AI and Company Boards

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It is not clear what boards of directors should be doing about AI.  (The answer will be applicable to public companies with anticipated SEC and possible Stock Exchange promulgations and mandatory disclosures, but much the same conundrum will affect managers of private companies which will suffer the same business risks if not the same level of disclosure risk.)

The obvious answers: protect systems from hacking and intrusion; restrict use of AI on company platforms; alert the persons such as the Audit Committee or the Risk Committee evaluating ERM (enterprise risk management) and make sure all parts of the company are included to avoid missing some risk in a functional corporate “silo”: obtain outside consulting support, perhaps direct employment of experts, and include a knowledgeable board of directors member; as their efficacy improves, employ systems that can identify received input as machine-generated (current technology is spotty; ask any University trying to analyze term papers).

The fundamental problems for companies and the persons responsible for running them is that the risk is new, powerful and sourced from outside, at the same time subtle, and in part based on the quality of judgment relying on unreliable input.  The arguable answers from a board of directors are i) don’t develop AI (too late, ii) don’t use it (largely too late and in any event uncontrollable), iii) make sure it is not corrupt at inception or corrupted in transition (good luck with that), (iv) rely on government regulation (whose government when and with what bias, v) ?

Solutions seem to lie beyond board governance actions, yet actions must and will be taken.

What will insurance against AI disruption or fraud look like and at what price point?

Can a board dare risk passing on the clear business benefits of AI in speed, efficiency and ability to eliminate some human overhead?  What will the shareholders say?

META Releases AI for Public Use

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Today’s Times reports that META has released its AI codes to the public so that anyone can use them as a base for creating chatboxes.   The argument is that the technology works best if shared and that it is the disseminators of chatboxes that should police and prevent misuse.

Critics naturally pointed out that regulation at the point of creation, which could be controlled by code inventors at for example the Open AI, META and Google level, thus becomes impossible.

The META release is particularly potent because, according to the Times, the version provided to the public includes what is known as “the weight.”  The algorithms have been processed to reflect what was already learned from various data sets; that learning takes time, money, sophistication, specialized chips not generally available.  This release thus not only empowers new chatboxes, but also provides a technological head start to anyone using the technology.  This may advantage the good guys, but not everyone has benign intent.

Although commentary on the details of AI releases best rests with those with specific technical expertise, which excludes this blogger, I am disquieted by the comments of a Berkeley researcher, who drew an analogy to the sale of grenades in a public grocery store. His research disclosed that the AI provided instructions for disposition of dead bodies, as well as generating racist comments supporting the view of Hitler.

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AI Risks

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How to think about risk when dealing with a tool of great efficiency and business value?  Two ways: risks identified and widely discussed, and risks no one is talking about with specificity.

On May 16, CEO Altman of Open AI, the company that developed GPT-4 (one of the most powerful AI products yet), addressed a Senate Committee and asked for government regulation to prevent abuse.  Congress, never robust in controlling technology, displayed palpable ignorance as to what AI really was, as Altman asked for government regulation to prevent harm while predicting that lost jobs would be covered by the technology creating new and different jobs.

Note that in March of this year, over 1,000 tech executives and developers issued a letter outlining  certain risks and stated that “profound risks to society and humanity” are possible.  Since publication, number of signers has increased to over 27,000.  Identified risks openly being discussed: AI speaks convincingly but is often wrong as it makes up answers; AI can have programmatic bias or toxic information; disinformation spreads so quickly today that accuracy is extremely critical; job loss at a time when we are not educating for future jobs (and indeed recent data shows that at least American education so slipped in the pandemic that some predict it will take from 13 to to 27 years to get back to where we were just prior to the pandemic); since AI replaces lower skill jobs, where will new jobs come from in a future setting.

The risk of “loss of control” of society, the Terminator / Skynet story line, is indeed deemed unlikely, yet it is contemplated that AI will write its own code; what will a hallucinating tool write down? I refer you to my February 23 post entitled “Chatbox as a Destroyer of Worlds,” reporting on a now-famous columnist’s conversation with a chatbox where the technology attempted to wean the reporter away from his spouse and requite the love felt by the chatbox itself.

Here is what is not mentioned with any real focus: every tool can be used for good or evil.  Powerful tech may be controlled by law but can be hijacked for evil.  And as it is more powerful, the evil will be more powerful.  It can be hacked, modified to remove controls, stolen, used by crooks, used for ransomware, misused by police or military, capture biometric data, used by dictators (already done in China) or by politicians who are so certain they hold the only true answers and morals that they will quash fundamental liberties.

Not surprisingly, two “governments” are already far ahead of the US with respect to regulation of AI.  The EU is about to promulgate rules controlling what is developed.  And, in graphic demonstration of risk, China is moving quickly to make sure that developed AI is politically correct from the perspective of the ruling regime.

Meanwhile, Congress is still at the learning stage, while the President has merely chided senior AI  executives that they are moving into dangerous territory.  And, notwithstanding the 27,000 signatures to the March letter,  which letter suggested a 6 month moratorium on AI development while regulation is considered, no industry moratorium been established.

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AI and Its Place in Social History

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Two points here: pace of AI penetration and how to understand that penetration.

To get to 50 million users, the automobile took five decades.  Pokeman Go got there in a few days.  Other apps reached that number in a matter of weeks.  AI will be here in spades immediately, if not yesterday.  You cannot duck it.  Educational systems need to train for it, and I don’t mean just blocking term papers written by chatbox tech; the future of work and information is about to be permanently and radically transformed.  If schools lately have taught to the test, today they must teach to the AI future.

The AI transformation has been characterized as so powerful and disruptive that it will be comparable in impact of the Industrial Revolution.  Stop and think about that.  The Industrial Revolution for the following century, and in many ways still today, has caused massive human misery in social fabric, economics, human values, societal equity.  The fearful have a point to be cautious.  I fear that the closer analogy is to atomic energy: huge pluses, huge risks of a cataclysmic nature.

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AI Understood– Maybe

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This is the first in what I envision as a series of posts tracking developments in AI.  Two schools of thought are emerging.  The first is that AI is the future of progress and work and a great boon to civilization.  The second is that AI may well spell the demise of liberty.  Both views share the view that AI is on the march and its primacy is inevitable.

Some simple understandings set forth below:  for these understandings I credit the New England Chapter of National Association of Corporate Directors, which ran a program yesterday to address the promise of AI and the role of the board of directors in handling this tool.  (Disclosure: I am a member of NACD/New England, served on its Board and now am on its Advisory Board.)

Simple takeaways:  AI is not new; ask Alexa, ask Seri, and note robotic telephone sites as simple examples.  Algorithms that drive AI have been with us for very many years.  The explosion of AI power is based upon the convergence of three things: vast explosion of data that can be utilized by the algorithms; more powerful computing that can rapidly handle huge data sets; massive increase in data storage technology at low cost.

Simple facts: Business people see profit and efficiency.  Scientists see pluses and minuses and some are carried away by potential; today’s on-line NY Times carries a story of a Microsoft research paper claiming development of AGI [get used to the new shorthand–this is “artificial general intelligence” which means thinking just like a human being].  Everyone recognizes that AI reaches out for analogy when lacking specific data and hence often generates inaccurate output (kindly called “hallucinations”).

Hype and risk abound.  From time to time I will post about both.  I will not post ChatGPT generated text, in case you were wondering.

SEC Heightens Regulation of Advisers to Private Funds

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The SEC has enacted new regulations effecting required reporting on the part of hedge fund and PE fund advisers, some of which are focused on disclosing events within the the management structure and some of which are designed to signal economic concerns.  Various regulations become effective at the six-month and twelve-month marks after enactment.

Aside from rather straight-forward management matters such as removal of general partners and certain fund-termination events, large PE funds will be required to report general or limited partner claw-backs on an annual basis.

In my view, the most interesting regulations are aimed at alerting investors to possible investment performance trouble.  Reports are required as to events which could stress the fund or harm the investor, extraordinary investment losses, margin and default events, major events involving prime broker relationships, and important withdrawal and redemption events.

Commentary from SEC Chair Gensler noted the expansion of the power and impact of these private funds on the broader capital markets.  No doubt true, but these regulations surely also reflect the majority Commission view that tighter regulation and disclosure is required across the investment infrastructure landscape

 

Stock Buy-Backs: New SEC Regulations

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Today, the SEC announced new Rules requiring wide disclosure relating to corporate redemption of shares.  Buy-backs are huge (in 2021, they totaled $950 Billion), and have been occasionally questioned in the liberal press as events that wrongly reward investors, while the purchase price paid for redeemed shares might have been better used to enhance the company.

Disclosure now is required from redeeming corporations about the obvious (what was redeemed at what price), the suspicious (what did insiders, officers and directors do with their shares around the time of redemption) and perhaps most interesting, the corporate objective for the buyback, and how the redemption decision was reached.

It will be interesting to see how companies explain why returning money to investors was smarter than investing in company growth. Investor return is, after all, the object of investment….

ESG Wars

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The battle over whether ESG belongs in investment decision-making, and whether failure to adhere to ESG principles can lead to litigation against companies, has  created some very curious legal situations.  The two below are wholly unrelated, but also illustrative of what it looks like in the weeds of ESG sensibilities.

Last month, Congress actually agreed on something: they sent to the president a bill that would not permit the US Department of Labor to allow regulated funds to take ESG into investment considerations.  The presumable argument is that ESG may have a downward pressure on profits, hurting worker beneficiaries.  President Biden used his first veto to strike down the law, leaving ESG as a permitted investment consideration in regulated plans.

Two days ago, Wells Fargo moved to dismiss a class action lawsuit brought on behalf of  current Wells Fargo shareholders.  Bear with me here.

*In 2020 WF adopted a policy requiring that diverse candidates constitute at least half the interviewees for high-paying jobs; the definition of diversity was broad and included women also.

*It is alleged that some WF employees conducted interviews after some slots were filled so as to reach the 50% level of interviewees.

*The suit complains that WF propped up the price of its own stock by such practices, and failed to report that WF was not complying with its own DE policy; during this time of allegedly propped-up stock prices, WF repurchased its own shares.

*When it became clear that the WF policy was allegedly not being followed, the share price fell.  SO—the claim is that if WF had not lied about complying with its own policy, the price of the stock would have dropped earlier and then the price of redeeming the stock at inflated valuation cost the company an extra $4.1 billion dollars.  A breach of fiduciary duty by management is alleged.

Putting aside what appears to be a clever basis for the claim and putting aside whether alleged facts are true, this case demonstrates another subtle way  in which ESG can  become relevant in the securities markets– all without regard to the question of whether ESG outside of investment practices is or is not a social benefit.

Who Can Sue if a Registration Statement is Misleading?

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For a long time, it has been settled law that if you bought shares on a public offering and if the prospectus was materially deficient, and if then the price of the shares you purchased fell, then you the investor had a claim for damages under applicable Federal securities laws.  It also seemed clear that this claim was for the benefit of purchases of shares covered by that erroneous filing.

It also was thought that, if someone purchased shares not issued pursuant to the incorrect prospectus, then the purchaser could not make a claim for losses arising from that prospectus since the purchased shares were not “covered” by the disclosures therein.

The US Supreme Court is soon to hear arguments over whether a purchaser of shares of the same class as those covered in the prospectus but not included in the registered securities, and who bought such shares at a higher price because of that erroneous prospectus, can claim damages by reason of buying shares NOT covered by that public offering.  In this case, the shares had not been previously registered and were thus by definition issued under the prospectus.  To decide in favor of the plaintiff would upset Federal law in the seven Federal circuits which have decided such a case and also per a prior SCOTUS decision.

If the Supreme Court decides that unregistered shares are transferred subject to the accuracy of public disclosures in a prospectus, then the potential plaintiff class is greatly expanded, as is the risk of the issuing company; the company then would be in effect making representations of facts to all of its shareholders.  The impact of such a determination on disclosure by registrants, risk metrics considered by underwriters, and the cost of insurance is not known but is potentially material.

Ivy League Athletes Sue Colleges for Price Fixing?

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I am not making this up.

It was reported two days ago that two Ivy League student athletes, a male and a female it seems, have sued all eight Ivy League schools, asserting a class action on behalf of more than 10,000 of their cohorts, claiming  –  wait for it — wait for it —claiming an agreement among those schools (via action of the Ivy League Council of Presidents)  to not grant Ivy Division 1 athletes an athletic scholarship or other incentives to attend, the injury to two distinct classes being that the cost of education increases and that compensation received by the athletes decreases.

Both named claimants, btw, seemingly did receive need-based financial help from their school (Brown, which is in Rhode Island while the litigation was filed in Connecticut where only Yale resides, for no doubt tactical reasons unknown to this writer).

To be fair, the Sherman Act (enacted I recall in 1890 when college students who might have raised this argument at that time would likely have been caned and then expelled) does prohibit price competition in relevant markets; and it is alleged that there are two markets here: smart kids who want to play Division 1 sports and athletic services provided by those students who are admitted.

To date there has been just one response from the Ivy League, which I find interesting but really not on point: it suggests that athletic scholarships might be taxable income to the students.

Given the intense scrutiny of university discrimination by our current US Supreme Court, it is interesting to speculate what they might do with this claim if it gets that far. Stay tuned (or not if you have bigger fish to fry, but I am going to follow this as it is just so darned interesting).