted two major rounds of equity fundraising, which resulted in $21 million of investment in the company.⁴ During these fundraising efforts, Raz made several lofty claims about the company’s operating position, including that Joonko: (1) had over 200 companies, including several Fortune 500 companies, in its customer base; (2) had 185,000 active monthly candidates on its platform in 2021; and (3) projected revenues to increase from $520,000 to over $2 million from 2020 to 2021, and further rise to $4.6 million and up to $8.5 million by the second half of 2023.⁵

Additionally, Raz made specific representations to investors about the basic technology underpinning Joonko’s platform, such as:

• Representing that Joonko used “AI-based technology” and provided an “automatic recruiting solution”;
• Claiming that Joonko’s technology was based on “seven different AI algorithms”; and
• Explaining that Joonko’s “proprietary algorithm first uses natural language processing and computer vision to scan public data on the candidates that are referred to us,” that Joonko used “machine learning to improve the matching process as candidates select the roles they’re interested in,” and that the matching of candidates was “automated from end to end.”⁶

According to the SEC, virtually none of Raz’s claims about Joonko were true: the company had far fewer customers and users, as well as substantially less revenue than was advertised to investors.⁷ Worse still, the SEC alleges that even the algorithmic technology that formed the core of Joonko’s operations did not in reality match the level of sophistication and automation that Raz had claimed.⁸ Indeed, according to the SEC, Raz simply “engaged in an old school fraud using new school buzzwords like ‘artificial intelligence’ and ‘automation,’”⁹ As a result, the SEC charged Raz with violations of Section 17(a) of the Securities Act, as well as Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder.¹⁰ The U.S. Attorney’s Office for the Southern District of New York also announced criminal charges against Raz.¹¹

With the dawn of new and rapidly evolving technologies like blockchain and AI, many companies and executives might feel pressure to overstate the company’s progress in developing and integrating such technology. While failure to accurately advertise technological advances can create risk unrelated to regulatory agencies,¹² the charges against Raz demonstrate that, when made in connection with the sale of securities, the SEC is on the lookout for registrants who overpromise and underdeliver on their technological advancements. The SEC has signaled as much. In its first panel on AI, held during the Securities Enforcement Forum West conference on May 28, 2024, SEC panelists highlighted two “first-of-their-kind settled enforcement actions,” both announced earlier this year, against companies who falsely represented to investors that their AI capabilities were far more advanced than the technology actually was.¹³ Additionally, on April 19, 2024, the SEC filed securities fraud charges against the founder of another AI-technology start-up for alleged misrepresentations about the company’s contract portfolio and revenues, made to investors during two rounds of equity funding that garnered a total of $2.8 million.¹⁴ As Gurbir S. Grewal, Director of the SEC’s Division of Enforcement, put it, “[a]s more and more people seek out AI-related investment opportunities, [the SEC] will continue to police the markets against AI-washing and the type of misconduct alleged in today’s complaint.”¹⁵

With demand for AI booming, and the SEC on the prowl for cases in this area, companies must continue to walk the thin line between effective marketing of technological advancements and potentially fraudulent misstatements. Registrants are encouraged to work closely with counsel to inspect their marketing activities — particularly when the subject is AI — and ensure that public statements involving emergent technologies are accurate and compliant with federal and state laws.

¹Complaint, Sec. Exch. Comm’n v. Raz, No. 1:24-CV-04466, 4–5 (filed June 11, 2024), available at https://www.sec.gov/files/litigation/complaints/2024/comp-pr2024-70.pdf.

²Id. at 6.

³Id.

⁴Id. at 6–7.

⁵Id.

⁶Id. at 13–14.

⁷Id.

⁸Id. at 14.

⁹U.S. Securities and Exchange Commission, “SEC Charges Founder of AI Hiring Startup Joonko with Fraud,” Press Release, June 11, 2024, https://www.sec.gov/news/press-release/2024-70.

¹⁰Id.

¹¹Id.

¹²See, for example, the ongoing class action lawsuit against Tesla, which alleges that the company mislead customers with advertisements related to its capabilities and progress towards developing a self-driving car. Jonathan Stempel, “Tesla must face vehicle owners’ lawsuit over self-driving claims,” Reuters, May 15, 2024, https://www.reuters.com/legal/tesla-must-face-vehicle-owners-lawsuit-over-self-driving-claims-2024-05-15/#:~:text=The%20lawsuit%20seeks%20unspecified%20damages,have%20contributed%20to%20fatal%20crashes.

¹³Rebecca Fike & Illana Gomez, “Cooperation and Compliance: Navigating Artificial Intelligence at the Securities Enforcement Forum,” V&E: Insight, June 12, 2024, https://www.velaw.com/insights/cooperation-and-compliance-navigating-artificial-intelligence-at-the-securities-enforcement-forum/. See also U.S. Securities and Exchange Commission, “SEC Charges Two Investment Advisers with Making False and Misleading Statements About Their Use of Artificial Intelligence,” Press Release, March 18, 2024, https://www.sec.gov/news/press-release/2024-36.

¹⁴U.S. Securities and Exchange Commission, “SEC Charges Founder of Artificial Intelligence Start-Up with Defrauding Investors,” Litigation Release No. 25980 (April 19, 2024), https://www.sec.gov/litigation/litreleases/lr-25980.

¹⁵See U.S. Securities and Exchange Commission, Press Release, at note 9 above.