Here’s a scenario: Plaintiffs purchase a Simple Agreement for Future Equity (SAFE) in an AI startup. SAFEs are a contractual arrangement where the startup receives a certain amount of financing from the investor, but the parties do not determine exactly how much equity is being purchased at that time. Later, after the startup receives investment from someone else that prices the equity, the original investor’s contract is converted into equity on similar (or slightly improved) terms from the later investor. It allows the original investor to make a fast investment without engaging in the very difficult task of valuing an early stage company; the later investor does that, when more information is available. But SAFEs are risky because they remain outstanding, with no obligation by the issuer to the investor, until another round of financing comes along, and that round may never come.
So if you purchase a SAFE based on what you come to believe is fraudulent information, and you bring a subsequent Section 10(b) claim, how do you establish losses attributable to the fraud?
That was the problem in Lifevoxel Virginia SPV v. Lifevoxel.AI (hey, look, bonus SPV!). The Ninth Circuit, in an unpublished opinion, held that it was too much for the district court to demand that plaintiffs show the fraud was so bad as to render a conversion event impossible; the SAFE is a financial instrument, it may have been worth different amounts at different times, and its value could have fluctuated as a result of the fraud. Still, said the court, the plaintiffs here – who alleged various misrepresentations regarding, inter alia, the company’s financial condition, income, and capitalization – had not plausibly alleged that these misrepresentations specifically were responsible for the decline in the SAFE’s value, or even that there was a decline in value in the first place.
It’s a difficult problem, I suppose, since the whole point of a SAFE is that it’s hard to value an early stage company, so you don’t even try to do it! I suppose in a future attempt, there might be some options-value formula that can be used for a situation like this.
Interesting side note: Why are they suing under Section 10(b) at all, given that state law fraud claims are usually much easier to bring, and the plaintiffs here were not trying to use 10(b)’s fraud on the market presumption, which is usually the main reason to choose federal claims over state ones? I can’t tell from the record but I am reminded of when I had a similar question about a lawsuit against WeWork, and the answer was, a contractual anti-reliance clause that was likely binding under state law, but not federal law.
Edit: Turns out, Gad Weiss wrote a paper on this issue, here!