On June 1, 2023, a unanimous U.S. Supreme Court voted to curtail investor protections in connection with a “direct listing” public offering. The decision is a setback for investors and provides a roadmap for companies to orchestrate public offerings in an attempt to avoid private enforcement of the securities laws.
To set the stage: the case involves claims under the Securities Act of 1933, which regulated public offerings of securities, traditionally done via an initial public offering or secondary public offering. Section 11 of the Securities Act is a powerful tool for investors, as it provides a cause of action for investors harmed by purchasing shares in a public offering where the offering materials (prospectus, registration statement) contain materially misleading statements. While Section 11 claims can only target a discrete set of actors (issuer, director, underwriters), it provides for a strict liability standard for issuers and a negligence standard for other actors. Thus, unlike a traditional Rule 10(b) case under the Securities Exchange Act of 1934, there is no scienter (fraudulent intent) requirement.
The case stemmed from Slack Technologies’ 2019 stock offering. Slack’s offering was made via a relatively new type of offering: the direct listing. A direct listing is an alternative method for a company to go public, but without the cost and procedures typical in a traditional offering, namely selling through underwriter banks. Instead, in a direct listing, a company’s previously issued shares (registered or unregistered) are simply listed on an exchange. While companies, like Slack, still file registration statements related to any registered shares, the direct listing route allows other insiders and early investors to immediately list and trade their unregistered shares without filing any additional offering documents with the SEC if they fall under an exception to the registration requirements (Rule 144). Thus, for any unregistered shares sold directly to the public, there is no lock-up period restricting when insiders can sell unregistered shares, which is typical in traditional offerings. Thus, from the date of the direct listing, both registered and unregistered shares may be available to the public. While there have only been 14 direct listing offerings to date, certain defense firms have advised clients that these offerings present the benefit of accessing the public markets with less cost while limiting liability exposure.
In its direct listing, Slack registered 118 million shares that were offered and sold pursuant to a registration statement, while simultaneously, an additional 165 million unregistered shares were listed for sale as well. Fiyyaz Pirani, the plaintiff, purchased 30,000 Slack shares on the day of the direct listing; and another 220,000 shares over the following months.
After the direct listing, Pirani brought an action alleging that the registration statement filed in connection with the sale of directly listed registered shares contained materially misleading statements about the Company’s financial conditions and liabilities and thus the stock price paid was inflated.
Slack filed a motion to dismiss in the district court overseeing the litigation, challenging Pirani’s standing and arguing that he could not show that he purchased registered shares traceable to the company’s registration statement, as opposed to unregistered shares. Pirani, however, argued that no sales could have been accomplished without the allegedly false registration statement that was filed with the SEC. Further, Pirani argued that any unregistered shares were encompassed under the phrase “such security” in the statute that references shares offered pursuant to a registration statement.
While both the district court and Ninth Circuit ruled in favor of Pirani, the Supreme Court unanimously reversed.
On appeal, Slack argued that Pirani lacked standing because he did not allege that he purchased registered shares traceable to offering documents. Pirani countered by arguing that investors were entitled to rely on the allegedly misleading prospectus in purchasing the shares, particularly where it may be impossible for an investor to determine whether they received registered or unregistered shares. In fact, Pirani argued that individuals selling unregistered shares made no filing with the SEC. Thus, Pirani asserted the registration statement for the registered shares was the only SEC filing available to Pirani and other investors in connection with the offering. In essence, the dispute came down to the definition of the phrase “such security” in the statute: namely, whether it was limited to registered shares or could encompass any shares offered in connection with a public offering.
The Supreme Court reversed the Ninth Circuit’s decision and remanded. In a unanimous decision authored by Justice Gorsuch, the Court sided with Slack, interpreting the term “such security” contained within Section 11 as limiting the Section’s reach to securities “registered under [a] particular registration statement alleged to contain a falsehood or misleading omission.” Basing its analysis on other textual provisions of the Securities Act, the Court concluded that while the statutory language was not crystal clear, various “contextual clues” persuaded the Court that Slack’s reading of Section 11 was “the better one.” Thus, the Court found that “[t]o bring a claim under §11, the securities held by the plaintiff must be traceable to the particular registration statement alleged to be false or misleading.” The Court remanded the case to the lower court to decide if Pirani’s complaint can satisfy the pleading requirement that he purchased shares traceable to the alleged defective registration statement.
The Court did not, however, reach the merits on Pirani’s claims under Section 12(a)(2) of the Securities Act—a separate provision also related to public offerings. That provision, creating liability for sellers of newly offered shares, was a focus of much debate during oral argument. For example, Justice Gorsuch questioned whether the Court needed to reach the issue at all, while Justices Kagan, Sotomayor, and Brown Jackson suggested that Section 12(a)(2) is broader in scope than Section 11 because it may apply outside the registration context, meaning liability would attach to both registered and unregistered shares sold simultaneously. Ultimately, the Court sidestepped the Section 12 issue, leaving it for the lower court to weigh in on upon remand. The Court did caution, however, that it was not expressing any views about the proper interpretation of Section 12, nor did it endorse the Ninth Circuit’s “apparent belief that §11 and §12 necessarily travel together, but instead caution[s] that the two provisions contain distinct language that warrants careful consideration.”
While Pirani lives to fight another day in the lower court, the Slack decision is likely to adversely impact investors going forward. While some commentators claim that the Court’s opinion merely re-enforces long-settled Section 11 law, the ruling’s language may invite further erosion of investor rights. First, defendants will certainly argue that the decision requires all Section 11 plaintiffs to “trace” their shares to an offering even where a shareholder purchased their shares directly from an underwriter. Increasingly, defendants challenge standing of such investors on the basis that for nearly every offering, the issued shares are immediately commingled and held by the Depository Trust Company. Thus, defendants have argued that no one—not even lead underwriters—can “trace” shares to an offering whenever there are any unregistered and/or previously issued shares in the market. Such a gross reading—which defendants would argue is further supported by this new Supreme Court decisions—would eviscerate Section 11 as a tool for plaintiffs and turn the clear purpose of Section 11 on its head. Second, the Slack decision will encourage more direct listings and alternative offering procedures that would allow companies to access public markets while seeking to evade the threat of Section 11 liability. This is a troubling sign during our increasingly volatile markets and where one need not look far for examples of the next “Enron,” from Theranos, to Nikola, to collapsing SPAC. Now is not the time to roll-back shareholder protections.
A copy of the case: Slack Technologies, LLC v. Pirani, is available here.