section-11-12-liability-memo.docx

1008-00002 · Lumos Analytics Inc · Registration Statement

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PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT This memorandum constitutes attorney work product prepared by Calderwood & Harkness LLP in anticipation of litigation and in connection with the rendition of legal advice. It is protected from disclosure by the attorney-client privilege, the attorney work product doctrine, and all other applicable privileges. Any unauthorized review, use, disclosure, or distribution is strictly prohibited.

CALDERWOOD & HARKNESS LLP Attorneys at Law One Market Plaza, Suite 4800 San Francisco, California 94105

MEMORANDUM

To: File — Lumos Analytics Inc. IPO (Matter No. 1008-00002)

From: Robert Adeyemi, Responsible Partner, Capital Markets Group Audrey Zhou, Lead Associate, Capital Markets Group

Date: April 2022 (prepared in connection with the public filing of the Registration Statement on Form S-1/A, Amendment No. 1, filed April 14, 2022; updated through June 24, 2022 in connection with the withdrawal of the Registration Statement)

Re: Analysis of Potential Liability Exposure Under Sections 11 and 12(a)(2) of the Securities Act of 1933, as Amended — Proposed Initial Public Offering of Class A Common Stock of Lumos Analytics Inc.

SEC File Number: 333-264518

CIK: 0001923847

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I. Purpose and Scope of Memorandum

This memorandum is an internal Calderwood & Harkness LLP work product prepared in anticipation of the proposed initial public offering (the "IPO" or the "Offering") of Class A Common Stock, par value $0.0001 per share (the "Class A Common Stock"), of Lumos Analytics Inc. ("Lumos," the "Company," or the "Issuer"), a Delaware corporation, on the Nasdaq Global Select Market under the ticker symbol "LMSA." This memorandum was initially prepared in April 2022 in connection with the public filing of Amendment No. 1 to the Registration Statement on Form S-1 (File No. 333-264518) (the "Registration Statement" or the "S-1") and has been updated through June 24, 2022 to reflect the subsequent withdrawal of the Registration Statement.

The purpose of this memorandum is to analyze the potential liability exposure of the Company, its directors, its signing officers, the underwriters of the Offering, the selling stockholders, and experts (as such term is defined under the Securities Act of 1933, as amended (the "Securities Act")) under Sections 11 and 12(a)(2) of the Securities Act. This analysis is intended to inform the due diligence process, guide disclosure decisions, and provide a contemporaneous record of counsel's assessment of the adequacy of the disclosure contained in the Registration Statement.

The scope of this memorandum encompasses the following topics:

(a) identification of all persons potentially liable under Sections 11 and 12(a)(2) of the Securities Act;

(b) a detailed examination of the elements of liability under each statutory provision, including applicable burdens of proof;

(c) an analysis of available defenses, with particular focus on the due diligence defense under Section 11(b)(3), the negative causation defense under Section 11(e), and the reasonable care defense under Section 12(a)(2);

(d) the materiality standards applicable to the Offering, including both quantitative and qualitative considerations;

(e) an assessment of the adequacy of disclosure in the Registration Statement on Form S-1 (File No. 333-264518), as amended by Amendment No. 1 filed April 14, 2022, in each material respect;

(f) a summary of the due diligence program undertaken by the various parties to the Offering; and

(g) recommendations to mitigate liability risk, both in the context of a completed offering and in connection with the withdrawal of the Registration Statement.

This memorandum should be read together with the S-1 Disclosure Backup Memorandum (the "Disclosure Backup Memo") prepared by Audrey Zhou and Brendan Walsh of the Capital Markets Group, which provides a line-by-line analysis of the material disclosure in the Registration Statement and cross-references to the supporting documentation maintained in the deal file. The Disclosure Backup Memo is incorporated herein by reference for all purposes.

The Offering, as described in the Registration Statement, contemplated the following parameters:

• Primary Shares: 12,941,176 shares of Class A Common Stock to be offered and sold by the Company.

• Secondary Shares: 3,500,000 shares of Class A Common Stock to be offered and sold by selling stockholders, consisting of (i) 2,000,000 shares from Velthryn Venture Partners Fund IV, L.P. ("Velthryn") and (ii) 1,500,000 shares from Arclight Equity Group Fund VII, L.P. ("Arclight").

• Preliminary Price Range: $16.00 to $18.00 per share, with a midpoint of $17.00 per share.

• Overallotment Option: The underwriters were to be granted an option, exercisable for 30 days following pricing, to purchase up to an additional 2,466,176 shares of Class A Common Stock from the Company at the public offering price, less the underwriting discount.

• Gross Proceeds to Issuer: Approximately $220,000,000 at the $17.00 midpoint (before the exercise of the overallotment option).

• Underwriting discount: 6.5% of the public offering price, or approximately $14,300,000 on the primary shares at the $17.00 midpoint.

• Estimated Net Proceeds to Issuer: Approximately $200,900,000, after deduction of the underwriting discount and estimated offering expenses of approximately $4,800,000.

• Listing: Nasdaq Global Select Market, under the ticker symbol "LMSA."

As discussed in detail in Section VIII below, the Registration Statement was ultimately withdrawn pursuant to Rule 477 under the Securities Act, and no securities were sold thereunder. The Form RW requesting withdrawal was filed on June 10, 2022, and the Commission granted the withdrawal on June 15, 2022. Notwithstanding this withdrawal, this memorandum is being finalized and included in the due diligence file for the reasons set forth in Sections VIII and X below.

II. Overview of Statutory Framework

This Section provides an overview of the statutory framework governing liability for material misstatements and omissions in connection with a registered public offering of securities, with a focus on Sections 11 and 12(a)(2) of the Securities Act. These provisions are the primary sources of civil liability exposure in connection with an initial public offering and, accordingly, are the central focus of the due diligence process.

A. Section 11 of the Securities Act

Section 11 of the Securities Act, codified at 15 U.S.C. § 77k, provides a private right of action for any person who acquires a security issued pursuant to a registration statement that, at the time it became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.

Section 11 is the most potent source of civil liability in the context of a registered public offering. Its purpose, as articulated by the Supreme Court and by the legislative history of the Securities Act, is to ensure the completeness and accuracy of the information contained in registration statements by imposing significant potential liability on the persons responsible for the preparation and accuracy of those documents. The provision was enacted as part of the original Securities Act of 1933 in the aftermath of the market collapse of 1929, and it reflects a congressional determination that the investing public is entitled to rely on the completeness and accuracy of a registration statement without the need to prove fraud or even negligence on the part of the issuer.

Strict Liability for Issuers. With respect to the issuer of the securities, Section 11 imposes what is effectively strict liability. The issuer cannot assert a due diligence defense and is liable for any material misstatement or omission in the registration statement at the time it became effective, regardless of whether the issuer exercised reasonable care or had any knowledge of the misstatement or omission. No showing of scienter, negligence, or even awareness of the error is required to establish the issuer's liability.

Negligence-Based Liability for Non-Issuers. For non-issuer defendants — including directors, signing officers, underwriters, and experts — Section 11 imposes liability subject to the due diligence defense set forth in Section 11(b), discussed in detail in Section V.A below. The practical effect is that non-issuer defendants bear a burden of proof similar to, but in some respects more demanding than, ordinary negligence liability: they must affirmatively demonstrate the exercise of reasonable care, rather than requiring the plaintiff to prove the absence of such care.

Standing. Under Section 11(a), any person who acquires a security issued pursuant to the registration statement has standing to bring a claim. The plaintiff need not demonstrate reliance on the allegedly misleading statement unless the plaintiff acquired the security after the issuer made generally available an earnings statement covering a period of at least twelve months beginning after the effective date of the registration statement. This broad standing provision is designed to ensure that all purchasers of securities issued under the registration statement are protected, even those who may not have read the prospectus or the registration statement.

No Scienter Requirement. Unlike claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, a Section 11 claim does not require proof of scienter. The plaintiff need not demonstrate that any defendant acted with knowledge of the misstatement or with reckless disregard for the truth. This significantly lowers the plaintiff's burden of proof and correspondingly increases the risk of liability.

Measure of Damages. Section 11(e) provides for damages measured as the difference between the amount paid for the security (not exceeding the public offering price) and one of the following: (i) the value of the security at the time of suit; (ii) the price at which the security was disposed of in the market before suit; or (iii) the price at which the security was disposed of in the market after suit but before judgment, provided that the damages shall not exceed the amount of the decrease in market price attributable to the misstatement or omission. This formula effectively caps the plaintiff's recovery at the difference between the offering price and the value of the security, with the further limitation that the defendant may prove that some or all of the decline in value resulted from factors unrelated to the misstatement or omission (the "negative causation" defense, discussed in Section V.B below).

Maximum Aggregate Exposure. For purposes of this Offering, the maximum aggregate exposure under Section 11 can be calculated as follows:

• Primary shares only: 12,941,176 shares × $17.00 per share (midpoint) = approximately $220,000,000.

• Total shares including secondary shares: 16,441,176 shares (12,941,176 primary + 3,500,000 secondary) × $17.00 per share = approximately $279,500,000.

• Total shares including overallotment: 18,907,352 shares (16,441,176 + 2,466,176 overallotment) × $17.00 per share = approximately $321,400,000.

These figures represent the theoretical maximum exposure and assume that every purchaser brings a claim, that the securities declined to zero value, and that no defendant successfully establishes a defense. In practice, actual exposure would be substantially lower in most scenarios. Nevertheless, these figures underscore the significance of the due diligence process and the importance of ensuring the accuracy and completeness of the Registration Statement.

B. Section 12(a)(2) of the Securities Act

Section 12(a)(2) of the Securities Act, codified at 15 U.S.C. § 77l(a)(2), provides a private right of action against any person who offers or sells a security by means of a prospectus or oral communication that includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading. The provision is available to any person purchasing the security from the defendant.

Privity Requirement. Unlike Section 11, Section 12(a)(2) requires privity between the plaintiff and the defendant. Specifically, the plaintiff must have purchased the security from the defendant or from a person who solicited the purchase, motivated at least in part by a desire to serve the financial interests of the seller. This requirement significantly limits the class of potential defendants under Section 12(a)(2) as compared to Section 11. In the context of an IPO, the statutory sellers typically include the issuer, the selling stockholders, and the underwriters. Whether other persons (such as directors, officers, or counsel) may be deemed statutory sellers or solicitors depends on the specific facts and circumstances, but in general, the courts have construed the privity requirement narrowly.

Negligence Standard. Section 12(a)(2) incorporates a negligence-based standard. The defendant may avoid liability by proving that it "did not know, and in the exercise of reasonable care could not have known, of such untruth or omission." This defense, commonly referred to as the "reasonable care" defense, is analogous in many respects to the due diligence defense available under Section 11(b), although the precise contours may differ depending on the jurisdiction and the nature of the defendant.

Remedy. The remedy under Section 12(a)(2) is rescission if the plaintiff still holds the security (i.e., the defendant must tender the purchase price in exchange for the return of the security) or damages if the security has been disposed of (i.e., the defendant must pay the difference between the purchase price and the disposition price). This rescissory remedy is a powerful tool for plaintiffs and creates a strong incentive for defendants to ensure the accuracy of the prospectus and any oral communications made in connection with the offering.

*Gustafson v. Alloyd Co. In Gustafson v. Alloyd Co.*, 513 U.S. 561 (1995), the Supreme Court held that Section 12(a)(2) applies to public offerings conducted pursuant to a registration statement, rather than to secondary market transactions or private sales. The Court construed the term "prospectus" in Section 12(a)(2) to refer to the document described in Section 10 of the Securities Act — i.e., the statutory prospectus included in a registration statement — rather than to any written communication used in the sale of a security. This holding limits the scope of Section 12(a)(2) to public offerings and confirms that it does not provide a general remedy for fraud in secondary market transactions, which are instead governed by the anti-fraud provisions of the Exchange Act.

C. Relationship Between Sections 11 and 12(a)(2)

Sections 11 and 12(a)(2) are complementary provisions that together provide comprehensive coverage of the liability risks arising in connection with a registered public offering. Each provision reaches somewhat different conduct and involves somewhat different elements, standing requirements, and defenses, but there is substantial overlap in the context of an IPO.

Section 11 is tied specifically to the registration statement. Liability attaches if the registration statement, at the time it became effective, contained a material misstatement or omission. The provision covers all persons who acquired securities issued under the registration statement, regardless of privity, and imposes strict liability on the issuer.

Section 12(a)(2) is tied to the prospectus and oral communications. Liability attaches if a prospectus or oral communication used in connection with the offering contained a material misstatement or omission. The provision requires privity but is potentially broader in scope than Section 11 in one significant respect: it reaches oral communications made in connection with the offering, which are not covered by Section 11.

In the context of the Lumos IPO, both provisions would be relevant. The Registration Statement (and the prospectus forming a part thereof) would be subject to scrutiny under Section 11, while the prospectus and any oral communications made during the testing-the-waters meetings and road show presentations would be subject to scrutiny under Section 12(a)(2). The overlap between the two provisions means that the same misstatement or omission could give rise to claims under both sections, although the practical consequences of a dual claim may differ depending on the identity of the defendant and the available defenses.

Both Section 11 and Section 12(a)(2) claims are subject to the statute of limitations set forth in Section 13 of the Securities Act, 15 U.S.C. § 77m. Under Section 13, claims must be brought within one year after the discovery of the untrue statement or omission (or after such discovery should have been made by the exercise of reasonable diligence), but in no event more than three years after the security was bona fide offered to the public. In the case of a Section 11 claim, the three-year period runs from the effective date of the registration statement; in the case of a Section 12(a)(2) claim, it runs from the date of the sale.

III. Identification of Potentially Liable Persons

This Section identifies all persons who would be potentially liable under Sections 11 and 12(a)(2) of the Securities Act in connection with the Lumos IPO, had the Offering been completed. A detailed chart of potentially liable persons with maximum exposure calculations is set forth in Appendix A to this memorandum.

A. The Issuer — Lumos Analytics Inc.

Lumos Analytics Inc. is a Delaware corporation, incorporated on March 14, 2016, with its principal executive offices located at 450 Folsom Street, Suite 1200, San Francisco, California 94105. The Company's Employer Identification Number (EIN) is 82-3194567, and its Delaware file number is 6281934. The Company is registered with the Commission under CIK number 0001923847.

Section 11 Liability. Under Section 11(a)(1), the issuer is strictly liable for material misstatements or omissions in the Registration Statement at the time it became effective. As noted above, the issuer is unique among Section 11 defendants in that it cannot assert a due diligence defense. Regardless of the care exercised by the Company in preparing the Registration Statement, and regardless of whether the Company had knowledge of or reason to know of any misstatement or omission, the Company would be liable under Section 11 if the Registration Statement contained a material misstatement or omission at the time of effectiveness. This strict liability standard reflects the congressional judgment that the issuer, as the entity with the most direct access to and control over the information contained in the registration statement, should bear the ultimate risk of inaccuracy.

Section 12(a)(2) Liability. The Company would also be liable under Section 12(a)(2) as a statutory seller with respect to the primary shares sold in the Offering. As the entity offering and selling 12,941,176 shares of Class A Common Stock, the Company would be in privity with each purchaser of a primary share and would be subject to claims for rescission or damages in the event that the prospectus or any oral communication used in connection with the Offering contained a material misstatement or omission.

Maximum Exposure. The Company's maximum exposure under Section 11 is the full amount of the gross offering proceeds, including both primary and secondary shares (since the issuer's liability is not limited to the shares it sold). However, as a practical matter, the Company's primary financial exposure would be determined by the gross proceeds received from the primary shares — approximately $220,000,000 at the $17.00 midpoint. The Company would also bear exposure for the secondary shares and any overallotment shares, although the selling stockholders and underwriters would bear proportionate liability for those shares under the contribution framework of Section 11(f).

B. Signing Officers

The following persons signed the Registration Statement, as required by Section 6(a) of the Securities Act:

• Priya Subramanian, Chief Executive Officer, Co-Founder, and Chair of the Board of Directors — signed as both the principal executive officer and as a director.

• David Lau, Chief Financial Officer — signed as both the principal financial officer and the principal accounting officer.

Under Section 11(a)(2), every person who signed the registration statement is potentially liable for material misstatements or omissions contained therein. The act of signing the Registration Statement is a statutory predicate for liability, and the signer need not have any other role in the offering. However, as discussed in Section V below, signing officers are entitled to assert the due diligence defense under Section 11(b). As officers of the Company with direct responsibility for the accuracy of the Company's disclosures, Ms. Subramanian and Mr. Lau would be held to a high standard of care in establishing that defense. Courts have consistently recognized that officers who sign a registration statement are presumed to have the most complete knowledge of the company's affairs and, accordingly, must demonstrate that they conducted a thorough and meaningful investigation of the disclosure contained in the Registration Statement.

C. Directors at Time of Filing

All members of the Board of Directors at the time the Registration Statement was filed (or became effective) are potentially liable under Section 11(a)(3), regardless of whether they individually signed the Registration Statement. The following seven individuals served as directors of Lumos at the relevant time:

1. Priya Subramanian — Chair of the Board, Co-Founder, and Chief Executive Officer. Ms. Subramanian is both a signing officer and a director and is therefore subject to liability under both Section 11(a)(2) and Section 11(a)(3). As an inside director with day-to-day management responsibility, she would be held to the highest standard of care among the directors for purposes of the due diligence defense.

2. Marcus Henley — Director, Co-Founder, and Chief Technology Officer. Mr. Henley is an inside director with responsibility for the Company's technology platform and product development. Although he did not sign the Registration Statement (having been named as a director but not as a signing officer), he is liable as a director under Section 11(a)(3). As an inside director, he would be held to a higher standard than the outside directors.

3. Diane Ochoa — Independent Director; Managing Partner of Ridgeline Capital Partners Fund II, L.P. ("Ridgeline"). Ms. Ochoa was designated to the Board by Ridgeline pursuant to the Investors' Rights Agreement. Although classified as independent under the Nasdaq listing standards, Ms. Ochoa's affiliation with Ridgeline, a significant pre-IPO investor, may subject her to more searching inquiry under the due diligence analysis, given her financial sophistication and access to information through her role as Managing Partner of the fund.

4. Samuel Adebayo — Independent Director; former Chief Financial Officer of Verdant Software Corp. Mr. Adebayo serves as Chair of the Audit Committee. His extensive financial expertise and accounting background may be relevant to the standard of care applicable to his review of the financial disclosure in the Registration Statement, although courts have not uniformly imposed a heightened standard on directors solely by reason of professional expertise.

5. Catherine Mercer — Independent Director; Operating Partner of Arclight Equity Group Fund VII, L.P. Ms. Mercer's affiliation with Arclight, one of the selling stockholders in the Offering, creates a potential conflict of interest and may subject her to heightened scrutiny under the due diligence analysis. As an Operating Partner of one of the selling funds, she has direct access to information regarding the fund's investment thesis and involvement with the Company.

6. Jonathan Tsai — Director and designee of Velthryn Venture Partners; Managing Partner, Velthryn Venture Partners. Mr. Tsai was designated to the Board by Velthryn pursuant to the Investors' Rights Agreement. As the Managing Partner of the largest selling stockholder and a significant pre-IPO investor (approximately 21.0% pre-IPO ownership), Mr. Tsai occupies a dual role that may subject him to heightened scrutiny. Courts have recognized that directors affiliated with significant investors may have access to information — and financial incentives — that warrant a more demanding application of the due diligence standard.

7. Rebecca Stahl — Director and designee of Arclight Equity Group; Partner, Arclight Equity Group. Ms. Stahl was designated to the Board by Arclight pursuant to the Investors' Rights Agreement. Like Mr. Tsai, her dual role as a director and a principal of a selling stockholder creates potential conflicts and may result in heightened scrutiny under the due diligence analysis.

Each of the foregoing directors is entitled to assert the due diligence defense under Section 11(b). The application of that defense to the various categories of directors — inside directors, outside/independent directors, and affiliate directors — is discussed in detail in Section V.A.2 below.

Note on Dual Roles. We observe that several directors serve in dual capacities that may complicate the due diligence analysis. Ms. Ochoa, although classified as independent, is affiliated with Ridgeline. Mr. Tsai is the Managing Partner of the general partner of Velthryn. Ms. Stahl and Ms. Mercer are both affiliated with Arclight. These affiliations create the potential for heightened scrutiny under the due diligence defense, as courts may conclude that such directors had greater access to information and more powerful financial incentives than truly independent, unaffiliated outside directors.

D. Selling Stockholders

Two selling stockholders are named in the Registration Statement:

1. Velthryn Venture Partners Fund IV, L.P. — a Delaware limited partnership selling up to 2,000,000 shares of Class A Common Stock in the Offering. The general partner of Velthryn is Velthryn Venture Partners Management IV, LLC, a Delaware limited liability company. The principal of the general partner is Jonathan Tsai, who also serves as a director of Lumos. Velthryn holds approximately 21.0% of the Company's pre-IPO equity on a fully diluted basis.

2. Arclight Equity Group Fund VII, L.P. — a Delaware limited partnership selling up to 1,500,000 shares of Class A Common Stock in the Offering. The general partner of Arclight is Arclight Equity Management VII, LLC, a Delaware limited liability company. The principals of the general partner include Rebecca Stahl (who serves as a director of Lumos) and Catherine Mercer (who serves as a director of Lumos as an Operating Partner of Arclight).

Section 12(a)(2) Liability. The selling stockholders are potentially liable under Section 12(a)(2) as statutory sellers of their respective shares. Each selling stockholder is in privity with the purchasers of the shares it offers and sells, and each would be subject to claims for rescission or damages if the prospectus (or any oral communication made in connection with the sale) contained a material misstatement or omission. The selling stockholders' liability under Section 12(a)(2) is limited to the consideration received for their respective shares:

• Velthryn: up to 2,000,000 shares × $17.00 per share = $34,000,000

• Arclight: up to 1,500,000 shares × $17.00 per share = $25,500,000

Potential Section 11 Liability. To the extent the selling stockholders signed the Registration Statement (or authorized its signing by power of attorney), they may also be treated as persons who signed the Registration Statement under Section 11(a)(2). We note that each selling stockholder signed the Registration Statement through its authorized representative pursuant to a power of attorney, as is customary for selling stockholders in registered offerings. This signature exposes the selling stockholders to Section 11 liability, although their financial exposure under Section 11 remains subject to the applicable damage limitations and contribution provisions.

E. Underwriters

Under Section 11(a)(5), every underwriter with respect to the securities is potentially liable for material misstatements or omissions in the Registration Statement. The following entities comprise the underwriting syndicate for the Offering:

1. Pinnacle Securities LLC — Lead Book-Running Managing Underwriter. Pinnacle is a full-service investment bank and broker-dealer registered with the Commission and a member of FINRA. The managing directors responsible for this engagement are Andrew Castellano (Coverage) and Lisa Drummond (Equity Capital Markets). Pinnacle's principal offices are located at 399 Park Avenue, New York, New York 10022. As lead book-runner, Pinnacle would bear the largest share of the underwriting commitment and, correspondingly, the largest share of potential liability among the syndicate members.

2. Whitfield & Company LLC — Joint Book-Running Managing Underwriter. Whitfield is a registered broker-dealer and FINRA member. The managing director responsible for this engagement is Derek Kaplan. Whitfield's principal offices are located at 200 Vesey Street, 38th Floor, New York, New York 10281. As joint book-runner, Whitfield shares lead responsibility for the marketing and distribution of the Offering.

3. Graystone Capital Markets Inc. — Co-Manager. Graystone is a registered broker-dealer and FINRA member. The managing director responsible for this engagement is Hannah Morales. Graystone's principal offices are located at 140 Broadway, 30th Floor, New York, New York 10005. As co-manager, Graystone's underwriting commitment and corresponding liability exposure are smaller than those of the book-running managers.

Section 11 Exposure. Under Section 11(e), the liability of each underwriter is limited to the total price at which the securities underwritten by such underwriter and distributed to the public were offered to the public. The total underwriting discount for the Offering was 6.5% of the public offering price, resulting in an aggregate discount of approximately $14,300,000 on the primary shares at the $17.00 midpoint. The allocation of the underwriting commitment among the syndicate members would be governed by the Agreement Among Underwriters (the "AAU"), which was negotiated but never finalized in executed form. Based on the draft AAU, Pinnacle would bear approximately 55% of the commitment, Whitfield approximately 35%, and Graystone approximately 10%, although these allocations remained subject to final confirmation at pricing.

Due Diligence Standard. Underwriters are entitled to assert the due diligence defense under Section 11(b), but they are held to a particularly high standard of care as "gatekeepers" of the capital markets. As discussed in Section V.A.2 below, the seminal decisions in Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968), and In re WorldCom, Inc. Securities Litigation, 346 F. Supp. 2d 628 (S.D.N.Y. 2004), make clear that underwriters must conduct an independent investigation of the issuer's business, financial condition, and disclosure, and cannot merely rely on management's representations or delegate their due diligence obligations to counsel or the auditor.

Underwriters' Counsel. Hargrove & Liddell LLP ("H&L") serves as counsel to the underwriters in the Offering. The lead partner is Michael Sorrentino, and the lead associate is Anika Patel. H&L's role is to conduct due diligence on behalf of the underwriters, review the disclosure in the Registration Statement, and prepare the underwriter due diligence report. However, H&L itself is not a statutory person liable under Section 11 unless H&L is named as an "expert" in the Registration Statement (which it is not). H&L's work product is intended to support the underwriters' due diligence defense, but it does not relieve the underwriters of their independent obligation to conduct a meaningful investigation.

Section 12(a)(2) Liability. The underwriters are also potentially liable under Section 12(a)(2) as statutory sellers or solicitors of the securities. As the entities through which the shares are offered and sold to the public, the underwriters are in privity with the purchasers and would be subject to claims for rescission or damages. The reasonable care defense under Section 12(a)(2) is available to the underwriters, subject to the same heightened standard of care applicable under Section 11.

F. Experts

Under Section 11(a)(4), every person who has, with his or her consent, been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, is potentially liable with respect to those portions of the registration statement that purport to have been prepared or certified by such person.

The following persons qualify as "experts" for purposes of the Lumos Registration Statement:

1. Meridian & Howe LLP ("M&H") — Independent Registered Public Accounting Firm. M&H (audit partner: Gregory Simmons) audited the Company's consolidated financial statements for the fiscal years ended December 31, 2019, December 31, 2020, and December 31, 2021, and issued its audit report thereon, which is included in the Registration Statement. M&H has consented to the inclusion of its audit report in the Registration Statement, as required by Section 7 of the Securities Act and Rule 436 thereunder. M&H's principal offices are located at 555 Mission Street, Suite 2500, San Francisco, California 94105.

M&H's liability under Section 11 is limited to the "expertised" portions of the Registration Statement — i.e., the audited consolidated financial statements and the audit report. M&H is not liable under Section 11 for the non-expertised portions of the Registration Statement, including the MD&A, the risk factors, the business description, the prospectus summary, or any other narrative disclosure, even where such disclosure incorporates or refers to data derived from the audited financial statements. As discussed in Section V.A.2 below, M&H is entitled to assert the due diligence defense with respect to the expertised portions by demonstrating that, after reasonable investigation, it had reasonable ground to believe, and did believe, that the statements in its audit report were true and that there was no omission of a material fact.

2. Calderwood & Harkness LLP ("C&H") — Issuer's Counsel. C&H rendered a legal opinion on the validity of the Class A Common Stock being offered in the IPO, which was included as Exhibit 5.1 to the Registration Statement (as amended). To the extent that C&H is named as an expert with respect to this legal opinion, liability could attach under Section 11(a)(4) with respect to that "expertised" portion of the Registration Statement only.

Additionally, to the extent that a tax opinion prepared by Sylvia Hartwell of C&H's Tax Group is included in the Registration Statement and attributed to C&H, such opinion would also constitute an "expertised" portion subject to Section 11(a)(4) liability. As of the date of the filing of Amendment No. 1, no separate tax opinion was included as an exhibit, although certain tax disclosure in the Registration Statement is based upon the advice of C&H's Tax Group.

Important Distinction. C&H's broader role as drafter of the Registration Statement does not, standing alone, render C&H an "expert" as to the non-expertised portions of the Registration Statement. Under established case law, issuer's counsel is not a statutory defendant under Section 11 for non-expertised portions, and the mere fact that counsel drafted the disclosure does not create liability under Section 11(a)(4). In theory, issuer's counsel could face exposure under Section 12(a)(2) if deemed a statutory seller or solicitor, but existing case law uniformly holds that counsel's role in preparing the registration statement does not constitute "solicitation" for purposes of Section 12(a)(2). See Pinter v. Dahl, 486 U.S. 622 (1988) (defining the scope of statutory seller under Section 12); see also In re Craftmatic Securities Litigation, 890 F.2d 628 (3d Cir. 1989). Accordingly, C&H's liability exposure under Sections 11 and 12 is limited to the expertised portions of the Registration Statement identified above, and is further limited by the due diligence defense available to experts under Section 11(b).

IV. Materiality Standards

The question of materiality is central to any analysis of potential liability under Sections 11 and 12(a)(2) of the Securities Act. Both provisions require that the alleged misstatement or omission be "material" in order to give rise to liability. This Section sets forth the applicable legal standards for materiality and applies those standards to the key areas of disclosure in the Lumos Registration Statement.

A. Legal Standard

The materiality standard applicable to claims under the Securities Act was established by the Supreme Court in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), and confirmed in Basic Inc. v. Levinson, 485 U.S. 224 (1988). Under this standard, a fact is material if there is a "substantial likelihood that a reasonable investor would consider it important in making an investment decision." The standard does not require that the misstatement or omission would have been determinative of the investor's decision; rather, the test is whether the information would have "significantly alter[ed] the 'total mix' of information made available" to the investor. TSC Industries, 426 U.S. at 449.

This standard is deliberately qualitative and context-dependent. It requires an assessment of whether the information in question, viewed in light of all the surrounding circumstances, would have been significant to a reasonable investor. The standard recognizes that materiality is a mixed question of law and fact and that the analysis must take into account the specific characteristics of the issuer, the industry, and the transaction.

In Omnicare, Inc. v. Laborers District Council Constructing Industry Pension Fund, 575 U.S. 175 (2015), the Supreme Court addressed the application of the materiality standard to opinion statements in registration statements. The Court held that opinion statements are actionable under Section 11 in two circumstances:

(a) where the speaker did not actually hold the stated belief at the time the statement was made (a subjective falsity theory); or

(b) where the statement, although reflecting a sincerely held belief, omits material facts about the speaker's inquiry into or knowledge of the subject matter that conflict with what a reasonable investor would take from the statement in context (an omission-based theory).

The Omnicare decision is particularly relevant to the Lumos Registration Statement because the prospectus contains numerous opinion statements and forward-looking statements, including statements about the Company's competitive position, market opportunity, growth trajectory, and path to profitability. Under Omnicare, these statements must not only reflect the speaker's actual beliefs but must also be accompanied by sufficient disclosure of the underlying facts and assumptions to avoid creating a misleading impression in the mind of a reasonable investor.

B. Quantitative and Qualitative Factors

The Commission's Staff Accounting Bulletin No. 99, "Materiality" (August 12, 1999), provides important guidance on the application of the materiality standard in the context of financial reporting. SAB 99 makes clear that materiality is not solely a quantitative determination and that a mechanical application of percentage thresholds (such as the commonly cited 5% of net income benchmark) is insufficient. Instead, materiality must be assessed in light of both quantitative and qualitative factors.

Among the qualitative factors identified in SAB 99 as potentially rendering a quantitatively small misstatement material are the following:

• whether the misstatement or omission masks a change in earnings or other trends;

• whether the misstatement or omission hides a failure to meet analysts' consensus expectations;

• whether the misstatement or omission changes a loss into income or vice versa;

• whether the misstatement or omission concerns a segment or other portion of the business that has been identified as playing a significant role in the company's operations or profitability;

• whether the misstatement or omission involves concealment of an unlawful transaction;

• whether the misstatement or omission affects the company's compliance with regulatory requirements; and

• whether the misstatement or omission affects the company's compliance with loan covenants or other contractual obligations.

This last factor is particularly relevant to Lumos in light of the Company's revolving credit facility with Ashford National Bank (the "Ashford Facility"). The Ashford Facility provides for a $50 million commitment (approximately $15 million drawn as of March 31, 2022) at a rate of SOFR + 275 basis points, maturing June 1, 2024. The Ashford Facility contains financial covenants, and any misstatement that affects the Company's reported compliance with those covenants could be material under the qualitative analysis set forth in SAB 99, even if the misstatement is quantitatively small.

Revenue Concentration. As disclosed in the Registration Statement, the Company's top 10 customers represent approximately 34% of annual recurring revenue ("ARR"). This level of customer concentration creates a material risk of revenue loss in the event that one or more significant customers terminates its subscription agreement or significantly reduces its usage. The Company has approximately 340 enterprise customers globally, and the loss of a major customer — or a failure to retain or expand relationships with existing customers — could have a material adverse effect on the Company's business, financial condition, and results of operations. This concentration risk must be assessed in the context of the overall materiality analysis to ensure that the Registration Statement adequately discloses the nature and magnitude of the risk.

C. Application to the Lumos S-1

The following areas of disclosure in the Lumos Registration Statement are particularly sensitive from a materiality perspective, and each has been the subject of careful review as part of the due diligence process:

1. Revenue Recognition Policies and ARR Methodology. The Company's revenue recognition policies under ASC 606 and its methodology for calculating ARR are critical to investors' understanding of the Company's financial performance and growth trajectory. The Company reported FY 2021 ARR of $206.8 million and Q1 2022 ARR of $219.5 million. Any misstatement in the methodology used to calculate ARR, or any inconsistency between the ARR figures and the Company's actual contractual commitments, could be material. We have reviewed the Company's ARR methodology and believe that the disclosure in the Registration Statement is accurate and consistent with the methodology described in the footnotes to the consolidated financial statements.

2. Non-GAAP Financial Measures. The Company presents Adjusted EBITDA as a key non-GAAP financial measure, which was $(18.7) million for FY 2021. The presentation of non-GAAP measures is governed by Regulation G and Item 10(e) of Regulation S-K, which require a reconciliation to the most directly comparable GAAP measure and a discussion of why management believes the non-GAAP measure is useful to investors. We have reviewed the Adjusted EBITDA reconciliation and believe it complies with applicable requirements. The SEC Staff's first comment letter (received February 14, 2022) included comments on the non-GAAP reconciliation, which were addressed in the Company's response letter dated March 4, 2022 and in the amended confidential draft registration statement.

3. History of Net Losses and Path to Profitability. The Company has a history of significant net losses. The Company reported a net loss of $(41.2) million for FY 2021 and a net loss of $(13.8) million for Q1 2022. The Company has never achieved profitability on an annual basis. The Registration Statement includes risk factor disclosure and MD&A discussion regarding the Company's history of losses, its expectation that losses may continue, and the uncertainty regarding the Company's ability to achieve profitability in the future. We believe this disclosure is adequate and consistent with the Company's actual financial condition, although the sensitivity of this issue is amplified by the general market environment for unprofitable growth-stage technology companies.

4. Revenue Growth Deceleration. The Company's year-over-year revenue growth rate decelerated from 58% (FY 2020 to FY 2021: $118.6 million to $187.4 million) to 40% (Q1 2021 to Q1 2022: $39.2 million to $54.9 million). This deceleration is a material trend that could affect investors' assessment of the Company's growth trajectory and valuation. The MD&A section of the Registration Statement addresses this deceleration and discusses the factors contributing to the slower growth rate, including the maturation of the customer base and the lengthening of enterprise sales cycles. We believe the disclosure is adequate but have recommended that management continue to monitor and update the disclosure as additional financial data becomes available.

5. Dual-Class Voting Structure. The Company's capital structure includes Class A Common Stock (1 vote per share) and Class B Common Stock (10 votes per share). The Class B Common Stock is held exclusively by the Company's founders, Priya Subramanian (16,500,000 Class B shares) and Marcus Henley (12,000,000 Class B shares). Following the completion of the IPO, the founders would hold approximately 73.5% of the total voting power of the Company (approximately 285,000,000 votes out of a total of approximately 387,641,176 votes), notwithstanding their ownership of a substantially smaller percentage of the total economic interest. The dual-class structure is fully disclosed in the Registration Statement, including the risk factors, the description of capital stock, and the prospectus summary. The sunset provision, which provides for the automatic conversion of Class B shares into Class A shares upon the earliest of (i) seven years following the completion of the IPO, (ii) a transfer of Class B shares to a non-permitted transferee, or (iii) the founders collectively holding less than 10% of the outstanding shares of common stock, is also disclosed.

6. Sunset Provision on Class B Shares. As noted above, the sunset provision is disclosed in the Registration Statement. We have reviewed the draft Amended and Restated Certificate of Incorporation to confirm that the sunset provision is accurately described.

7. Related-Party Transactions. The Registration Statement discloses the related-party transactions involving Velthryn Venture Partners, Arclight Equity Group, and Ridgeline Capital Partners, including the investor rights agreements, registration rights agreements, and board designation rights. Additionally, the indemnification agreements entered into between the Company and its directors and officers are disclosed. We have reviewed these transactions and believe the disclosure complies with the requirements of Item 404 of Regulation S-K. The SEC comment letter process included questions regarding the related-party transactions, which were addressed in the Company's response.

8. Stock-Based Compensation and Cheap Stock Analysis. The Company's equity incentive plan authorizes the issuance of up to 14,800,000 shares, of which 11,300,000 options were outstanding at a weighted-average exercise price ("WAEP") of $4.82 per share. The gap between the WAEP and the proposed IPO price range ($16.00 to $18.00, midpoint $17.00) raises "cheap stock" issues, as the SEC Staff may question whether the Company's historical stock-based compensation charges were adequately recognized in connection with options granted at exercise prices below the fair value implied by the IPO price range. The Company's Series D preferred stock round was priced at $12.50 per share, creating a narrower (but still significant) gap with the IPO price range. The SEC Staff's second comment letter (received March 18, 2022; 12 comments) included comments on the cheap stock analysis, and the Company's response included a retrospective fair value analysis supporting the exercise prices of the options granted during the relevant periods.

9. Customer Concentration Risk. As noted above, the Company's top 10 customers represent approximately 34% of ARR. The Registration Statement discloses this concentration risk in the risk factors section. We have recommended that the Company consider whether any single customer accounts for more than 10% of revenue (which would require specific identification under Item 101(c)(1)(vii) of Regulation S-K) and have been informed by management that no single customer exceeds this threshold.

10. Material Contracts. The Registration Statement identifies and describes the Company's material contracts, including (a) the Brindoval Data Centers LLC agreement (a five-year infrastructure hosting agreement with an annual minimum commitment of $8.2 million), (b) the Nordwell Financial Technologies Inc. strategic partnership (a three-year initial term technology partnership), and (c) the Ashford National Bank revolving credit facility ($50 million commitment, approximately $15 million drawn as of March 31, 2022, bearing interest at SOFR + 275 basis points, maturing June 1, 2024). We have reviewed these contracts and believe the disclosure is accurate and adequate.

11. intellectual Property. The Company's intellectual property portfolio consists of 14 issued U.S. utility patents, 7 pending patent applications, and registered trademarks (including Lumos, Lumos AI, LumosIQ, and FraudLens). The Registration Statement describes the Company's intellectual property and the risks associated with its protection and enforcement. We have reviewed the intellectual property portfolio with the assistance of C&H's intellectual property group and believe the disclosure is accurate and adequate.

V. Defenses

This Section analyzes the defenses available to the various categories of defendants under Sections 11 and 12(a)(2) of the Securities Act. The due diligence defense under Section 11(b) is the most significant defense for non-issuer defendants and is the primary driver of the due diligence process. Additional defenses, including the negative causation defense under Section 11(e), the reasonable care defense under Section 12(a)(2), the statute of limitations defense under Section 13, and control person liability under Section 15, are also discussed.

A. Due Diligence Defense — Section 11(b)

1. General Framework

Section 11(b) provides that a non-issuer defendant may avoid liability by establishing that, after reasonable investigation, such defendant had reasonable ground to believe, and did believe, at the time the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading. The standard of "reasonableness" for purposes of this defense is defined by the statute as "that required of a prudent man in the management of his own property." 15 U.S.C. § 77k(c).

The due diligence defense is an affirmative defense, meaning that the burden of proof rests on the defendant to demonstrate compliance with the statutory standard. The defendant must show both (a) that it conducted a reasonable investigation and (b) that, based on that investigation, it had reasonable ground to believe, and did believe, that the registration statement was accurate and complete. Both elements must be satisfied; it is not sufficient to demonstrate a general process of investigation without also demonstrating that the investigation produced a reasonable basis for the defendant's belief in the accuracy of the disclosure.

The due diligence defense operates differently depending on whether the portion of the registration statement at issue is an "expertised" or "non-expertised" portion:

Expertised Portions. For portions of the registration statement that are prepared or certified by an expert (such as the audited financial statements and audit report prepared by M&H), non-expert defendants need only show that they "had no reasonable ground to believe and did not believe" that there was a misstatement or omission. This is a "reliance" standard — the non-expert defendant may rely on the expert's work product unless the defendant had reason to believe that the expert's work was unreliable or that the expertised portion contained a material error. This is a significantly lower bar than the affirmative investigation required for non-expertised portions.

Non-Expertised Portions. For all portions of the registration statement that are not expertised (including the prospectus summary, risk factors, MD&A, business description, description of capital stock, and all other narrative disclosure), every non-issuer defendant must demonstrate that it conducted a reasonable investigation. This requires an affirmative, meaningful inquiry into the accuracy and completeness of the disclosure, not mere passive acceptance or cursory review.

2. Application to Specific Defendant Categories

The due diligence standard is not applied uniformly across all categories of defendants. The courts have recognized that the level of investigation required to satisfy the standard varies depending on the defendant's role, access to information, expertise, and relationship to the issuer. The following analysis applies the due diligence standard to the specific categories of defendants identified in Section III above.

Directors (including Ochoa, Adebayo, Mercer, Tsai, Stahl, Subramanian, and Henley).

The due diligence obligation of directors has been the subject of extensive judicial analysis, beginning with the landmark decision in Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968). The key principles established in BarChris and subsequent cases may be summarized as follows:

Inside Directors. Directors who are also officers of the company (in this case, Ms. Subramanian as CEO and Mr. Henley as CTO) are held to a higher standard of care than outside or independent directors. Inside directors are presumed to have access to the company's books and records, financial information, and operational details, and they are expected to have a thorough understanding of the company's business and financial condition. Inside directors cannot claim ignorance of material facts that were available to them in their capacity as officers. To satisfy the due diligence defense, inside directors must demonstrate that they were actively involved in the preparation and review of the registration statement, that they reviewed the disclosure for accuracy and completeness, and that they brought their knowledge of the company's affairs to bear on the review process. A perfunctory review or mere delegation to counsel is insufficient.

Outside/Independent Directors. Outside directors who have no management role or day-to-day involvement with the company (in this case, Mr. Adebayo) are held to a somewhat lower standard, reflecting their more limited access to information. However, BarChris makes clear that outside directors cannot simply "rubber stamp" the registration statement. They must conduct a meaningful review, ask appropriate questions of management and experts, and take reasonable steps to verify the accuracy of the disclosure. At a minimum, outside directors should demonstrate that they attended board meetings at which the registration statement was discussed, reviewed drafts of the registration statement, read and considered the due diligence materials made available to them, and made reasonable inquiries of management and the company's advisors.

Affiliate Directors. Directors who are affiliated with significant investors or selling stockholders present a more complex analysis. In this case, Mr. Tsai (Velthryn designee), Ms. Stahl (Arclight designee), Ms. Ochoa (Ridgeline affiliate), and Ms. Mercer (Arclight operating partner) each have dual loyalties and may possess information about the company's affairs that they obtained through their respective funds' involvement. Courts have applied a more searching inquiry to such directors, recognizing that their financial sophistication, industry experience, and access to information through the fund relationship may give them a greater ability to identify potential misstatements or omissions. Affiliate directors should be prepared to demonstrate not only that they conducted a meaningful review of the registration statement but also that they disclosed to the board any material information that they possessed by virtue of their fund affiliation.

Officers (Subramanian as CEO, Lau as CFO).

Officers who sign the registration statement are held to the highest standard of care among all non-issuer defendants. As the individuals most directly responsible for the accuracy of the company's financial and operational disclosures, signing officers are expected to have conducted a thorough and comprehensive review of the registration statement and to have brought their detailed knowledge of the company's affairs to bear on the review process.

Ms. Subramanian, as CEO and Co-Founder, has the broadest knowledge of the Company's business, strategy, and operations. Mr. Lau, as CFO and both the principal financial officer and the principal accounting officer, bears particular responsibility for the accuracy of the financial disclosure, including the financial statements, the MD&A, and the non-GAAP financial measures. To satisfy the due diligence defense, each signing officer should be prepared to demonstrate that he or she personally reviewed the registration statement in detail, verified the accuracy of the key factual statements, ensured the completeness of the risk factors and other disclosure items, and made inquiries of other members of management as appropriate.

We also note the potential exposure of two additional officers who did not sign the Registration Statement but participated extensively in its preparation:

• Naomi Feinberg, General Counsel and Corporate Secretary, coordinated the due diligence process and managed the SEC comment letter response process. Although Ms. Feinberg is not a signing officer and is not directly liable under Section 11(a)(2), she may be subject to liability as a "control person" under Section 15 of the Securities Act (discussed in Section V.E below) if she exercised actual control over the persons liable under Section 11.

• Tomás Aguilar, Chief Revenue Officer, provided significant input on the business description, customer metrics, and revenue-related disclosure. Like Ms. Feinberg, Mr. Aguilar is not a signing officer but could be subject to control person liability analysis if the facts establish that he exercised actual control.

Underwriters (Pinnacle Securities, Whitfield & Co., Graystone Capital Markets).

Underwriters occupy a unique pos

PRIVILEGED AND CONFIDENTIAL — ATTORNEY-CLIENT PRIVILEGE / ATTORNEY WORK PRODUCT This memorandum constitutes attorney work product prepared by Calderwood & Harkness LLP in anticipation of litigation and in connection with the rendition of legal advice. It is protected from disclosure by the attorney-client privilege, the attorney work product doctrine, and all other applicable privileges. Any unauthorized review, use, disclosure, or distribution is strictly prohibited.
CALDERWOOD & HARKNESS LLP Attorneys at Law One Market Plaza, Suite 4800 San Francisco, California 94105
MEMORANDUM
To: File — Lumos Analytics Inc. IPO (Matter No. 1008-00002)
From: Robert Adeyemi, Responsible Partner, Capital Markets Group Audrey Zhou, Lead Associate, Capital Markets Group
Date: April 2022 (prepared in connection with the public filing of the Registration Statement on Form S-1/A, Amendment No. 1, filed April 14, 2022; updated through June 24, 2022 in connection with the withdrawal of the Registration Statement)
Re: Analysis of Potential Liability Exposure Under Sections 11 and 12(a)(2) of the Securities Act of 1933, as Amended — Proposed Initial Public Offering of Class A Common Stock of Lumos Analytics Inc.
SEC File Number: 333-264518
CIK: 0001923847
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I. Purpose and Scope of Memorandum
This memorandum is an internal Calderwood & Harkness LLP work product prepared in anticipation of the proposed initial public offering (the "IPO" or the "Offering") of Class A Common Stock, par value $0.0001 per share (the "Class A Common Stock"), of Lumos Analytics Inc. ("Lumos," the "Company," or the "Issuer"), a Delaware corporation, on the Nasdaq Global Select Market under the ticker symbol "LMSA." This memorandum was initially prepared in April 2022 in connection with the public filing of Amendment No. 1 to the Registration Statement on Form S-1 (File No. 333-264518) (the "Registration Statement" or the "S-1") and has been updated through June 24, 2022 to reflect the subsequent withdrawal of the Registration Statement.
The purpose of this memorandum is to analyze the potential liability exposure of the Company, its directors, its signing officers, the underwriters of the Offering, the selling stockholders, and experts (as such term is defined under the Securities Act of 1933, as amended (the "Securities Act")) under Sections 11 and 12(a)(2) of the Securities Act. This analysis is intended to inform the due diligence process, guide disclosure decisions, and provide a contemporaneous record of counsel's assessment of the adequacy of the disclosure contained in the Registration Statement.
The scope of this memorandum encompasses the following topics:
(a) identification of all persons potentially liable under Sections 11 and 12(a)(2) of the Securities Act;
(b) a detailed examination of the elements of liability under each statutory provision, including applicable burdens of proof;
(c) an analysis of available defenses, with particular focus on the due diligence defense under Section 11(b)(3), the negative causation defense under Section 11(e), and the reasonable care defense under Section 12(a)(2);
(d) the materiality standards applicable to the Offering, including both quantitative and qualitative considerations;
(e) an assessment of the adequacy of disclosure in the Registration Statement on Form S-1 (File No. 333-264518), as amended by Amendment No. 1 filed April 14, 2022, in each material respect;
(f) a summary of the due diligence program undertaken by the various parties to the Offering; and
(g) recommendations to mitigate liability risk, both in the context of a completed offering and in connection with the withdrawal of the Registration Statement.
This memorandum should be read together with the S-1 Disclosure Backup Memorandum (the "Disclosure Backup Memo") prepared by Audrey Zhou and Brendan Walsh of the Capital Markets Group, which provides a line-by-line analysis of the material disclosure in the Registration Statement and cross-references to the supporting documentation maintained in the deal file. The Disclosure Backup Memo is incorporated herein by reference for all purposes.
The Offering, as described in the Registration Statement, contemplated the following parameters:
•  Primary Shares: 12,941,176 shares of Class A Common Stock to be offered and sold by the Company.
•  Secondary Shares: 3,500,000 shares of Class A Common Stock to be offered and sold by selling stockholders, consisting of (i) 2,000,000 shares from Velthryn Venture Partners Fund IV, L.P. ("Velthryn") and (ii) 1,500,000 shares from Arclight Equity Group Fund VII, L.P. ("Arclight").
•  Preliminary Price Range: $16.00 to $18.00 per share, with a midpoint of $17.00 per share.
•  Overallotment Option: The underwriters were to be granted an option, exercisable for 30 days following pricing, to purchase up to an additional 2,466,176 shares of Class A Common Stock from the Company at the public offering price, less the underwriting discount.
•  Gross Proceeds to Issuer: Approximately $220,000,000 at the $17.00 midpoint (before the exercise of the overallotment option).
•  Underwriting discount: 6.5% of the public offering price, or approximately $14,300,000 on the primary shares at the $17.00 midpoint.
•  Estimated Net Proceeds to Issuer: Approximately $200,900,000, after deduction of the underwriting discount and estimated offering expenses of approximately $4,800,000.
•  Listing: Nasdaq Global Select Market, under the ticker symbol "LMSA."
As discussed in detail in Section VIII below, the Registration Statement was ultimately withdrawn pursuant to Rule 477 under the Securities Act, and no securities were sold thereunder. The Form RW requesting withdrawal was filed on June 10, 2022, and the Commission granted the withdrawal on June 15, 2022. Notwithstanding this withdrawal, this memorandum is being finalized and included in the due diligence file for the reasons set forth in Sections VIII and X below.
II. Overview of Statutory Framework
This Section provides an overview of the statutory framework governing liability for material misstatements and omissions in connection with a registered public offering of securities, with a focus on Sections 11 and 12(a)(2) of the Securities Act. These provisions are the primary sources of civil liability exposure in connection with an initial public offering and, accordingly, are the central focus of the due diligence process.
A. Section 11 of the Securities Act
Section 11 of the Securities Act, codified at 15 U.S.C. § 77k, provides a private right of action for any person who acquires a security issued pursuant to a registration statement that, at the time it became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading.
Section 11 is the most potent source of civil liability in the context of a registered public offering. Its purpose, as articulated by the Supreme Court and by the legislative history of the Securities Act, is to ensure the completeness and accuracy of the information contained in registration statements by imposing significant potential liability on the persons responsible for the preparation and accuracy of those documents. The provision was enacted as part of the original Securities Act of 1933 in the aftermath of the market collapse of 1929, and it reflects a congressional determination that the investing public is entitled to rely on the completeness and accuracy of a registration statement without the need to prove fraud or even negligence on the part of the issuer.
Strict Liability for Issuers. With respect to the issuer of the securities, Section 11 imposes what is effectively strict liability. The issuer cannot assert a due diligence defense and is liable for any material misstatement or omission in the registration statement at the time it became effective, regardless of whether the issuer exercised reasonable care or had any knowledge of the misstatement or omission. No showing of scienter, negligence, or even awareness of the error is required to establish the issuer's liability.
Negligence-Based Liability for Non-Issuers. For non-issuer defendants — including directors, signing officers, underwriters, and experts — Section 11 imposes liability subject to the due diligence defense set forth in Section 11(b), discussed in detail in Section V.A below. The practical effect is that non-issuer defendants bear a burden of proof similar to, but in some respects more demanding than, ordinary negligence liability: they must affirmatively demonstrate the exercise of reasonable care, rather than requiring the plaintiff to prove the absence of such care.
Standing. Under Section 11(a), any person who acquires a security issued pursuant to the registration statement has standing to bring a claim. The plaintiff need not demonstrate reliance on the allegedly misleading statement unless the plaintiff acquired the security after the issuer made generally available an earnings statement covering a period of at least twelve months beginning after the effective date of the registration statement. This broad standing provision is designed to ensure that all purchasers of securities issued under the registration statement are protected, even those who may not have read the prospectus or the registration statement.
No Scienter Requirement. Unlike claims under Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 thereunder, a Section 11 claim does not require proof of scienter. The plaintiff need not demonstrate that any defendant acted with knowledge of the misstatement or with reckless disregard for the truth. This significantly lowers the plaintiff's burden of proof and correspondingly increases the risk of liability.
Measure of Damages. Section 11(e) provides for damages measured as the difference between the amount paid for the security (not exceeding the public offering price) and one of the following: (i) the value of the security at the time of suit; (ii) the price at which the security was disposed of in the market before suit; or (iii) the price at which the security was disposed of in the market after suit but before judgment, provided that the damages shall not exceed the amount of the decrease in market price attributable to the misstatement or omission. This formula effectively caps the plaintiff's recovery at the difference between the offering price and the value of the security, with the further limitation that the defendant may prove that some or all of the decline in value resulted from factors unrelated to the misstatement or omission (the "negative causation" defense, discussed in Section V.B below).
Maximum Aggregate Exposure. For purposes of this Offering, the maximum aggregate exposure under Section 11 can be calculated as follows:
•  Primary shares only: 12,941,176 shares × $17.00 per share (midpoint) = approximately $220,000,000.
•  Total shares including secondary shares: 16,441,176 shares (12,941,176 primary + 3,500,000 secondary) × $17.00 per share = approximately $279,500,000.
•  Total shares including overallotment: 18,907,352 shares (16,441,176 + 2,466,176 overallotment) × $17.00 per share = approximately $321,400,000.
These figures represent the theoretical maximum exposure and assume that every purchaser brings a claim, that the securities declined to zero value, and that no defendant successfully establishes a defense. In practice, actual exposure would be substantially lower in most scenarios. Nevertheless, these figures underscore the significance of the due diligence process and the importance of ensuring the accuracy and completeness of the Registration Statement.
B. Section 12(a)(2) of the Securities Act
Section 12(a)(2) of the Securities Act, codified at 15 U.S.C. § 77l(a)(2), provides a private right of action against any person who offers or sells a security by means of a prospectus or oral communication that includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading. The provision is available to any person purchasing the security from the defendant.
Privity Requirement. Unlike Section 11, Section 12(a)(2) requires privity between the plaintiff and the defendant. Specifically, the plaintiff must have purchased the security from the defendant or from a person who solicited the purchase, motivated at least in part by a desire to serve the financial interests of the seller. This requirement significantly limits the class of potential defendants under Section 12(a)(2) as compared to Section 11. In the context of an IPO, the statutory sellers typically include the issuer, the selling stockholders, and the underwriters. Whether other persons (such as directors, officers, or counsel) may be deemed statutory sellers or solicitors depends on the specific facts and circumstances, but in general, the courts have construed the privity requirement narrowly.
Negligence Standard. Section 12(a)(2) incorporates a negligence-based standard. The defendant may avoid liability by proving that it "did not know, and in the exercise of reasonable care could not have known, of such untruth or omission." This defense, commonly referred to as the "reasonable care" defense, is analogous in many respects to the due diligence defense available under Section 11(b), although the precise contours may differ depending on the jurisdiction and the nature of the defendant.
Remedy. The remedy under Section 12(a)(2) is rescission if the plaintiff still holds the security (i.e., the defendant must tender the purchase price in exchange for the return of the security) or damages if the security has been disposed of (i.e., the defendant must pay the difference between the purchase price and the disposition price). This rescissory remedy is a powerful tool for plaintiffs and creates a strong incentive for defendants to ensure the accuracy of the prospectus and any oral communications made in connection with the offering.
*Gustafson v. Alloyd Co. In Gustafson v. Alloyd Co.*, 513 U.S. 561 (1995), the Supreme Court held that Section 12(a)(2) applies to public offerings conducted pursuant to a registration statement, rather than to secondary market transactions or private sales. The Court construed the term "prospectus" in Section 12(a)(2) to refer to the document described in Section 10 of the Securities Act — i.e., the statutory prospectus included in a registration statement — rather than to any written communication used in the sale of a security. This holding limits the scope of Section 12(a)(2) to public offerings and confirms that it does not provide a general remedy for fraud in secondary market transactions, which are instead governed by the anti-fraud provisions of the Exchange Act.
C. Relationship Between Sections 11 and 12(a)(2)
Sections 11 and 12(a)(2) are complementary provisions that together provide comprehensive coverage of the liability risks arising in connection with a registered public offering. Each provision reaches somewhat different conduct and involves somewhat different elements, standing requirements, and defenses, but there is substantial overlap in the context of an IPO.
Section 11 is tied specifically to the registration statement. Liability attaches if the registration statement, at the time it became effective, contained a material misstatement or omission. The provision covers all persons who acquired securities issued under the registration statement, regardless of privity, and imposes strict liability on the issuer.
Section 12(a)(2) is tied to the prospectus and oral communications. Liability attaches if a prospectus or oral communication used in connection with the offering contained a material misstatement or omission. The provision requires privity but is potentially broader in scope than Section 11 in one significant respect: it reaches oral communications made in connection with the offering, which are not covered by Section 11.
In the context of the Lumos IPO, both provisions would be relevant. The Registration Statement (and the prospectus forming a part thereof) would be subject to scrutiny under Section 11, while the prospectus and any oral communications made during the testing-the-waters meetings and road show presentations would be subject to scrutiny under Section 12(a)(2). The overlap between the two provisions means that the same misstatement or omission could give rise to claims under both sections, although the practical consequences of a dual claim may differ depending on the identity of the defendant and the available defenses.
Both Section 11 and Section 12(a)(2) claims are subject to the statute of limitations set forth in Section 13 of the Securities Act, 15 U.S.C. § 77m. Under Section 13, claims must be brought within one year after the discovery of the untrue statement or omission (or after such discovery should have been made by the exercise of reasonable diligence), but in no event more than three years after the security was bona fide offered to the public. In the case of a Section 11 claim, the three-year period runs from the effective date of the registration statement; in the case of a Section 12(a)(2) claim, it runs from the date of the sale.
III. Identification of Potentially Liable Persons
This Section identifies all persons who would be potentially liable under Sections 11 and 12(a)(2) of the Securities Act in connection with the Lumos IPO, had the Offering been completed. A detailed chart of potentially liable persons with maximum exposure calculations is set forth in Appendix A to this memorandum.
A. The Issuer — Lumos Analytics Inc.
Lumos Analytics Inc. is a Delaware corporation, incorporated on March 14, 2016, with its principal executive offices located at 450 Folsom Street, Suite 1200, San Francisco, California 94105. The Company's Employer Identification Number (EIN) is 82-3194567, and its Delaware file number is 6281934. The Company is registered with the Commission under CIK number 0001923847.
Section 11 Liability. Under Section 11(a)(1), the issuer is strictly liable for material misstatements or omissions in the Registration Statement at the time it became effective. As noted above, the issuer is unique among Section 11 defendants in that it cannot assert a due diligence defense. Regardless of the care exercised by the Company in preparing the Registration Statement, and regardless of whether the Company had knowledge of or reason to know of any misstatement or omission, the Company would be liable under Section 11 if the Registration Statement contained a material misstatement or omission at the time of effectiveness. This strict liability standard reflects the congressional judgment that the issuer, as the entity with the most direct access to and control over the information contained in the registration statement, should bear the ultimate risk of inaccuracy.
Section 12(a)(2) Liability. The Company would also be liable under Section 12(a)(2) as a statutory seller with respect to the primary shares sold in the Offering. As the entity offering and selling 12,941,176 shares of Class A Common Stock, the Company would be in privity with each purchaser of a primary share and would be subject to claims for rescission or damages in the event that the prospectus or any oral communication used in connection with the Offering contained a material misstatement or omission.
Maximum Exposure. The Company's maximum exposure under Section 11 is the full amount of the gross offering proceeds, including both primary and secondary shares (since the issuer's liability is not limited to the shares it sold). However, as a practical matter, the Company's primary financial exposure would be determined by the gross proceeds received from the primary shares — approximately $220,000,000 at the $17.00 midpoint. The Company would also bear exposure for the secondary shares and any overallotment shares, although the selling stockholders and underwriters would bear proportionate liability for those shares under the contribution framework of Section 11(f).
B. Signing Officers
The following persons signed the Registration Statement, as required by Section 6(a) of the Securities Act:
•  Priya Subramanian, Chief Executive Officer, Co-Founder, and Chair of the Board of Directors — signed as both the principal executive officer and as a director.
•  David Lau, Chief Financial Officer — signed as both the principal financial officer and the principal accounting officer.
Under Section 11(a)(2), every person who signed the registration statement is potentially liable for material misstatements or omissions contained therein. The act of signing the Registration Statement is a statutory predicate for liability, and the signer need not have any other role in the offering. However, as discussed in Section V below, signing officers are entitled to assert the due diligence defense under Section 11(b). As officers of the Company with direct responsibility for the accuracy of the Company's disclosures, Ms. Subramanian and Mr. Lau would be held to a high standard of care in establishing that defense. Courts have consistently recognized that officers who sign a registration statement are presumed to have the most complete knowledge of the company's affairs and, accordingly, must demonstrate that they conducted a thorough and meaningful investigation of the disclosure contained in the Registration Statement.
C. Directors at Time of Filing
All members of the Board of Directors at the time the Registration Statement was filed (or became effective) are potentially liable under Section 11(a)(3), regardless of whether they individually signed the Registration Statement. The following seven individuals served as directors of Lumos at the relevant time:
1.  Priya Subramanian — Chair of the Board, Co-Founder, and Chief Executive Officer. Ms. Subramanian is both a signing officer and a director and is therefore subject to liability under both Section 11(a)(2) and Section 11(a)(3). As an inside director with day-to-day management responsibility, she would be held to the highest standard of care among the directors for purposes of the due diligence defense.
2.  Marcus Henley — Director, Co-Founder, and Chief Technology Officer. Mr. Henley is an inside director with responsibility for the Company's technology platform and product development. Although he did not sign the Registration Statement (having been named as a director but not as a signing officer), he is liable as a director under Section 11(a)(3). As an inside director, he would be held to a higher standard than the outside directors.
3.  Diane Ochoa — Independent Director; Managing Partner of Ridgeline Capital Partners Fund II, L.P. ("Ridgeline"). Ms. Ochoa was designated to the Board by Ridgeline pursuant to the Investors' Rights Agreement. Although classified as independent under the Nasdaq listing standards, Ms. Ochoa's affiliation with Ridgeline, a significant pre-IPO investor, may subject her to more searching inquiry under the due diligence analysis, given her financial sophistication and access to information through her role as Managing Partner of the fund.
4.  Samuel Adebayo — Independent Director; former Chief Financial Officer of Verdant Software Corp. Mr. Adebayo serves as Chair of the Audit Committee. His extensive financial expertise and accounting background may be relevant to the standard of care applicable to his review of the financial disclosure in the Registration Statement, although courts have not uniformly imposed a heightened standard on directors solely by reason of professional expertise.
5.  Catherine Mercer — Independent Director; Operating Partner of Arclight Equity Group Fund VII, L.P. Ms. Mercer's affiliation with Arclight, one of the selling stockholders in the Offering, creates a potential conflict of interest and may subject her to heightened scrutiny under the due diligence analysis. As an Operating Partner of one of the selling funds, she has direct access to information regarding the fund's investment thesis and involvement with the Company.
6.  Jonathan Tsai — Director and designee of Velthryn Venture Partners; Managing Partner, Velthryn Venture Partners. Mr. Tsai was designated to the Board by Velthryn pursuant to the Investors' Rights Agreement. As the Managing Partner of the largest selling stockholder and a significant pre-IPO investor (approximately 21.0% pre-IPO ownership), Mr. Tsai occupies a dual role that may subject him to heightened scrutiny. Courts have recognized that directors affiliated with significant investors may have access to information — and financial incentives — that warrant a more demanding application of the due diligence standard.
7.  Rebecca Stahl — Director and designee of Arclight Equity Group; Partner, Arclight Equity Group. Ms. Stahl was designated to the Board by Arclight pursuant to the Investors' Rights Agreement. Like Mr. Tsai, her dual role as a director and a principal of a selling stockholder creates potential conflicts and may result in heightened scrutiny under the due diligence analysis.
Each of the foregoing directors is entitled to assert the due diligence defense under Section 11(b). The application of that defense to the various categories of directors — inside directors, outside/independent directors, and affiliate directors — is discussed in detail in Section V.A.2 below.
Note on Dual Roles. We observe that several directors serve in dual capacities that may complicate the due diligence analysis. Ms. Ochoa, although classified as independent, is affiliated with Ridgeline. Mr. Tsai is the Managing Partner of the general partner of Velthryn. Ms. Stahl and Ms. Mercer are both affiliated with Arclight. These affiliations create the potential for heightened scrutiny under the due diligence defense, as courts may conclude that such directors had greater access to information and more powerful financial incentives than truly independent, unaffiliated outside directors.
D. Selling Stockholders
Two selling stockholders are named in the Registration Statement:
1.  Velthryn Venture Partners Fund IV, L.P. — a Delaware limited partnership selling up to 2,000,000 shares of Class A Common Stock in the Offering. The general partner of Velthryn is Velthryn Venture Partners Management IV, LLC, a Delaware limited liability company. The principal of the general partner is Jonathan Tsai, who also serves as a director of Lumos. Velthryn holds approximately 21.0% of the Company's pre-IPO equity on a fully diluted basis.
2.  Arclight Equity Group Fund VII, L.P. — a Delaware limited partnership selling up to 1,500,000 shares of Class A Common Stock in the Offering. The general partner of Arclight is Arclight Equity Management VII, LLC, a Delaware limited liability company. The principals of the general partner include Rebecca Stahl (who serves as a director of Lumos) and Catherine Mercer (who serves as a director of Lumos as an Operating Partner of Arclight).
Section 12(a)(2) Liability. The selling stockholders are potentially liable under Section 12(a)(2) as statutory sellers of their respective shares. Each selling stockholder is in privity with the purchasers of the shares it offers and sells, and each would be subject to claims for rescission or damages if the prospectus (or any oral communication made in connection with the sale) contained a material misstatement or omission. The selling stockholders' liability under Section 12(a)(2) is limited to the consideration received for their respective shares:
•  Velthryn: up to 2,000,000 shares × $17.00 per share = $34,000,000
•  Arclight: up to 1,500,000 shares × $17.00 per share = $25,500,000
Potential Section 11 Liability. To the extent the selling stockholders signed the Registration Statement (or authorized its signing by power of attorney), they may also be treated as persons who signed the Registration Statement under Section 11(a)(2). We note that each selling stockholder signed the Registration Statement through its authorized representative pursuant to a power of attorney, as is customary for selling stockholders in registered offerings. This signature exposes the selling stockholders to Section 11 liability, although their financial exposure under Section 11 remains subject to the applicable damage limitations and contribution provisions.
E. Underwriters
Under Section 11(a)(5), every underwriter with respect to the securities is potentially liable for material misstatements or omissions in the Registration Statement. The following entities comprise the underwriting syndicate for the Offering:
1.  Pinnacle Securities LLC — Lead Book-Running Managing Underwriter. Pinnacle is a full-service investment bank and broker-dealer registered with the Commission and a member of FINRA. The managing directors responsible for this engagement are Andrew Castellano (Coverage) and Lisa Drummond (Equity Capital Markets). Pinnacle's principal offices are located at 399 Park Avenue, New York, New York 10022. As lead book-runner, Pinnacle would bear the largest share of the underwriting commitment and, correspondingly, the largest share of potential liability among the syndicate members.
2.  Whitfield & Company LLC — Joint Book-Running Managing Underwriter. Whitfield is a registered broker-dealer and FINRA member. The managing director responsible for this engagement is Derek Kaplan. Whitfield's principal offices are located at 200 Vesey Street, 38th Floor, New York, New York 10281. As joint book-runner, Whitfield shares lead responsibility for the marketing and distribution of the Offering.
3.  Graystone Capital Markets Inc. — Co-Manager. Graystone is a registered broker-dealer and FINRA member. The managing director responsible for this engagement is Hannah Morales. Graystone's principal offices are located at 140 Broadway, 30th Floor, New York, New York 10005. As co-manager, Graystone's underwriting commitment and corresponding liability exposure are smaller than those of the book-running managers.
Section 11 Exposure. Under Section 11(e), the liability of each underwriter is limited to the total price at which the securities underwritten by such underwriter and distributed to the public were offered to the public. The total underwriting discount for the Offering was 6.5% of the public offering price, resulting in an aggregate discount of approximately $14,300,000 on the primary shares at the $17.00 midpoint. The allocation of the underwriting commitment among the syndicate members would be governed by the Agreement Among Underwriters (the "AAU"), which was negotiated but never finalized in executed form. Based on the draft AAU, Pinnacle would bear approximately 55% of the commitment, Whitfield approximately 35%, and Graystone approximately 10%, although these allocations remained subject to final confirmation at pricing.
Due Diligence Standard. Underwriters are entitled to assert the due diligence defense under Section 11(b), but they are held to a particularly high standard of care as "gatekeepers" of the capital markets. As discussed in Section V.A.2 below, the seminal decisions in Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968), and In re WorldCom, Inc. Securities Litigation, 346 F. Supp. 2d 628 (S.D.N.Y. 2004), make clear that underwriters must conduct an independent investigation of the issuer's business, financial condition, and disclosure, and cannot merely rely on management's representations or delegate their due diligence obligations to counsel or the auditor.
Underwriters' Counsel. Hargrove & Liddell LLP ("H&L") serves as counsel to the underwriters in the Offering. The lead partner is Michael Sorrentino, and the lead associate is Anika Patel. H&L's role is to conduct due diligence on behalf of the underwriters, review the disclosure in the Registration Statement, and prepare the underwriter due diligence report. However, H&L itself is not a statutory person liable under Section 11 unless H&L is named as an "expert" in the Registration Statement (which it is not). H&L's work product is intended to support the underwriters' due diligence defense, but it does not relieve the underwriters of their independent obligation to conduct a meaningful investigation.
Section 12(a)(2) Liability. The underwriters are also potentially liable under Section 12(a)(2) as statutory sellers or solicitors of the securities. As the entities through which the shares are offered and sold to the public, the underwriters are in privity with the purchasers and would be subject to claims for rescission or damages. The reasonable care defense under Section 12(a)(2) is available to the underwriters, subject to the same heightened standard of care applicable under Section 11.
F. Experts
Under Section 11(a)(4), every person who has, with his or her consent, been named as having prepared or certified any part of the registration statement, or as having prepared or certified any report or valuation which is used in connection with the registration statement, is potentially liable with respect to those portions of the registration statement that purport to have been prepared or certified by such person.
The following persons qualify as "experts" for purposes of the Lumos Registration Statement:
1.  Meridian & Howe LLP ("M&H") — Independent Registered Public Accounting Firm. M&H (audit partner: Gregory Simmons) audited the Company's consolidated financial statements for the fiscal years ended December 31, 2019, December 31, 2020, and December 31, 2021, and issued its audit report thereon, which is included in the Registration Statement. M&H has consented to the inclusion of its audit report in the Registration Statement, as required by Section 7 of the Securities Act and Rule 436 thereunder. M&H's principal offices are located at 555 Mission Street, Suite 2500, San Francisco, California 94105.
M&H's liability under Section 11 is limited to the "expertised" portions of the Registration Statement — i.e., the audited consolidated financial statements and the audit report. M&H is not liable under Section 11 for the non-expertised portions of the Registration Statement, including the MD&A, the risk factors, the business description, the prospectus summary, or any other narrative disclosure, even where such disclosure incorporates or refers to data derived from the audited financial statements. As discussed in Section V.A.2 below, M&H is entitled to assert the due diligence defense with respect to the expertised portions by demonstrating that, after reasonable investigation, it had reasonable ground to believe, and did believe, that the statements in its audit report were true and that there was no omission of a material fact.
2.  Calderwood & Harkness LLP ("C&H") — Issuer's Counsel. C&H rendered a legal opinion on the validity of the Class A Common Stock being offered in the IPO, which was included as Exhibit 5.1 to the Registration Statement (as amended). To the extent that C&H is named as an expert with respect to this legal opinion, liability could attach under Section 11(a)(4) with respect to that "expertised" portion of the Registration Statement only.
Additionally, to the extent that a tax opinion prepared by Sylvia Hartwell of C&H's Tax Group is included in the Registration Statement and attributed to C&H, such opinion would also constitute an "expertised" portion subject to Section 11(a)(4) liability. As of the date of the filing of Amendment No. 1, no separate tax opinion was included as an exhibit, although certain tax disclosure in the Registration Statement is based upon the advice of C&H's Tax Group.
Important Distinction. C&H's broader role as drafter of the Registration Statement does not, standing alone, render C&H an "expert" as to the non-expertised portions of the Registration Statement. Under established case law, issuer's counsel is not a statutory defendant under Section 11 for non-expertised portions, and the mere fact that counsel drafted the disclosure does not create liability under Section 11(a)(4). In theory, issuer's counsel could face exposure under Section 12(a)(2) if deemed a statutory seller or solicitor, but existing case law uniformly holds that counsel's role in preparing the registration statement does not constitute "solicitation" for purposes of Section 12(a)(2). See Pinter v. Dahl, 486 U.S. 622 (1988) (defining the scope of statutory seller under Section 12); see also In re Craftmatic Securities Litigation, 890 F.2d 628 (3d Cir. 1989). Accordingly, C&H's liability exposure under Sections 11 and 12 is limited to the expertised portions of the Registration Statement identified above, and is further limited by the due diligence defense available to experts under Section 11(b).
IV. Materiality Standards
The question of materiality is central to any analysis of potential liability under Sections 11 and 12(a)(2) of the Securities Act. Both provisions require that the alleged misstatement or omission be "material" in order to give rise to liability. This Section sets forth the applicable legal standards for materiality and applies those standards to the key areas of disclosure in the Lumos Registration Statement.
A. Legal Standard
The materiality standard applicable to claims under the Securities Act was established by the Supreme Court in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), and confirmed in Basic Inc. v. Levinson, 485 U.S. 224 (1988). Under this standard, a fact is material if there is a "substantial likelihood that a reasonable investor would consider it important in making an investment decision." The standard does not require that the misstatement or omission would have been determinative of the investor's decision; rather, the test is whether the information would have "significantly alter[ed] the 'total mix' of information made available" to the investor. TSC Industries, 426 U.S. at 449.
This standard is deliberately qualitative and context-dependent. It requires an assessment of whether the information in question, viewed in light of all the surrounding circumstances, would have been significant to a reasonable investor. The standard recognizes that materiality is a mixed question of law and fact and that the analysis must take into account the specific characteristics of the issuer, the industry, and the transaction.
In Omnicare, Inc. v. Laborers District Council Constructing Industry Pension Fund, 575 U.S. 175 (2015), the Supreme Court addressed the application of the materiality standard to opinion statements in registration statements. The Court held that opinion statements are actionable under Section 11 in two circumstances:
(a) where the speaker did not actually hold the stated belief at the time the statement was made (a subjective falsity theory); or
(b) where the statement, although reflecting a sincerely held belief, omits material facts about the speaker's inquiry into or knowledge of the subject matter that conflict with what a reasonable investor would take from the statement in context (an omission-based theory).
The Omnicare decision is particularly relevant to the Lumos Registration Statement because the prospectus contains numerous opinion statements and forward-looking statements, including statements about the Company's competitive position, market opportunity, growth trajectory, and path to profitability. Under Omnicare, these statements must not only reflect the speaker's actual beliefs but must also be accompanied by sufficient disclosure of the underlying facts and assumptions to avoid creating a misleading impression in the mind of a reasonable investor.
B. Quantitative and Qualitative Factors
The Commission's Staff Accounting Bulletin No. 99, "Materiality" (August 12, 1999), provides important guidance on the application of the materiality standard in the context of financial reporting. SAB 99 makes clear that materiality is not solely a quantitative determination and that a mechanical application of percentage thresholds (such as the commonly cited 5% of net income benchmark) is insufficient. Instead, materiality must be assessed in light of both quantitative and qualitative factors.
Among the qualitative factors identified in SAB 99 as potentially rendering a quantitatively small misstatement material are the following:
•  whether the misstatement or omission masks a change in earnings or other trends;
•  whether the misstatement or omission hides a failure to meet analysts' consensus expectations;
•  whether the misstatement or omission changes a loss into income or vice versa;
•  whether the misstatement or omission concerns a segment or other portion of the business that has been identified as playing a significant role in the company's operations or profitability;
•  whether the misstatement or omission involves concealment of an unlawful transaction;
•  whether the misstatement or omission affects the company's compliance with regulatory requirements; and
•  whether the misstatement or omission affects the company's compliance with loan covenants or other contractual obligations.
This last factor is particularly relevant to Lumos in light of the Company's revolving credit facility with Ashford National Bank (the "Ashford Facility"). The Ashford Facility provides for a $50 million commitment (approximately $15 million drawn as of March 31, 2022) at a rate of SOFR + 275 basis points, maturing June 1, 2024. The Ashford Facility contains financial covenants, and any misstatement that affects the Company's reported compliance with those covenants could be material under the qualitative analysis set forth in SAB 99, even if the misstatement is quantitatively small.
Revenue Concentration. As disclosed in the Registration Statement, the Company's top 10 customers represent approximately 34% of annual recurring revenue ("ARR"). This level of customer concentration creates a material risk of revenue loss in the event that one or more significant customers terminates its subscription agreement or significantly reduces its usage. The Company has approximately 340 enterprise customers globally, and the loss of a major customer — or a failure to retain or expand relationships with existing customers — could have a material adverse effect on the Company's business, financial condition, and results of operations. This concentration risk must be assessed in the context of the overall materiality analysis to ensure that the Registration Statement adequately discloses the nature and magnitude of the risk.
C. Application to the Lumos S-1
The following areas of disclosure in the Lumos Registration Statement are particularly sensitive from a materiality perspective, and each has been the subject of careful review as part of the due diligence process:
1.  Revenue Recognition Policies and ARR Methodology. The Company's revenue recognition policies under ASC 606 and its methodology for calculating ARR are critical to investors' understanding of the Company's financial performance and growth trajectory. The Company reported FY 2021 ARR of $206.8 million and Q1 2022 ARR of $219.5 million. Any misstatement in the methodology used to calculate ARR, or any inconsistency between the ARR figures and the Company's actual contractual commitments, could be material. We have reviewed the Company's ARR methodology and believe that the disclosure in the Registration Statement is accurate and consistent with the methodology described in the footnotes to the consolidated financial statements.
2.  Non-GAAP Financial Measures. The Company presents Adjusted EBITDA as a key non-GAAP financial measure, which was $(18.7) million for FY 2021. The presentation of non-GAAP measures is governed by Regulation G and Item 10(e) of Regulation S-K, which require a reconciliation to the most directly comparable GAAP measure and a discussion of why management believes the non-GAAP measure is useful to investors. We have reviewed the Adjusted EBITDA reconciliation and believe it complies with applicable requirements. The SEC Staff's first comment letter (received February 14, 2022) included comments on the non-GAAP reconciliation, which were addressed in the Company's response letter dated March 4, 2022 and in the amended confidential draft registration statement.
3.  History of Net Losses and Path to Profitability. The Company has a history of significant net losses. The Company reported a net loss of $(41.2) million for FY 2021 and a net loss of $(13.8) million for Q1 2022. The Company has never achieved profitability on an annual basis. The Registration Statement includes risk factor disclosure and MD&A discussion regarding the Company's history of losses, its expectation that losses may continue, and the uncertainty regarding the Company's ability to achieve profitability in the future. We believe this disclosure is adequate and consistent with the Company's actual financial condition, although the sensitivity of this issue is amplified by the general market environment for unprofitable growth-stage technology companies.
4.  Revenue Growth Deceleration. The Company's year-over-year revenue growth rate decelerated from 58% (FY 2020 to FY 2021: $118.6 million to $187.4 million) to 40% (Q1 2021 to Q1 2022: $39.2 million to $54.9 million). This deceleration is a material trend that could affect investors' assessment of the Company's growth trajectory and valuation. The MD&A section of the Registration Statement addresses this deceleration and discusses the factors contributing to the slower growth rate, including the maturation of the customer base and the lengthening of enterprise sales cycles. We believe the disclosure is adequate but have recommended that management continue to monitor and update the disclosure as additional financial data becomes available.
5.  Dual-Class Voting Structure. The Company's capital structure includes Class A Common Stock (1 vote per share) and Class B Common Stock (10 votes per share). The Class B Common Stock is held exclusively by the Company's founders, Priya Subramanian (16,500,000 Class B shares) and Marcus Henley (12,000,000 Class B shares). Following the completion of the IPO, the founders would hold approximately 73.5% of the total voting power of the Company (approximately 285,000,000 votes out of a total of approximately 387,641,176 votes), notwithstanding their ownership of a substantially smaller percentage of the total economic interest. The dual-class structure is fully disclosed in the Registration Statement, including the risk factors, the description of capital stock, and the prospectus summary. The sunset provision, which provides for the automatic conversion of Class B shares into Class A shares upon the earliest of (i) seven years following the completion of the IPO, (ii) a transfer of Class B shares to a non-permitted transferee, or (iii) the founders collectively holding less than 10% of the outstanding shares of common stock, is also disclosed.
6.  Sunset Provision on Class B Shares. As noted above, the sunset provision is disclosed in the Registration Statement. We have reviewed the draft Amended and Restated Certificate of Incorporation to confirm that the sunset provision is accurately described.
7.  Related-Party Transactions. The Registration Statement discloses the related-party transactions involving Velthryn Venture Partners, Arclight Equity Group, and Ridgeline Capital Partners, including the investor rights agreements, registration rights agreements, and board designation rights. Additionally, the indemnification agreements entered into between the Company and its directors and officers are disclosed. We have reviewed these transactions and believe the disclosure complies with the requirements of Item 404 of Regulation S-K. The SEC comment letter process included questions regarding the related-party transactions, which were addressed in the Company's response.
8.  Stock-Based Compensation and Cheap Stock Analysis. The Company's equity incentive plan authorizes the issuance of up to 14,800,000 shares, of which 11,300,000 options were outstanding at a weighted-average exercise price ("WAEP") of $4.82 per share. The gap between the WAEP and the proposed IPO price range ($16.00 to $18.00, midpoint $17.00) raises "cheap stock" issues, as the SEC Staff may question whether the Company's historical stock-based compensation charges were adequately recognized in connection with options granted at exercise prices below the fair value implied by the IPO price range. The Company's Series D preferred stock round was priced at $12.50 per share, creating a narrower (but still significant) gap with the IPO price range. The SEC Staff's second comment letter (received March 18, 2022; 12 comments) included comments on the cheap stock analysis, and the Company's response included a retrospective fair value analysis supporting the exercise prices of the options granted during the relevant periods.
9.  Customer Concentration Risk. As noted above, the Company's top 10 customers represent approximately 34% of ARR. The Registration Statement discloses this concentration risk in the risk factors section. We have recommended that the Company consider whether any single customer accounts for more than 10% of revenue (which would require specific identification under Item 101(c)(1)(vii) of Regulation S-K) and have been informed by management that no single customer exceeds this threshold.
10.  Material Contracts. The Registration Statement identifies and describes the Company's material contracts, including (a) the Brindoval Data Centers LLC agreement (a five-year infrastructure hosting agreement with an annual minimum commitment of $8.2 million), (b) the Nordwell Financial Technologies Inc. strategic partnership (a three-year initial term technology partnership), and (c) the Ashford National Bank revolving credit facility ($50 million commitment, approximately $15 million drawn as of March 31, 2022, bearing interest at SOFR + 275 basis points, maturing June 1, 2024). We have reviewed these contracts and believe the disclosure is accurate and adequate.
11.  intellectual Property. The Company's intellectual property portfolio consists of 14 issued U.S. utility patents, 7 pending patent applications, and registered trademarks (including Lumos, Lumos AI, LumosIQ, and FraudLens). The Registration Statement describes the Company's intellectual property and the risks associated with its protection and enforcement. We have reviewed the intellectual property portfolio with the assistance of C&H's intellectual property group and believe the disclosure is accurate and adequate.
V. Defenses
This Section analyzes the defenses available to the various categories of defendants under Sections 11 and 12(a)(2) of the Securities Act. The due diligence defense under Section 11(b) is the most significant defense for non-issuer defendants and is the primary driver of the due diligence process. Additional defenses, including the negative causation defense under Section 11(e), the reasonable care defense under Section 12(a)(2), the statute of limitations defense under Section 13, and control person liability under Section 15, are also discussed.
A. Due Diligence Defense — Section 11(b)
1. General Framework
Section 11(b) provides that a non-issuer defendant may avoid liability by establishing that, after reasonable investigation, such defendant had reasonable ground to believe, and did believe, at the time the registration statement became effective, that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading. The standard of "reasonableness" for purposes of this defense is defined by the statute as "that required of a prudent man in the management of his own property." 15 U.S.C. § 77k(c).
The due diligence defense is an affirmative defense, meaning that the burden of proof rests on the defendant to demonstrate compliance with the statutory standard. The defendant must show both (a) that it conducted a reasonable investigation and (b) that, based on that investigation, it had reasonable ground to believe, and did believe, that the registration statement was accurate and complete. Both elements must be satisfied; it is not sufficient to demonstrate a general process of investigation without also demonstrating that the investigation produced a reasonable basis for the defendant's belief in the accuracy of the disclosure.
The due diligence defense operates differently depending on whether the portion of the registration statement at issue is an "expertised" or "non-expertised" portion:
Expertised Portions. For portions of the registration statement that are prepared or certified by an expert (such as the audited financial statements and audit report prepared by M&H), non-expert defendants need only show that they "had no reasonable ground to believe and did not believe" that there was a misstatement or omission. This is a "reliance" standard — the non-expert defendant may rely on the expert's work product unless the defendant had reason to believe that the expert's work was unreliable or that the expertised portion contained a material error. This is a significantly lower bar than the affirmative investigation required for non-expertised portions.
Non-Expertised Portions. For all portions of the registration statement that are not expertised (including the prospectus summary, risk factors, MD&A, business description, description of capital stock, and all other narrative disclosure), every non-issuer defendant must demonstrate that it conducted a reasonable investigation. This requires an affirmative, meaningful inquiry into the accuracy and completeness of the disclosure, not mere passive acceptance or cursory review.
2. Application to Specific Defendant Categories
The due diligence standard is not applied uniformly across all categories of defendants. The courts have recognized that the level of investigation required to satisfy the standard varies depending on the defendant's role, access to information, expertise, and relationship to the issuer. The following analysis applies the due diligence standard to the specific categories of defendants identified in Section III above.
Directors (including Ochoa, Adebayo, Mercer, Tsai, Stahl, Subramanian, and Henley).
The due diligence obligation of directors has been the subject of extensive judicial analysis, beginning with the landmark decision in Escott v. BarChris Construction Corp., 283 F. Supp. 643 (S.D.N.Y. 1968). The key principles established in BarChris and subsequent cases may be summarized as follows:
Inside Directors. Directors who are also officers of the company (in this case, Ms. Subramanian as CEO and Mr. Henley as CTO) are held to a higher standard of care than outside or independent directors. Inside directors are presumed to have access to the company's books and records, financial information, and operational details, and they are expected to have a thorough understanding of the company's business and financial condition. Inside directors cannot claim ignorance of material facts that were available to them in their capacity as officers. To satisfy the due diligence defense, inside directors must demonstrate that they were actively involved in the preparation and review of the registration statement, that they reviewed the disclosure for accuracy and completeness, and that they brought their knowledge of the company's affairs to bear on the review process. A perfunctory review or mere delegation to counsel is insufficient.
Outside/Independent Directors. Outside directors who have no management role or day-to-day involvement with the company (in this case, Mr. Adebayo) are held to a somewhat lower standard, reflecting their more limited access to information. However, BarChris makes clear that outside directors cannot simply "rubber stamp" the registration statement. They must conduct a meaningful review, ask appropriate questions of management and experts, and take reasonable steps to verify the accuracy of the disclosure. At a minimum, outside directors should demonstrate that they attended board meetings at which the registration statement was discussed, reviewed drafts of the registration statement, read and considered the due diligence materials made available to them, and made reasonable inquiries of management and the company's advisors.
Affiliate Directors. Directors who are affiliated with significant investors or selling stockholders present a more complex analysis. In this case, Mr. Tsai (Velthryn designee), Ms. Stahl (Arclight designee), Ms. Ochoa (Ridgeline affiliate), and Ms. Mercer (Arclight operating partner) each have dual loyalties and may possess information about the company's affairs that they obtained through their respective funds' involvement. Courts have applied a more searching inquiry to such directors, recognizing that their financial sophistication, industry experience, and access to information through the fund relationship may give them a greater ability to identify potential misstatements or omissions. Affiliate directors should be prepared to demonstrate not only that they conducted a meaningful review of the registration statement but also that they disclosed to the board any material information that they possessed by virtue of their fund affiliation.
Officers (Subramanian as CEO, Lau as CFO).
Officers who sign the registration statement are held to the highest standard of care among all non-issuer defendants. As the individuals most directly responsible for the accuracy of the company's financial and operational disclosures, signing officers are expected to have conducted a thorough and comprehensive review of the registration statement and to have brought their detailed knowledge of the company's affairs to bear on the review process.
Ms. Subramanian, as CEO and Co-Founder, has the broadest knowledge of the Company's business, strategy, and operations. Mr. Lau, as CFO and both the principal financial officer and the principal accounting officer, bears particular responsibility for the accuracy of the financial disclosure, including the financial statements, the MD&A, and the non-GAAP financial measures. To satisfy the due diligence defense, each signing officer should be prepared to demonstrate that he or she personally reviewed the registration statement in detail, verified the accuracy of the key factual statements, ensured the completeness of the risk factors and other disclosure items, and made inquiries of other members of management as appropriate.
We also note the potential exposure of two additional officers who did not sign the Registration Statement but participated extensively in its preparation:
•  Naomi Feinberg, General Counsel and Corporate Secretary, coordinated the due diligence process and managed the SEC comment letter response process. Although Ms. Feinberg is not a signing officer and is not directly liable under Section 11(a)(2), she may be subject to liability as a "control person" under Section 15 of the Securities Act (discussed in Section V.E below) if she exercised actual control over the persons liable under Section 11.
•  Tomás Aguilar, Chief Revenue Officer, provided significant input on the business description, customer metrics, and revenue-related disclosure. Like Ms. Feinberg, Mr. Aguilar is not a signing officer but could be subject to control person liability analysis if the facts establish that he exercised actual control.
Underwriters (Pinnacle Securities, Whitfield & Co., Graystone Capital Markets).
Underwriters occupy a unique pos

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