PRIVILEGED AND CONFIDENTIAL ATTORNEY-CLIENT PRIVILEGED ATTORNEY WORK PRODUCT
CALDERWOOD & HARKNESS LLP 555 California Street, 30th Floor San Francisco, California 94104
INTERNAL MEMORANDUM
Matter Number: 1008-00003
Date: October 12, 2023
To: Patricia Dunmore, Partner
From: Omar Siddiqui, Associate
Re: Lumos Analytics Inc. — Disclosure Obligations to SAFE Holders Under Information Rights Provisions in Light of Prism Core v2.0 Validation Failure
Client: Lumos Analytics Inc.
I. Executive Summary
Calderwood & Harkness LLP represents Lumos Analytics Inc. ("Lumos" or the "Company"), a Delaware C-corporation headquartered at 340 Folsom Street, Suite 1100, San Francisco, California 94105, as issuer's counsel in connection with an ongoing $6,800,000 Simple Agreement for Future Equity ("SAFE") financing round (the "Round"). The purpose of this memorandum is to analyze the Company's disclosure obligations to its existing SAFE holders in light of a recent and significant product development failure, and to provide recommendations to the Company's board of directors regarding next steps.
On October 9, 2023, Peralta IP Consulting LLC ("Peralta"), the independent third-party validation firm engaged by the Company, issued its functionality and accuracy validation report (the "Peralta Report") for the Prism Core v2.0 machine-learning compliance scoring module ("Prism Core v2.0"). The Peralta Report found that the module achieved only 61% accuracy against its designated benchmark, falling far short of the 92% accuracy target that had been established as the minimum threshold for commercial viability and that had been communicated to prospective investors in the Company's August 2023 fundraising materials.
On October 10, 2023, the Company's Chief Technology Officer, Elliot Marsh, disclosed this validation failure to the Lumos board of directors. The board convened an emergency meeting on October 12, 2023, at which it determined that the Prism Core v2.0 failure constitutes a material product setback with an estimated remediation timeline of four to six months. The board is now actively debating whether and how to communicate this development to the Company's SAFE holders.
This memorandum analyzes whether the information rights provisions contained in the three executed SAFEs — held by Vantage Peak Ventures Fund II, L.P. ("Vantage Peak"), Ridgeline Angel Fund, L.P. ("Ridgeline"), and Canopy Growth Capital LLC ("Canopy Growth") — require Lumos to affirmatively disclose the Prism Core v2.0 validation failure to those investors. This memorandum further assesses the legal consequences under Delaware law, federal securities law, and applicable state law of non-disclosure, including potential claims for breach of contract, fraud, negligent misrepresentation, and breach of fiduciary duty, as well as the risk of personal liability for the Company's officers and directors.
Conclusion: For the reasons set forth below, I strongly recommend that Lumos promptly and affirmatively disclose the Prism Core v2.0 product setback to all current SAFE holders. Non-disclosure is not a viable option given the contractual information rights provisions, the clear materiality of the product setback, the acute risk of fraud and misrepresentation claims under Delaware law and federal and state securities laws, and the potential for personal liability of the Company's officers and directors. Additionally, disclosure must precede any further steps toward execution of the SAFE with Atlas Fintech Syndicate, L.P., the prospective co-investor that has signed a term sheet but has not yet executed its SAFE.
II. Factual Background
A. The SAFE Financing Round
Lumos is conducting the Round pursuant to Post-Money SAFE instruments based on the standard form published by Calderon Partners LLC ("YC"), as modified through negotiations with investor counsel. The Round has a total target of $6,800,000, with SAFEs issued at a post-money valuation cap of $28,000,000 and no discount rate. The SAFEs were offered in reliance on the exemption from registration provided by Rule 506(b) of Regulation D promulgated under the Securities Act of 1933, as amended (the "Securities Act"), and the Company filed a Form D with the Securities and Exchange Commission in connection therewith.
The Round has been structured with a lead investor and multiple co-investors. The current status of the Round is as follows:
Lead Investor — Vantage Peak Ventures Fund II, L.P. Vantage Peak executed its SAFE on September 12, 2023 for a purchase amount of $3,500,000. The purchase amount was wired to the Lumos operating account at Silicon Valley Commerce Bank (Account No. 8801-4427-3390) on September 14, 2023. Vantage Peak is a venture capital fund with approximately $185 million in committed capital under management. Its principal office is located in Menlo Park, California. The deal leads at Vantage Peak are Catherine Aldridge (Managing Partner), Raymond Petrov (Partner), and Samantha Reyes (Principal). Vantage Peak was represented by Whitfield Harte & Associates LLP ("Whitfield Harte") in the negotiation and execution of the SAFE. Whitfield Harte proposed certain modifications to the standard YC SAFE form, including an expanded information rights provision, which were negotiated during the September 8, 2023 markup session and incorporated into the final executed SAFE. The Vantage Peak SAFE serves as the template for the remaining SAFEs in the Round.
Co-Investor — Ridgeline Angel Fund, L.P. Ridgeline executed its SAFE on September 22, 2023 for a purchase amount of $1,200,000. The purchase amount was wired to the Lumos operating account on September 25, 2023. Ridgeline is also an existing pre-seed investor in the Company, having previously invested $500,000 via a SAFE at an $8,000,000 valuation cap in August 2022. The deal lead at Ridgeline is David Choi (General Partner). The Ridgeline SAFE incorporates the same terms as the Vantage Peak SAFE by operation of the most favored nation ("MFN") provision.
Co-Investor — Canopy Growth Capital LLC. Canopy Growth executed its SAFE on September 29, 2023 for a purchase amount of $1,100,000. The purchase amount was wired to the Lumos operating account on October 2, 2023. The deal lead at Canopy Growth is Lena Petrova (Managing Director). Like the Ridgeline SAFE, the Canopy Growth SAFE incorporates the same terms as the Vantage Peak SAFE by operation of the MFN provision.
Prospective Co-Investor — Atlas Fintech Syndicate, L.P. Atlas Fintech Syndicate, L.P. ("Atlas Fintech") signed a term sheet with Lumos on October 4, 2023 for a purchase amount of $1,000,000. However, as of the date of this memorandum, the SAFE has not yet been executed and no funds have been transferred. The deal lead at Atlas Fintech is Marcus Greenfield (Partner). The Company's discussions with Atlas Fintech remain ongoing, and execution of the Atlas Fintech SAFE would bring the total Round proceeds to the $6,800,000 target.
Total Funded to Date: $5,800,000 (representing the sum of the Vantage Peak, Ridgeline, and Canopy Growth purchase amounts). The remaining $1,000,000 from Atlas Fintech is pending SAFE execution.
B. Prism Core v2.0 and Investor Representations
Lumos's core product is "Lumos Prism," an AI-driven financial analytics platform that provides financial institutions with real-time regulatory compliance dashboards and predictive risk scoring capabilities. Lumos Prism is designed to enable banks, credit unions, and other regulated financial entities to monitor compliance with federal and state regulatory requirements in real time, using machine-learning algorithms trained on historical enforcement data, regulatory guidance, and industry benchmarks.
Prism Core v2.0 is the next-generation machine-learning compliance scoring module that represents the centerpiece of Lumos's product roadmap. Prism Core v2.0 is intended to replace the existing Prism Core v1.x scoring engine with a substantially more sophisticated and accurate predictive model. The Company filed U.S. Provisional Patent Application No. 63/987,214 on June 15, 2023, covering the Prism Core predictive risk algorithm, which is the proprietary technology underlying the v2.0 module.
Prism Core v2.0 was prominently featured in the Company's August 2023 fundraising materials, including the investor pitch deck and the product roadmap summary distributed to prospective investors. In these materials, Lumos represented that Prism Core v2.0 was "beta-ready by Q4 2023." This representation was a central element of the investment thesis presented to investors in the Round: the Company positioned the v2.0 module as the key differentiator that would enable Lumos to expand from its current customer base of approximately twelve pilot clients to a commercially scalable product with significantly higher subscription revenue.
In early October 2023, the Company retained Peralta IP Consulting LLC to conduct an independent functionality and accuracy validation of the Prism Core v2.0 module. Peralta's Principal Consultant, Dr. Amir Farouk, completed the validation testing on October 8, 2023. Peralta's validation report, dated October 9, 2023 (the "Peralta Report"), delivered findings that were markedly negative. Specifically, the Peralta Report found that the Prism Core v2.0 module achieved only 61% accuracy against the designated benchmark dataset, as compared to the 92% accuracy target that had been established as the threshold for commercial readiness. The 31-percentage-point shortfall is not a marginal underperformance that could be addressed through incremental tuning or parameter adjustment; rather, it indicates fundamental performance deficiencies in the underlying machine-learning model architecture and training methodology.
CTO Elliot Marsh has reviewed the Peralta Report in detail and estimates that remediation — including model re-architecture, additional training data acquisition, and renewed validation testing — will require an additional four to six months of development time beyond the previously projected timeline. This means that Prism Core v2.0 will not be beta-ready by Q4 2023 as represented in the Company's pitch materials. The earliest realistic beta availability, based on Marsh's assessment, would be Q2 2024 at the earliest.
C. Board Awareness and Current Status
The timeline of internal awareness and deliberation regarding the Prism Core v2.0 failure is as follows:
October 9, 2023: Peralta IP Consulting LLC issued the Peralta Report to CTO Elliot Marsh.
October 10, 2023: CTO Marsh disclosed the substance of the Peralta Report and the validation failure to the full Lumos board of directors. The board consists of three members: Priya Narasimhan (CEO and Chair of the Board), Elliot Marsh (CTO and Director), and Kenji Watanabe (Independent Director). The initial disclosure was made via a secure communication to all board members, accompanied by a copy of the Peralta Report.
October 12, 2023: The board convened an emergency meeting to discuss the implications of the Prism Core v2.0 failure. At this meeting, the board determined that the validation failure constitutes a material product setback. The board is now actively debating the Company's disclosure obligations to its SAFE holders and has engaged Calderwood & Harkness for guidance on this question.
As of the date of this memorandum, no investor has been notified of the Prism Core v2.0 validation failure or the associated delay in the product roadmap. All three existing SAFE holders — Vantage Peak, Ridgeline, and Canopy Growth — remain uninformed. Similarly, Atlas Fintech Syndicate, L.P., the prospective co-investor with a signed term sheet, has not been advised of the development. The Company has not issued any updated investor communications or amended its pitch materials to reflect the changed circumstances.
The status of the Atlas Fintech SAFE is of particular concern. Atlas Fintech has a signed term sheet dated October 4, 2023, and the parties were in the process of finalizing the SAFE documentation when the Peralta Report was received. Any further steps toward execution of the Atlas Fintech SAFE raise heightened concerns, as discussed in Section IV.D below.
III. Information Rights Provisions in the Executed SAFEs
A. Overview of Applicable SAFE Provisions
The three executed SAFEs in the Round are based on the YC standard Post-Money SAFE form, with certain modifications negotiated principally between the Company (represented by Calderwood & Harkness) and Whitfield Harte & Associates LLP, acting on behalf of the lead investor, Vantage Peak. The negotiations took place primarily during a markup session on September 8, 2023, at which Whitfield Harte proposed several enhancements to the standard YC SAFE form, including, most notably, an expanded information rights provision.
The standard YC Post-Money SAFE form includes a relatively brief and limited information rights clause that grants investors certain basic rights to receive financial information from the Company. Whitfield Harte's September 8 markup proposed a substantially expanded version of this clause, and the parties reached agreement on a modified provision that includes both periodic financial reporting obligations and an affirmative duty to notify investors of certain material developments. The final negotiated language was incorporated into the Vantage Peak SAFE executed on September 12, 2023.
The Ridgeline and Canopy Growth SAFEs incorporate the same material terms as the Vantage Peak SAFE. Each of these SAFEs includes an MFN provision that entitles the holder to receive the benefit of any more favorable terms granted to any other SAFE holder in the same round. Because the Vantage Peak SAFE contains the most extensive information rights provision, the MFN clause effectively ensures that all three SAFE holders are entitled to the same information rights.
B. Scope of Information Rights
The information rights provision in the executed SAFEs, as negotiated in the September 8 markup and agreed upon in the final executed instruments, grants investors the following rights:
Periodic Financial Reporting. The Company shall provide each SAFE holder with (i) audited annual financial statements within one hundred twenty (120) days following the end of each fiscal year and (ii) unaudited quarterly financial statements within forty-five (45) days following the end of each fiscal quarter. Quarterly financial statements shall include a balance sheet, income statement, and cash flow statement prepared in accordance with generally accepted accounting principles ("GAAP"), consistently applied.
Notice of Material Events. The Company shall promptly notify each SAFE holder of any material event or development that affects, or could reasonably be expected to affect, the Company's business, financial condition, or prospects. This provision was added to the standard YC SAFE form at the request of Whitfield Harte during the September 8 markup. The original Whitfield Harte proposal used the phrase "any event that is or may be material to the Company's business, financial condition, operations, or prospects." The agreed-upon language, which was the product of negotiation, retained the operative terms "material event or development" and "business, financial condition, or prospects," but the parties did not include a standalone definition of "material" or "material adverse" within the four corners of the SAFE instrument.
Notice of Material Adverse Developments. Additionally, the agreed version of the information rights provision includes a specific covenant requiring the Company to provide written notice to each SAFE holder within ten (10) business days of the Company's becoming aware of any material adverse development relating to the Company's products, intellectual property, or technology that could reasonably be expected to result in a significant delay or impairment of the Company's product roadmap or commercialization timeline. This provision was among the most heavily negotiated elements of the September 8 markup. Whitfield Harte originally proposed a five (5) business day notice period and an even broader scope; the final agreed language represents a compromise, but it is still notably more expansive than the information rights provisions found in the standard YC SAFE form.
Additional Information Requests. The Company shall, upon the reasonable written request of any SAFE holder holding a SAFE with a purchase amount of at least $1,000,000, provide such additional information regarding the Company's business, operations, and financial condition as may be reasonably requested, provided that the Company shall not be required to disclose trade secrets, proprietary technology, or information subject to confidentiality obligations to third parties.
C. Definition of Materiality in the SAFE Context
As noted above, the executed SAFEs do not define "material" or "material adverse" with specificity. Neither the standard YC SAFE form nor the Whitfield Harte modifications include a standalone definition of materiality or a materiality qualifier tied to a specific quantitative threshold. In the absence of an express definition, the term "material" as used in the SAFEs must be construed according to its standard legal meaning under applicable law.
The SAFEs are governed by Delaware law, as specified in the governing law provisions of each instrument. Under well-established Delaware case law, information is "material" if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. This standard derives from the seminal U.S. Supreme Court decision in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), and has been consistently adopted and applied by Delaware courts. The Delaware Court of Chancery has further elaborated that materiality does not require a showing that the information would have changed the investment decision, but only that there is a substantial likelihood that a reasonable investor would have considered the information significant in the total mix of information available. See Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985).
Applying this standard to the facts at hand, the Prism Core v2.0 validation failure is almost certainly material. The analysis proceeds on several interrelated grounds:
First, Prism Core v2.0 was a central element of the investment thesis that Lumos presented to all of its SAFE investors. The Company's August 2023 pitch materials prominently featured the v2.0 module and represented that it would be "beta-ready by Q4 2023." Investors in the Round were investing, at least in substantial part, based on the expected commercial viability and near-term availability of Prism Core v2.0 as a competitive differentiator. A reasonable investor who learned that the module achieved only 61% accuracy against a 92% target — a 31-percentage-point shortfall indicating fundamental performance deficiencies — would unquestionably consider that information important in evaluating the investment.
Second, the remediation timeline of four to six months, as estimated by CTO Marsh, means that the product roadmap communicated to investors is materially inaccurate. The representation that Prism Core v2.0 would be "beta-ready by Q4 2023" is no longer accurate; the earliest realistic beta availability is now Q2 2024. This delay has direct implications for the Company's revenue projections, competitive positioning, and ability to convert pilot clients to paying customers on the timeline presented to investors.
Third, the magnitude of the shortfall — a 31-percentage-point gap between actual and target performance — is not a minor deviation that could be characterized as normal product development risk. It indicates a fundamental deficiency in the module's underlying architecture that will require significant additional investment of time and resources to remediate. This is qualitatively different from, for example, a two- or three-percentage-point shortfall that might be addressed through incremental tuning.
For these reasons, I conclude that the Prism Core v2.0 validation failure constitutes a "material event or development" affecting the Company's business and prospects, and a "material adverse development" relating to the Company's products and technology that could reasonably be expected to result in a significant delay or impairment of the Company's product roadmap, within the meaning of the information rights provisions in the executed SAFEs.
IV. Legal Analysis: Obligation to Disclose
A. Contractual Disclosure Obligations
The information rights provisions in the executed SAFEs, as described in Section III above, include an express and affirmative obligation on the Company to notify SAFE holders of material adverse developments relating to the Company's products, intellectual property, or technology that could reasonably be expected to result in a significant delay or impairment of the Company's product roadmap or commercialization timeline. For the reasons discussed in Section III.C, the Prism Core v2.0 validation failure falls squarely within the scope of this provision. Accordingly, Lumos has a clear contractual duty to disclose the Prism Core v2.0 failure to all three existing SAFE holders.
Moreover, the broader "material events" notification covenant — requiring prompt notice of any material event or development that affects, or could reasonably be expected to affect, the Company's business, financial condition, or prospects — provides an independent basis for the same conclusion. Even if one were to argue that the "material adverse developments" provision relating to products and technology does not precisely cover the situation (a position I do not believe is tenable), the broader material events provision clearly does. The Prism Core v2.0 failure is a development that affects the Company's business (its core product roadmap), financial condition (potential revenue shortfall and extended cash burn), and prospects (delayed commercialization and competitive positioning).
Even under the most restrictive reading of the information rights provisions — one that would limit the affirmative notification obligation to events with direct financial impact — the contractual duty would still be triggered. The practical consequences of the Prism Core v2.0 validation failure include:
(a) A delayed product launch that will postpone the Company's expected transition from pilot-stage revenue to commercial-stage subscription revenue, directly affecting near-term financial performance and projections;
(b) An extended development period of four to six additional months, which will increase the Company's cash burn by an estimated $380,000 to $570,000 (based on the current monthly burn rate of approximately $95,000) before Prism Core v2.0 reaches commercial readiness;
(c) Potential loss of competitive positioning in the AI-driven compliance analytics market, where several well-funded competitors are pursuing similar product offerings;
(d) Potential loss of existing pilot client relationships if those clients have been anticipating the availability of Prism Core v2.0 on the previously communicated timeline; and
(e) Reduced ability to conduct future fundraising on favorable terms, given that the next-generation product — a key element of the Company's growth story — has been materially delayed.
Each of these consequences has direct and measurable financial implications that fall within even the narrowest construction of the information rights provisions.
Timeliness of Disclosure. The material adverse developments provision in the SAFEs specifies that notice must be provided "within ten (10) business days of the Company's becoming aware" of the relevant development. The Company became aware of the Prism Core v2.0 failure on October 9, 2023, when the Peralta Report was received by CTO Marsh. The board was informed on October 10, 2023 and formally deliberated on October 12, 2023. Counting from October 9, 2023, the ten-business-day notice period expires on or about October 23, 2023. While the Company has a brief window within which to comply with the contractual notice requirement, I recommend prompt disclosure rather than waiting until the deadline. Delay — even delay within the contractual window — carries risks, as discussed below, and prompt voluntary disclosure will be viewed far more favorably by investors than disclosure that appears reluctant or belated.
B. Fiduciary Duty Analysis Under Delaware Law
Delaware law imposes fiduciary duties on corporate directors and officers, including the duty of care and the duty of loyalty. These duties run primarily to the corporation and its stockholders, and it is well established that SAFE holders, as holders of instruments that have not yet converted into equity, are not stockholders and are generally owed only those duties specified by contract. Delaware courts have been reluctant to extend the full panoply of stockholder fiduciary protections to holders of convertible instruments or contingent equity rights.
However, the analysis does not end there. Delaware courts have recognized that in certain contexts, issuers may owe duties of candor and good faith in connection with ongoing contractual relationships, particularly where the issuer has voluntarily undertaken information obligations to counter-parties. In such circumstances, the contractual duty to provide information may be supplemented by an implied duty to provide information that is complete, accurate, and not misleading. See, e.g., Malone v. Brincat, 722 A.2d 5 (Del. 1998) (recognizing duties of disclosure and candor in the context of communications with stockholders, and noting that directors who knowingly disseminate false information breach their fiduciary duties).
While Malone concerned duties to stockholders, the principles it articulated — that those who undertake to communicate material information have a duty to do so honestly and completely — resonate in the present context. Here, Lumos has voluntarily undertaken, through the negotiated information rights provisions, an obligation to communicate material developments to its SAFE holders. Having assumed that obligation, the Company cannot satisfy it by remaining silent in the face of clearly material adverse information. The duty of good faith and fair dealing, which is implied in every contract under Delaware law, further supports the conclusion that the Company's silence in these circumstances would be inconsistent with its contractual obligations.
Additionally, the individual board members — Priya Narasimhan, Elliot Marsh, and Kenji Watanabe — have fiduciary duties to the Company that bear on this analysis. These duties include the duty not to knowingly allow the Company to make or maintain material misrepresentations. The August 2023 pitch materials, which represented that Prism Core v2.0 was "beta-ready by Q4 2023," are now materially inaccurate. While these materials are not ongoing representations in the sense that a registration statement or periodic filing would be, the Company's silence in the face of known inaccuracy — particularly when it has an affirmative contractual duty to update — could be construed as a knowing maintenance of the misrepresentation. Under Delaware law, directors who are aware that a prior corporate communication is materially misleading and fail to take corrective action may be liable for breach of their duties of loyalty and care.
C. Fraud and Misrepresentation Risk from Non-Disclosure
If Lumos fails to disclose the Prism Core v2.0 validation failure and the investors discover the Company's silence, the Company and its officers and directors could face claims on several grounds:
Common-Law Fraud Under Delaware Law. Under Delaware law, a claim for common-law fraud requires the plaintiff to establish: (i) a false representation or omission; (ii) of a material fact; (iii) made with knowledge of its falsity or reckless indifference to its truth or falsity (scienter); (iv) with the intent to induce the plaintiff's reliance; (v) the plaintiff's actual and justifiable reliance; and (vi) resulting damages. See Stephenson v. Capano Dev., Inc., 462 A.2d 1069 (Del. 1983).
Here, each element could plausibly be satisfied in a post-discovery claim by any of the SAFE holders. The Company's August 2023 pitch materials contained representations regarding the expected readiness of Prism Core v2.0 that are now known to be inaccurate. The Company's continued silence in the face of the Peralta Report findings, particularly after the board's October 12, 2023 determination that the validation failure constitutes a material setback, could support a finding of scienter — the Company knows that its prior representations were materially inaccurate and is choosing not to correct them. The investors relied on the pitch materials, including the Prism Core v2.0 representations, in making their investment decisions, and their continued holding of the SAFEs is premised on assumptions about the Company's product roadmap that are no longer accurate. Damages could be measured by the difference between the value of the SAFEs as purchased (based on the $28,000,000 post-money valuation cap) and their value in light of the product setback, or by the full purchase price in a rescission claim.
Negligent Misrepresentation. Delaware law also recognizes a claim for negligent misrepresentation, which requires a lesser showing than common-law fraud. Rather than intentional deception, the plaintiff need only establish that the defendant failed to exercise reasonable care in communicating information that the defendant knew or should have known was false or incomplete. See Outdoor Technologies, Inc. v. Allfirst Financial, Inc., 2001 WL 541472 (Del. Super. Ct. 2001). Given that the Company is now in possession of the Peralta Report and has had a board-level determination that the information is material, failure to communicate corrective information to the SAFE holders would fall well short of the reasonable care standard.
Fraudulent Concealment / Omission. Under Delaware law, silence can be actionable as fraud where there is a duty to disclose. The duty to disclose can arise from a fiduciary relationship, a contractual obligation, or other circumstances that make it unconscionable for one party to remain silent. See Gaffin v. Teledyne, Inc., 611 A.2d 467 (Del. 1992). Here, the information rights provisions in the SAFEs create an express contractual duty to disclose material adverse developments. The Company's silence in the face of this duty would constitute actionable concealment or omission. Importantly, a claim for fraudulent concealment does not require the plaintiff to prove an affirmative misstatement — the wrongful act is the failure to speak when there is a duty to do so.
The pitch materials' representation that Prism Core v2.0 was "beta-ready by Q4 2023" heightens the exposure created by non-disclosure. That representation was accurate when made in August 2023 (based on the Company's then-current development projections), but it has now become materially inaccurate in light of the Peralta Report findings and the estimated four-to-six-month remediation timeline. Under Delaware law, a party that makes a representation that is accurate when made but that subsequently becomes inaccurate before the transaction is consummated may have a duty to update or correct the prior representation, particularly where the party knows that the other party is continuing to rely on it. See Siga Technologies, Inc. v. PharmAthene, Inc., 67 A.3d 330 (Del. 2013) (discussing obligations of good faith and fair dealing in the context of ongoing business relationships). The Company's continued silence after learning that the representation is inaccurate could be viewed as an implicit reaffirmation of the original representation, compounding the fraud exposure.
D. Impact on Atlas Fintech Syndicate (Prospective Investor)
The situation with Atlas Fintech Syndicate, L.P. presents a particularly acute concern. Atlas Fintech signed a term sheet with Lumos on October 4, 2023, for a $1,000,000 SAFE investment. The term sheet was signed five days before the Peralta Report was issued. As of the date of this memorandum, the Atlas Fintech SAFE has not been executed and no funds have been transferred.
If Lumos proceeds to execute the Atlas Fintech SAFE without first disclosing the Prism Core v2.0 validation failure, the Company would be consummating a securities transaction — the sale of a SAFE instrument — while in possession of material undisclosed adverse information regarding its core product. The Atlas Fintech investment decision would necessarily be based on the same pitch materials and product roadmap that were presented to the other investors, including the representation that Prism Core v2.0 was "beta-ready by Q4 2023." Atlas Fintech would have no knowledge that this representation is no longer accurate or that the Company has experienced a fundamental product failure.
This scenario would create a textbook case for fraud and misrepresentation claims. Unlike the existing SAFE holders — who invested before the Peralta Report was issued, and whose claims would be based on the Company's failure to update or correct — Atlas Fintech would be making a new investment based on information that the Company knows to be materially inaccurate at the time of execution. The scienter element would be readily established: the Company's board of directors has formally determined that the Prism Core v2.0 failure is a material product setback, and any decision to proceed with the Atlas Fintech SAFE without disclosure would reflect a deliberate choice to withhold material information from a prospective investor.
Accordingly, I recommend in the strongest possible terms that Lumos not execute the Atlas Fintech SAFE until the Prism Core v2.0 validation failure has been fully disclosed to Marcus Greenfield, the deal lead at Atlas Fintech. Disclosure must precede any further steps toward SAFE execution, including the circulation of final documentation, the scheduling of a closing, or any other action that might be construed as an inducement to complete the investment. Alternatively, the Company may consider pausing all discussions with Atlas Fintech pending resolution of the disclosure process with existing investors, which would allow the Company to address the situation with its existing SAFE holders first before engaging Atlas Fintech on the question.
E. Securities Law Considerations
SAFEs are securities under both federal and state securities laws. While the precise classification of SAFEs has been the subject of some academic and regulatory discussion, the SEC has made clear that SAFEs are securities, and the anti-fraud provisions of the federal securities laws apply to their offer and sale. See SEC Investor Bulletin, "Updated Investor Bulletin: Be Cautious of SAFEs in Crowdfunding" (May 2017); SEC Staff Guidance on SAFEs (2020).
Federal Securities Law. Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder prohibit, in connection with the purchase or sale of any security, (a) the use of any device, scheme, or artifice to defraud, (b) any untrue statement of a material fact or omission to state a material fact necessary to make the statements made not misleading, and (c) any act, practice, or course of business that operates as a fraud or deceit upon any person. These provisions apply regardless of whether the securities are registered or exempt from registration. Accordingly, although Lumos is a private company conducting the Round in reliance on the Rule 506(b) exemption, the anti-fraud provisions of Section 10(b) and Rule 10b-5 apply with full force to the SAFE transactions.
The failure to disclose the Prism Core v2.0 validation failure could constitute a material omission in violation of Rule 10b-5. The August 2023 pitch materials, which were provided to all investors in connection with the SAFE transactions, contained representations regarding the Prism Core v2.0 module that are now materially inaccurate. The Company's continued silence — particularly in the context of ongoing contractual relationships with the SAFE holders and in light of the affirmative information rights provisions — could be viewed as a failure to state a material fact necessary to make prior statements not misleading. Under Rule 10b-5, liability for material omissions can arise where there is a duty to disclose, and the contractual information rights provisions in the SAFEs provide a strong basis for finding such a duty.
With respect to Atlas Fintech, the analysis is even more straightforward. Execution of the Atlas Fintech SAFE without prior disclosure of the Prism Core v2.0 failure would constitute the sale of a security in connection with which the seller (Lumos) knowingly omitted a material fact. This would be a classic Rule 10b-5 violation.
State Securities Law. The anti-fraud provisions of California state securities law are similarly applicable. California Corporations Code Section 25401 provides that it is unlawful for any person to offer or sell a security by means of any written or oral communication that includes an untrue statement of a material fact or omits to state a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading. Unlike Rule 10b-5, Section 25401 does not require a showing of scienter — it is a strict liability provision. California Corporations Code Section 25501 provides a private right of action for damages to any person who purchases a security in violation of Section 25401.
The Company's failure to disclose the Prism Core v2.0 validation failure — particularly in a context where its prior pitch materials contained representations about the product that are now materially inaccurate — could expose Lumos to liability under Section 25401. Because Section 25401 does not require proof of intent to deceive, the Company's subjective state of mind is irrelevant; the only question is whether a material fact was omitted. Given the clear materiality of the Prism Core v2.0 failure, as analyzed in Section III.C above, a violation of Section 25401 would be difficult to defend.
In sum, non-disclosure of the Prism Core v2.0 validation failure could expose Lumos and its officers to liability under both federal and state anti-fraud provisions. These provisions apply to all securities transactions, regardless of the availability of a registration exemption, and they create substantial risk for the Company, its directors, and its officers in the event that non-disclosure is later discovered.
V. Consequences of Non-Disclosure
A. Contractual Remedies
A failure to provide timely notice of the Prism Core v2.0 validation failure to the SAFE holders would constitute a breach of the information rights provisions in the executed SAFEs. As described in Section III.B above, the SAFEs include specific covenants requiring the Company to promptly notify SAFE holders of material events affecting the Company's business and to provide written notice within ten business days of becoming aware of material adverse developments relating to the Company's products or technology.
Breach of these provisions would give the affected SAFE holders contractual grounds to claim breach of the SAFE agreement. Under Delaware law, the available remedies for breach of contract include compensatory damages, specific performance, and other equitable relief. In the context of the SAFEs, potential contractual remedies could include:
(a) An award of damages measured by the difference between the value of the SAFE as purchased and the value of the SAFE in light of the undisclosed information;
(b) Rescission of the SAFE agreement and return of the purchase amount, potentially with interest;
(c) Specific performance of the information rights provisions, requiring the Company to provide the disclosure that it failed to provide;
(d) A declaratory judgment establishing the scope of the Company's disclosure obligations under the SAFEs; and
(e) In the event that the breach is found to have been willful or in bad faith, an award of attorneys' fees and costs.
The contractual remedies analysis is separate from, and in addition to, the fraud, misrepresentation, and securities law claims discussed in Section IV above. An investor could pursue both contractual and tort/statutory claims simultaneously, seeking the remedy or combination of remedies that provides the greatest recovery.
B. Rescission and Refund Risk
The most significant financial consequence of non-disclosure is the risk of rescission. If the Prism Core v2.0 validation failure is later discovered by the SAFE holders — whether through subsequent due diligence, informal information channels within the venture capital community, or any other means — the investors may seek rescission of their SAFE investments and return of their full purchase amounts.
The total purchase amounts at risk are:
Rescission based on fraud or misrepresentation would likely be on less favorable terms to Lumos than a voluntary, negotiated disclosure. An investor seeking rescission following the discovery of non-disclosure would be in a position of significantly greater leverage than it would be in a scenario where the Company proactively disclosed the product setback. In a rescission proceeding, the investor would likely seek not only return of the full purchase amount but also prejudgment interest, attorneys' fees and costs, and potentially consequential or punitive damages.
The Company's ability to fund rescission of all three SAFEs — a total refund obligation of $5,800,000 — is highly questionable given its current financial position. As discussed in Section VII below, the Company had approximately $420,000 in cash on hand prior to the Round, and it has been deploying the SAFE proceeds for operational purposes at a monthly burn rate of approximately $95,000 (net of approximately $38,000 in monthly recurring revenue). If rescission claims were to arise several months from now, the Company may not have sufficient funds to satisfy them, which could precipitate insolvency and further compound the legal exposure for the Company's officers and directors.
C. Officer and Director Personal Liability
Priya Narasimhan (CEO and Chair of the Board), Elliot Marsh (CTO and Director), and Kenji Watanabe (Independent Director) are now personally aware of the Prism Core v2.0 validation failure and the board's determination that it constitutes a material product setback. Their awareness of this information, combined with a decision not to disclose it to the SAFE holders, could expose them to personal liability on several grounds.
Fraud and Misrepresentation. As discussed in Section IV.C, individual officers and directors who participate in or authorize a decision to withhold material information from investors may be personally liable for common-law fraud, negligent misrepresentation, or fraudulent concealment. The scienter element of a fraud claim would be readily established given the board's formal determination of materiality.
Breach of Fiduciary Duty. Under Delaware law, directors who knowingly allow the corporation to make or maintain material misrepresentations breach their duties of loyalty and care. While this duty runs primarily to the corporation and its stockholders, the Delaware Court of Chancery has recognized that in egregious cases, third parties who are the victims of director misconduct may have standing to pursue claims. Moreover, in the event of subsequent litigation by SAFE holders, the directors' breach of fiduciary duty to the corporation could form the basis of a derivative claim or could be used as evidence of the directors' state of mind in connection with fraud claims.
Aiding and Abetting. Under Delaware law, a person who knowingly assists in the commission of a tort — including fraud or breach of fiduciary duty — may be liable for aiding and abetting. If any individual director or officer is found to have actively participated in or facilitated the decision to withhold information from the SAFE holders, he or she could face liability as an aider and abettor of the corporate fraud.
The personal liability risk is particularly acute for CEO Narasimhan, who is the primary corporate spokesperson and the individual most likely to be held responsible for investor communications. CTO Marsh is also at heightened risk given his direct involvement in the Prism Core v2.0 product development and his personal knowledge of the technical deficiencies. Independent Director Watanabe, while less directly involved in day-to-day operations, is not immune; his participation in the October 12 board deliberation and any vote not to disclose would establish his awareness and involvement.
It should also be noted that the Company's directors and officers liability ("D&O") insurance policy, if any, may not cover claims arising from fraud or intentional misconduct. Most D&O policies include a fraud exclusion that precludes coverage for claims based on intentional misrepresentation or fraudulent concealment. The Company should review its D&O policy (if one is in place) to assess the scope of coverage and any applicable exclusions.
D. Reputational and Relationship Harm
Beyond the legal and financial consequences discussed above, the reputational harm that would result from non-disclosure followed by later discovery cannot be overstated. The venture capital ecosystem, particularly in the San Francisco Bay Area, is relationship-driven and reputation-dependent. Information flows quickly through informal channels, and a company's reputation for transparency and integrity is a critical asset in its ability to attract investment, talent, and business partners.
Vantage Peak Ventures is a significant fund with approximately $185 million in committed capital under its Fund II. Its principal office in Menlo Park places it at the center of the Silicon Valley venture capital community. The deal leads at Vantage Peak — Catherine Aldridge, Raymond Petrov, and Samantha Reyes — are well-connected investors who maintain extensive relationships throughout the venture ecosystem. If the Prism Core v2.0 failure were to come to light after a period of non-disclosure, the damage to Lumos's relationship with Vantage Peak would likely be irreparable. Moreover, negative word-of-mouth would propagate rapidly through the venture community, jeopardizing the Company's ability to raise future rounds of financing or to attract other strategic relationships.
Ridgeline Angel Fund occupies a particularly important position in the Company's investor base. Ridgeline is both an existing pre-seed investor (having invested $500,000 via a SAFE at an $8,000,000 valuation cap in August 2022) and a follow-on investor in the current Round ($1,200,000). The pre-existing relationship reflects a multi-year commitment to the Company's success. Damaging this relationship through non-disclosure would have compounding effects: not only would it undermine the current SAFE relationship, but it would retroactively taint the earlier investment relationship and potentially provoke scrutiny of the Company's disclosures in connection with the August 2022 SAFE as well.
In contrast, prompt and transparent disclosure of the product setback — while undoubtedly unwelcome news — is far more likely to preserve investor relationships and goodwill. Experienced venture investors understand that product development setbacks are a normal part of the startup lifecycle. What distinguishes companies that maintain investor trust from those that lose it is not the absence of setbacks, but the manner in which setbacks are communicated. Proactive, honest, and well-framed disclosure demonstrates the kind of management integrity that investors value and that supports long-term relationships.
VI. Recommendation
Based on the foregoing analysis, I recommend the following course of action:
Lumos should promptly and affirmatively disclose the Prism Core v2.0 validation failure to all current SAFE holders — Vantage Peak Ventures Fund II, L.P., Ridgeline Angel Fund, L.P., and Canopy Growth Capital LLC. The disclosure should be made as soon as practicable following the October 12, 2023 board meeting, and in any event within the ten (10) business day notice period specified in the information rights provisions of the SAFEs.
Content of Disclosure. The disclosure communication should include the following elements:
(a) The substance of the Peralta IP Consulting LLC validation report dated October 9, 2023, including the finding that the Prism Core v2.0 module achieved only 61% accuracy against its designated benchmark, as compared to the 92% accuracy target;
(b) The estimated remediation timeline of four to six months, as determined by CTO Elliot Marsh, and the resulting impact on the previously communicated product roadmap, including the fact that Prism Core v2.0 will not be beta-ready by Q4 2023 as previously represented;
(c) The Company's planned corrective steps, including the proposed approach to model re-architecture, additional training data acquisition, and renewed validation testing;
(d) The Company's assessment of the impact on its overall business plan, competitive positioning, and financial projections; and
(e) An invitation for each investor to contact the Company with questions or requests for additional information.
Manner of Disclosure. The disclosure should be made by CEO Priya Narasimhan directly to the deal leads at each investor fund, as follows:
• Samantha Reyes (Principal, Vantage Peak Ventures Fund II, L.P.)
• David Choi (General Partner, Ridgeline Angel Fund, L.P.)
• Lena Petrova (Managing Director, Canopy Growth Capital LLC)
The disclosure should be delivered initially by telephone or video conference, followed by a written communication (email or letter) that memorializes the substance of the disclosure for the record. The telephone or video conference allows for a personal, direct communication that conveys the seriousness with which the Company is treating the situation and provides an opportunity for immediate dialogue and questions. The follow-up written communication ensures that the Company has a clear record of having provided the disclosure and of the specific information communicated.
Atlas Fintech Syndicate, L.P. With respect to Atlas Fintech, Lumos should disclose the Prism Core v2.0 validation failure to Marcus Greenfield (Partner) before taking any further steps toward execution of the Atlas Fintech SAFE. The disclosure should be made in the same manner and with the same content as the disclosures to the existing SAFE holders. Following disclosure, Atlas Fintech will need to make its own determination as to whether it wishes to proceed with the investment. Alternatively, the Company may consider pausing discussions with Atlas Fintech pending resolution of the disclosure process with existing investors and development of a more complete remediation plan, which would give Atlas Fintech a more informed basis on which to evaluate the investment.
Review of Disclosure Communication. I recommend that the disclosure communication — both the talking points for the telephone or video conference and the follow-up written communication — be reviewed by Calderwood & Harkness before transmission. This review will ensure that the disclosure is accurate, complete, and appropriately framed, and that it does not inadvertently create additional legal exposure through imprecise language or overstatement. The framing should be factual and forward-looking, emphasizing the Company's commitment to transparency and its concrete plan for remediation, without minimizing the significance of the setback or making new commitments that the Company may not be able to honor.
Board Authorization. The board should formally authorize the disclosure and the approach to each investor at or following the October 12, 2023 board meeting. The board resolution should memorialize the board's determination that the Prism Core v2.0 failure is a material development requiring disclosure under the information rights provisions of the SAFEs, the board's decision to disclose, and the board's designation of CEO Narasimhan as the authorized spokesperson for purposes of the investor communications. A written board resolution provides important documentation that the board acted thoughtfully, in good faith, and in compliance with its fiduciary duties.
Non-Disclosure Is Not a Viable Option. I want to be direct on this point: non-disclosure is not a viable option for Lumos. The contractual information rights provisions in the executed SAFEs create a clear and enforceable obligation to disclose material adverse developments. The Prism Core v2.0 validation failure is unambiguously material under any reasonable construction of that term. Non-disclosure would expose the Company to breach of contract claims, fraud and misrepresentation claims under Delaware common law, liability under federal and state anti-fraud provisions, and claims for breach of fiduciary duty. It would expose the Company's individual officers and directors — Narasimhan, Marsh, and Watanabe — to personal liability, potentially beyond the scope of any D&O insurance coverage. And it would cause disproportionate and potentially irreparable harm to the Company's relationships with its investors and its reputation in the venture capital community. The risks of non-disclosure vastly outweigh any perceived short-term benefit of delay.
VII. Next Steps
Subject to your review and approval, I propose the following next steps:
1. Prepare Draft Disclosure Communication. Calderwood & Harkness will prepare a draft disclosure communication for CEO Narasimhan's review. This will include (a) a set of talking points for use in telephone or video conference calls with each investor's deal lead, and (b) a draft written follow-up communication (email or letter) to be sent to each investor following the initial call. I anticipate having a draft ready for your review by end of day on October 13, 2023, and for Narasimhan's review by October 16, 2023, with the goal of completing the initial disclosure calls no later than October 18, 2023.
2. Anticipate Investor Reactions. We should prepare Narasimhan and the board for a range of potential investor reactions, including requests for additional information (e.g., a copy of the Peralta Report, a meeting with CTO Marsh, a revised product roadmap and financial model), requests for renegotiation of SAFE terms (e.g., a lower valuation cap, a discount provision, or additional information rights), and in a worst-case scenario, investor withdrawal from the Round and requests for rescission and refund of purchase amounts. We should develop a response framework for each of these scenarios.
3. Assess Cash Position and Operational Runway. We should work with the Company's finance team to prepare a detailed assessment of Lumos's cash position and operational runway in the event that the Round is disrupted. Based on the information currently available, the Company's pre-Round cash was approximately $420,000, and its current monthly burn rate is approximately $95,000, offset by approximately $38,000 in monthly recurring revenue (resulting in a net monthly cash consumption of approximately $57,000). With $5,800,000 in SAFE proceeds received, the Company should have a substantial cash runway under normal circumstances. However, if one or more investors seek rescission and refund of their purchase amounts, the Company's liquidity position could deteriorate rapidly. A detailed cash flow analysis and scenario plan should be prepared.
4. Prepare for Potential SAFE Termination and Refund Negotiations. In the event that disclosure triggers investor withdrawal requests, we should be prepared to advise the Company on the legal framework for SAFE termination and refund. The SAFEs may or may not include express provisions addressing investor withdrawal or termination rights; we should review the relevant provisions and advise on the Company's obligations. If refund negotiations become necessary, we should counsel the Company on structuring a refund arrangement that preserves maximum liquidity for the Company while satisfying its legal obligations.
5. Confirm Revolving Credit Facility. The Company has indicated that it may have a $200,000 revolving line of credit at Silicon Valley Commerce Bank, with Trevor Quinlan serving as the relationship manager. We should confirm the existence, terms, and availability of this facility, as it could provide an additional liquidity buffer in the event of disruption to the SAFE round. We should also review the credit agreement to determine whether any of the events described herein (the product failure, potential investor rescission claims, etc.) constitute events of default or conditions that would limit the Company's ability to draw on the facility.
6. Ongoing Counsel. Calderwood & Harkness will remain available to advise the Company and its board throughout the disclosure process and any subsequent investor discussions, negotiations, or disputes. I recommend that all communications with investors regarding the Prism Core v2.0 situation be coordinated through, or at a minimum reviewed by, outside counsel to ensure consistency and to minimize legal risk.
I am available to discuss this memorandum and the recommended course of action at your convenience. Please let me know if you would like to schedule a call to discuss before I begin drafting the disclosure communication.
Distribution: Internal Calderwood & Harkness LLP only — Patricia Dunmore, George Trujillo (billing partner, for awareness)
Copies to File: Matter No. 1008-00003
Do not distribute outside the firm without partner approval.
| Investor | Purchase Amount |
| Vantage Peak Ventures Fund II, L.P. | $3,500,000 |
| Ridgeline Angel Fund, L.P. | $1,200,000 |
| Canopy Growth Capital LLC | $1,100,000 |
| Total | $5,800,000 |