Among the most distinctive and important securities class action lawsuit filing trends this year has been the influx of new lawsuit based on alleged AI-related misrepresentations. In the latest example, on October 15, 2024, a plaintiff shareholder filed a securities class action lawsuit against China-based AI and robotics company, Xiao-I, in which the shareholder alleged financial reporting issues and also that the company overstated its AI capabilities. A copy of the October complaint against the company can be found here.
Background
Xiao-I is organized under the laws of the Cayman Islands with its headquarters in China. Xioa-I operates through subsidiaries. Its Shanghai Xaio-I Robot Technology Co. Ltd. (Shanghai Xiao) comprises the company’s AI business. Xiao-I completed an IPO in the U.S. on March 9, 2023, after which it shares were publicly traded on Nasdaq. In its IPO documents, the company self-identified its Shanghai Xiao subsidiary an industry leader in AI technologies and robotics research and development.
As a result of its corporate structure, the company transfers cash and other assets between itself and its subsidiaries, including Shanghai Xiao. However, its ability to do so is limited as a result of certain of its Chinese shareholders’ non-compliance with applicably Chinese foreign exchange rules (particularly a rule set out in “Circular 37”).
As a listed company, Xiao-I is subject to the Nasdaq listing requirements, including the requirement to maintain a minimum closing bid price of $1.00 per share, as well as the requirement to comply with GAAP. In July 2023, the SEC issued a letter to the company citing the company’s purported failure to comply with GAAP in its 2022 annual report, and the failure to include complete disclosure regarding its Chinese shareholders’ non-compliance with Circular 37.
In September 2023 and October 2023 press releases, the company reported its financial results, among other things disclosing that its operating expenses had increased 355% and its R&D expenses had increased 708%. In its October press release, the company explained these increases, saying that OpenAI’s November 2022 launch of ChatGPT had forced the company to increase its investments in research and development. In its April 2024 financial results press release, the company announced further increases in its expenses and R&D costs. On July 15, 2024, the company disclosed that it had received a notice from Nasdaq that it was out of compliance with the minimum bid requirement. According to the complaint at the time of each of these various disclosures, the company’s share price declined.
The Lawsuit
On October 15, 2024, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against the company, certain of its executives, and its offering underwriter. The complaint purports to be filed on behalf of a class of persons consisting of persons who purchased shares traceable to the company’s March 9, 2023, IPO or who purchased shares on the open market between March 9, 2023 and July 12, 2024.
The complaint alleges that in the IPO offering documents and during the class period, the defendants made false or misleading statements or failed to disclose that “(i) Defendants had downplayed the true scope and severity of risks that Xiao-I faced due to certain of its Chinese shareholders’ non-compliance with Circular 37 Registration, including the Company’s inability to use Offering proceeds for intended business purposes; (ii) Xiao-I failed to comply with GAAP in preparing its financial statements; (iii) Defendants overstated Xiao-I’s efforts to remediate material weaknesses in the Company’s financial controls; (iv) Xiao-I was forced to incur significant R&D expenses to effectively compete in the AI industry; (v) Xiao-I downplayed the significant negative impact that such expenses would have on the Company’s business and financial results; (vi) accordingly, Xiao-I overstated its AI capabilities, R&D resources, and overall ability to compete in the AI market; (viii) as a result of all the foregoing, there was a substantial likelihood that Xiao-I would fail to comply with the NASDAQ’s Minimum Bid Price Requirement; and (viii) as a result, the Offering Documents and Defendants’ public statements throughout the Class Period were materially false and/or misleading and failed to state information required to be stated therein.”
The plaintiff alleges that the defendants violated the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks to recover damages on behalf of the plaintiff class.
Discussion
There is no doubt that this lawsuit is about more than just the AI allegations. The financial reporting and accounting allegations would support a lawsuit against the defendants, even in the absence of the AI-related allegations. Nevertheless, the AI allegations are an important part of this lawsuit as filed. And there is not doubt that this lawsuit is AI-related; the complaint specifically and expressly alleges that the company “overstated its AI capabilities, R&D resources, and overall ability to compete in the AI market.”
While I have no trouble classifying this lawsuit as AI-related, the AI allegations are of a peculiar sort. Boiled down to their essence, the AI allegations are based on the increased spending the company was compelled to undertake as a result of new and unexpected competition. These kinds of ‘meeting competition” developments are not typical kinds of securities fraud allegations.
But whether or not the allegations fit general patterns, there is no doubt that this new lawsuit joins the ranks of the other AI-related lawsuits filed so far this year. According to the Stanford Law School Securities Class Action Clearinghouse, prior to the filing of this lawsuit, there were twelve AI-related securities suit filings so far this year, meaning that with the addition of this new lawsuit, there have now been thirteen AI-related suits this year. It is apparent that when the time comes to tally up all of the securities suit filings this year, the AI-related filings will have been an important contributor.
SEC Files Another AI-Related Enforcement Action: As I noted in a post late last week, the SEC has been active in pursuing AI-related enforcement actions. The SEC is at it again this week. On Monday, the agency filed an enforcement action against Destiny Robotics Corp., a robotics and artificial intelligence start-up, alleging that the company and its founder, Megi Kavtaradze, misled investors concerning the company’s ability to develop an AI-infused hologram and a robot to help families with childcare and other tasks. The company allegedly claimed that it was “making the world’s first humanoid robot and hologram assistance for household use,” supposedly “capable of forming ‘deep and meaningful relationships with humans.” The company claimed that it was using “cutting edge technology and AI.” The SEC alleged that none of this was true and that the companies’ products fell far short of representations. The company allegedly raised about $141,000 from investors, but the project and eventually the company were abandoned. The SEC’s complaint in the action can be found here.