The US Supreme Court recently agreed to hear an important appeal of a US Court of Appeals for the Ninth Circuit decision interpreting Sections 11 and 12(a)(2) of the Securities Act of 1933 in the context of a direct stock listing.
These sections of the Securities Act of 1933 (the Securities Act) allow investors to bring claims based on a false or misleading statement in a registration statement. Such claims typically fail where the investors cannot prove that their shares were issued under the challenged registration statement. In Slack Technologies, LLC et al. v. Pirani, No. 22-200, the Court will address whether investors can bring Section 11 and 12(a)(2) claims where the investors purchased shares sold in a direct listing but cannot plead or prove that they purchased those shares under the pertinent registration statement.
Direct stock listings are a relatively new and, so far, uncommon way for companies to go public. They came into usage in 2018 after the US Securities and Exchange Commission approved the New York Stock Exchange’s proposal to allow qualifying private companies to directly list their shares for public trading without conducting a full initial public offering. The rule required that the company seeking a direct listing file a Securities Act registration statement.
Because of the registration statement requirement, investors in direct-listed companies have pursued Section 11 and 12(a)(2) claims based upon alleged false or misleading statements in the registration statement. However, Section 11’s strict standing requirements limit claims to aggrieved investors who can “trace” their shares to the allegedly defective registration statement. And Section 12(a)(2) limits claims to only purchasers who bought their shares “by means of a prospectus.”
In Slack, the US Supreme Court will resolve how these requirements apply in a direct listing. In Slack’s June 2019 direct listing, the company registered 118 million shares held by existing shareholders for sale to the public. In addition to those registered shares, 165 million unregistered shares became publicly tradeable on the effective date of Slack’s registration statement because SEC rules exempted those shares from registration.
It is typically impossible for investors in publicly traded shares to trace their shares to an allegedly defective registration statement because those shares are held by brokerage firms in fungible, mass book-entry form. Thus, after Slack’s direct listing, the plaintiff—who had purchased his shares on the open market—could not show that his shares were among the 118 million registered shares. In other words, the Slack plaintiff could not “trace” his shares to the securities that were the subject of the registration statement that he claimed included false or misleading statements.
Before Slack, courts consistently held that Section 11 and 12(a)(2) claims must be dismissed where a plaintiff cannot meet the tracing requirement. In Slack, however, the district court denied Slack’s motion to dismiss, holding that in a direct listing where registered and unregistered shares enter the market simultaneously, the plaintiff does not need to be able to trace his or her purchases to the allegedly defective registration statement.
A split panel of the Ninth Circuit agreed, stating that “Slack's unregistered shares sold in a direct listing are ‘such securities’ within the meaning of Section 11 because their public sale cannot occur without the only operative registration in existence. Any person who acquired Slack shares through its direct listing could do so only because of the effectiveness of its registration statement.” Pirani v. Slack Techs., Inc., 13 F.4th 940, 947 (9th Cir. 2021).
Slack argued in its petition for a writ of certiorari that the Ninth Circuit’s decision erred, explaining, “[P]laintiffs suing under Sections 11 and 12(a)(2) of the Securities Act must show that they bought shares registered under the registration statement they allege is misleading. Before this case, every court of appeals to consider the question had held that they must.”
The Supreme Court granted Slack’s cert petition to resolve the apparent split in authority created by the Ninth Circuit’s decision.
Eliminating Section 11 and Section 12(a)(2)’s strict standing requirements in direct stock listings may have broad implications for class action litigation brought under Sections 11 and 12(a)(2). The potential importance of this decision is evidenced by the multiple amicus briefs that were filed in support of and in opposition to Slack’s cert petition.
The significance of the Slack ruling has been heightened by recent exchange rule changes that may encourage more companies to sell shares by means of a direct listing. On December 9, 2022, Nasdaq reported that it has obtained approval to expand the ability of companies undertaking a direct listing to raise capital by selling shares to the public. In a recent interview, Karen Snow, senior vice president and head of US listings and revenue at Nasdaq, called these new rules a “silver bullet,” and said that “you will see large and small companies using it on a more regular basis going forward.”
The Supreme Court’s ruling in Slack is expected by the end of the 2022–2023 term in June 2023.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:
 Katherine Doherty and Katie Roof, “Nasdaq, NYSE Set to Ease Rules on Direct-Listing Capital Raises,” Bloomberg Law News, December 9, 2022.