I have previously blogged about the SPV phenomenon, whereby investors can get access to private company shares by investing through a vehicle dedicated to that purpose. As I previously explained, the trend has recently exploded, with numerous LLCs selling interests to retail investors through platforms like EquityZen, often with high fees and opaque pricing.  Among other things, the SPV phenomenon allows capital-hungry startups to raise money while (nominally) staying below the 2,000 investor threshold that would trigger mandatory reporting – and startups are increasingly pushing the limits of the law by coordinating with SPV sponsors.

Which is why I was fascinated by recent reports that some startups – particularly Anthropic and OpenAI – have gotten concerned about the number of uncontrolled SPVs selling interests in their shares.

I agree it’s a wild west, and for sure some retail investors are being taken advantage of.  The more interesting question is why companies like Anthropic would care.  Investors in SPVs – and SPVs of SPVs – don’t have a direct relationship with the company and don’t have rights against it, so what are they concerned about? I have a couple of thoughts. 

First, as the Financial Times article explains, OpenAI and Anthropic both have government contracts that require disclosure of their investors, out of concern for foreign investment that might pose a national security risk.  The use of far flung SPVs might make it impossible for both companies to comply.

Second, the original SPV, the one that actually holds the shares – if at some point those managers choose to assert some kind of rights against the entity on behalf of their own (unknown, shifting) retail investors (either by choice, or because the retail investors force action), that might be a problem for the company, especially if those retail investors’ interests diverge from the interests of the venture capital firms who have done most of the sponsoring.  We can spin out scenarios; what if the SPV is leveraged and forced to sell its assets?  What if the company merges and the SPV has appraisal rights? Etc etc

Third, the fees that are layered on top of LLC shares represent, well, rents that could have gone to the operating companies.  And if you assume the LLC interests trade, or new LLCs constantly offer interests on internet platforms, that means the operating company loses control over how its shares are priced.

Fourth, I suppose the operating companies may simply want to protect their images.  To the extent there are shady LLC operators who mislead their investors or even claim to have access to shares they don’t have, the operating company may want to avoid any air of scandal, even if it is not at fault.  And it’s kind of like Hermes handbags, you know?  The company may keep its valuation high by avoiding association with all those… people.

The fifth reason, though, is the most interesting.  Suppose an officer of Anthropic publicly makes some kind of false statement about its finances (I am not accusing Anthropic of anything!  This is just a thought experiment).  It’s not impossible the company will face 10b-5 liability from its direct shareholders, but it’s unlikely.  Most investors who bought directly from Anthropic probably got truthful information, and even those that didn’t may not want to burn their relationship enough to file a lawsuit.  The fraud would have to be fairly extreme, in other words, before we could expect 10b-5 claims from direct investors.

But what about a retail investor who buys shares in an SPV that holds Anthropic shares?  Can that investor sue Anthropic under 10b-5?  I have absolutely no idea.  On the one hand, the SPV is simply a vehicle for investing in Anthropic; Anthropic’s fraud could easily induce a retail shareholder to make a purchase, and injure the shareholder when the truth is revealed.  But, then, there’s been this line of caselaw recently requiring that the false statement only concern the entity in which the plaintiff bought shares, although how that standard is defined is … opaque, to me. (Most recent blog post here.)

Plus, in Stoyas v. Toshiba, 896 F.3d 933 (9th Cir. 2018), the Ninth Circuit held that if American investors buy unsponsored ADRs of a foreign issuer, the foreign issuer’s false statements may not have been made “in connection with” the ADR purchases.  Maybe.

Frankly, this is all very confusing which means the only real certainty I have is that there is no certainty as to whether these cases would, or would not, bar an investor in an Anthropic SPV from suing Anthropic directly under 10b-5.  And god only knows what the common law fraud standards might look like.

So, yeah, I can see why these companies are fine with coordinated SPVs, and less fine with uncoordinated ones.

Of course, then, that gets back to the original problem – the more coordination, the more risk that these arrangements look like a mechanism to avoid the requirements of public reporting. 

Which, to be fair, they are.