4 MIN READ
Published 01/23/2025
The integration of artificial intelligence (“AI”) into business operations has become increasingly common. As with any innovation, it is important for companies to consider both the risk and rewards of AI.
The promise and potential benefits of AI
By integrating AI, companies hope to enhance their decision-making processes, improve governance, and ensure more effective oversight. Potential business benefits associated with leveraging this technology include:
- Amplifying efficiency, bolstering efficacy, and fostering sustainable growth
- Expediting a multitude of business processes
- Larger-scale and more comprehensive decision-making
- Identifying patterns and trends that aren’t immediately obvious and providing vital information for making changes to corporate strategies
- Streamlining compliance processes
- Reducing biases in the boardroom through objective data analysis and offering unbiased insights for more effective decision-making
However, AI’s advancement poses new risks that companies should consider.
AI may pose increased potential for directors and officers (“D&O”) & related claims (“D&O claims”). Two of the more common risks associated with AI that may lead to potential D&O claims include:
- AI washing: When a company overstates or misrepresents its AI capabilities.
- AI hallucinations: When AI systems generate incorrect or misleading information.
These AI risks may lead to regulatory scrutiny, legal challenges, poor business decisions, compliance issues, and legal liabilities. This is a growing challenge, as use of generative AI in business applications may result in claims that impact companies, boards of directors, and potentially, their D&O insurance programs.
As companies incorporate AI into operations, boards must balance AI’s risks and rewards and develop, implement, and communicate responsible, ethical, and fair usage guidelines. This is a critical step that enables companies to mitigate potential D&O insurance-related claims that may occur from using AI technology.
As AI grows in popularity, companies should be aware of risks this technology may introduce including potential D&O claims.
1. SEC enforcement actions
In 2023, Gary Gensler, chair of the U.S. Securities and Exchange Commission (“SEC”), warned companies to be mindful of AI washing, which was the basis for two SEC enforcement actions against investment adviser firms Delphia (USA) Inc. and Global Predictions for making allegedly false statements about their uses of AI. The SEC announced the settlement of these matters in early 2024 but underscored that false and misleading statements made by companies about their respective use of AI would not be tolerated by the SEC.
2. Securities litigation
Companies’ use of AI has led to securities class action lawsuits brought by investors who claim they were misled by a company’s AI-related disclosures. This has put the accuracy and transparency of such disclosures under even greater scrutiny. Two examples include:
- The AI-related securities lawsuit, David D’Agostino v. Innodata Inc. et al., was filed in New Jersey Federal Court on Feb. 21, 2024, by David D’Agostino (“Plaintiff”) against Innodata, a software-based data management company. Plaintiff alleged Innodata misrepresented the extent of its AI technology and investment. Plaintiff argued that despite the company’s assertions of being an AI pioneer, its products and services were powered by thousands of low-wage offshore workers not proprietary AI technology. Thus, Plaintiff asserted Innodata made false and misleading statements and failed to disclose that it lacked viable AI technology, was not effectively investing in AI research and development, and lacked a reasonable basis for positive statements about its business, financial results, growth, and prospects.
- Another AI securities lawsuit was filed on behalf of investors who purchased Evolv securities between June 28, 2021, and March 13, 2024. Evolv Technologies Holdings Inc., (“Evolv”) is a leader in AI-based weapons detection for security screenings and became a publicly traded company in 2021. The lawsuit alleges Evolv made materially false and misleading statements about its business, operations, and prospects by overstating the efficacy of its products, and deceiving the public, customers, and investors about its products’ effectiveness.
3. Derivative lawsuits
Corporate boards may face derivative lawsuits and potential breach of fiduciary duty claims for failing to implement appropriate company oversight for AI use. D&Os of companies heavily investing in AI for their operations or integrating AI into their products or services will be tasked with ensuring effective controls and reporting systems for AI use are in place. D&Os may face claims for lack of oversight and noncompliance with AI protocols that may lead to AI-related risks in company performance.
Striking a balance between AI risks and rewards
A company’s board of directors should take a holistic approach to incorporating AI into operations so it can implement it effectively, develop robust risk management strategies to better mitigate potential liabilities, and help ensure the responsible use of AI technologies.
Here are key actions companies can take:
- Evaluate potential risks. A company should assess the potential risks and benefits associated with AI. Areas to consider include potential impacts to the organization’s image, ethical issues, data privacy, strategic and financial concerns, cybersecurity incidents, and social implications.
- Implement protective factors. Companies utilizing AI must deploy protective safeguards to ensure data privacy, address ethical considerations, protect intellectual property and copyrights, maintain regulatory compliance, and provide employee training and awareness programs.
- Establish an ethical environment and culture set by senior leadership. A company’s board should create a “strong tone at the top” regarding AI and ethics. This helps ensure compliance with applicable laws and regulations that are in accordance with the company’s mission and principles.
- Review your insurance program and understand coverage and limits. It’s crucial for a company’s board to understand what its D&O policy covers, its terms and conditions, and available limits. Collaborating with a broker and carrier and sharing how the company is using or plans to use AI can help limit coverage gaps and potential litigation.
Moving forward with AI
As use of AI grows among companies, so do the potential risks. This underscores the importance and value a robust D&O insurance policy can offer companies as they navigate the complexities of AI technology while fostering innovation and growth.
Learn more about how our directors and officers (D&O) liability insurance solutions can help protect an organization’s leaders from claims arising from management decisions and actions here.
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This website is general in nature, and is provided as a courtesy to you. Information is accurate to the best of Liberty Mutual’s knowledge, but companies and individuals should not rely on it to prevent and mitigate all risks as an explanation of coverage or benefits under an insurance policy. Consult your professional advisor regarding your particular facts and circumstance. By citing external authorities or linking to other websites, Liberty Mutual is not endorsing them.
