Extracted from Law360
The U.S. Supreme Court has agreed to hear a number of appeals over the years involving the federal securities laws.
The most recent such appeal that will be briefed and argued this year is Slack Technologies LLC v. Pirani,[1] an appeal from the U.S. Court of Appeals for the Ninth Circuit. Slack deals with the question of whether claims exist under Sections 11 and 12(a)(2) of the Securities Act for shares made available for public sale in what is known as a direct listing.
A direct listing allows a company to go public without going through the traditional route of issuing new shares in an underwritten initial public offering.
In a direct listing, the company files a registration statement that allows existing shares held by early investors and employees to be sold to the public on the same day as unregistered shares, if those shares are exempt from registration.[2] Under that scenario, a member of the public buying shares in a direct listing will likely have no way of knowing whether he or she bought a registered or an unregistered share.
In year-end commentary on securities law developments, many commentators singled out the Slack appeal as an important case to watch. If you look at the securities cases the Supreme Court has agreed to hear over the years, the question is always whether the court will resolve the appeal on narrow grounds or in such a way that the decision could have broad potential impact for securities practitioners.
In several instances over the years, the court's ultimate ruling failed to yield any dramatic changes in the day-to-day practice of private securities litigation.[3]
The question is whether the Slack appeal will follow a similar path. For the reasons described below, we anticipate that the appeal will not have the potential broad impact that some are predicting, but we acknowledge that oral argument, which is still several months away, will provide additional insight into how this appeal may be resolved.
Background on the Slack Appeal
The Ninth Circuit affirmed the conclusion of the U.S. District Court for the Northern District of California in 2021 that Fiyyaz Pirani, who bought Slack Technologies stock in that company's direct listing, had standing to bring claims under Sections 11 and 12(a)(2),[4] despite the fact that he was unable to prove that the shares he bought were registered under the allegedly misleading registration statement that he was challenging.[5]
In the Slack direct listing, roughly 41% of the shares available for purchase were registered shares, with the rest of the shares being unregistered because they were exempt from registration.[6]
The court of appeals observed that, even though unregistered shares were simultaneously sold in the direct listing, the company still had to file a registration statement in order to pursue a direct listing.
As a result, the Ninth Circuit determined that a plaintiff need not prove the purchase of registered shares because no member of the public in a direct listing can buy any shares whether registered or not "without the issuance of [the company's] registration statement."[7] In other words, "[a]ny person who acquired ... shares through [the] direct listing could do so only because of the effectiveness of [the] registration statement."[8]
This concept of needing to show that the shares purchased were registered pursuant to the allegedly misleading registration statement comes from the existing case law on standing to pursue claims in the context of traditional public offerings.
This issue arose in the past where, for example, a company issued stock in a secondary public offering after it already had shares trading publicly.
If the plaintiff's claim is that the registration statement for the secondary offering was false and misleading, then the existing body of case law discussed in more detail below requires the plaintiff to show that the shares he or she bought were registered pursuant to the specific registration statement being challenged and, thus, were not made available for sale under some other earlier registration statement.
The Ninth Circuit reasoned that there was no such tracing problem in the direct listing context because there would be only one registration statement filed by a company as of that point in time and, thus, all the "shares sold in this direct listing, whether labeled as registered or unregistered, can be traced to that one registration."[9]
Potential Outcome and Impact of the Appeal
Assuming that the Supreme Court limits its decision to claims brought where shares are acquired in a direct listing — which, as discussed below, we expect them to do — the decision by definition would be limited by the rarity of direct listings.
Since 2018, fewer than 15 companies have entered the public market via direct listing, many of which are consumer brands with high name recognition such as Spotify or Warby Parker.[10]
Notably, more than 600 companies went public via a traditional IPO between January 2019 and January 2023, and 400 companies completed a special-purpose acquisition company de-SPAC transaction between January 2019 and September 2022.[11] This makes direct listings by far the least favored method to go public, as compared to other available methods.
Moreover, we do not think it likely that the court would decide to carve out a special, more expansive rule of potential liability for shares that go public via a direct listing.
This is so because of the strict liability nature of the claims at issue, the inconsistency such a rule would have with the existing body of case law developed for conventional offering scenarios, and the fact that other types of claims under the federal securities laws would still be available to shareholders.
Indeed, one of the challenges the plaintiff faces on appeal in Slack is the uphill battle of explaining why claims arising from a direct listing should be treated any differently than the more typical scenario courts have encountered over the years with successive public offerings.
In devising the existing rule that limits the number of plaintiffs with standing, courts have already analyzed the same statutory text at issue in Slack and the interpretation of that text should not change when applied to new facts.
Although some have argued that this appeal could threaten the well-established body of case law on successive public offerings, we see no need for the court to go there. In other words, it seems improbable that the court would choose to alter the well-established and largely uniform case law across the circuits that requires tracing of shares to a specific registration statement under Section 11.
The U.S. Court of Appeals for the Second Circuit's 1967 decision in Barnes v. Osofsky,[12] which held as a matter of first impression that Section 11 claims may only be brought by plaintiffs whose shares were issued pursuant to the faulty registration statement, makes clear that the strict liability leveled by Section 11 is intentionally balanced by narrowing the plaintiff class through the traceability requirement.
U.S. Circuit Judge Eric Miller said in his Slack v. Pirani dissent:
Strict liability is strong medicine, so the statute tempers it by limiting the class of plaintiffs who can sue.[13]
In the more than 50 years since Barnes, seven circuit courts, notably including the Ninth Circuit, have held that plaintiffs who cannot prove that their shares were issued under the allegedly false or misleading registration statement lack standing to bring Section 11 claims.[14]
Further, in our opinion, a decision limiting claims under the Securities Act for direct listings to only the purchase of registered shares would not create a free-for-all environment for issuers, as some have claimed.[15]
Plaintiffs who cannot prove that their shares were registered pursuant to the allegedly false and misleading registration statement still have a remedy for harm under other aspects of the federal securities laws, such as fraud-based claims pursuant to Section 10(b) of the Securities Exchange Act and U.S. Securities and Exchange Commission Rule 10b-5.[16]
And while it is true that Section 10(b) claims have more rigorous pleading burdens on the front end, those additional burdens do not seem to deter plaintiffs who pursue such claims on a regular basis.
[1] No. 22-200 (petition for writ of certiorari granted by 214 L. Ed. 311 (Dec. 13, 2022).
[2] Pirani v. Slack Techs., Inc ., 13 F.4th 940, 944 (9th Cir. 2021).
[3] See, e.g., Erica P. John Fund, Inc. v. Halliburton Co. , 563 U.S. 804 (2011) (rejecting the Fifth Circuit's unique class certification requirements that had not been adopted by any other circuit); Amgen Inc. v. Conn. Ret. Plans & Tr. Funds , 568 U.S. 455 (2013) (deciding that materiality was a merits issue which was dispositive because defendants had conceded all other aspects of Rule 23's predominance requirement).
[4] Section 11 provides a cause of action for false and misleading statements in a registration statement for "any person acquiring such security" against "every person who signed the registration statement . . . ." 15 U.S.C. § 77(k)(a)(1)-(2). Section 12(a)(2) provides a cause of action against "[a]ny person who . . . offers or sells a security . . . by means of a [false or misleading] prospectus" (which is part of the registration statement) that can be brought by "the person purchasing such security." 15 U.S.C. § 77l(a)(2).
[5] Pirani, 13 F.4th at 943.
[6] When Slack went public, it "release[ed] 118 million registered shares and 165 million unregistered shares into the public market for purchase." Id. at 944. The plaintiff purchased 30,000 shares on the first day the shares became available and purchased 220,000 additional shares over several months. Id. Slack issued no new shares in the direct listing. Id. at 945.
[7] Id. at 943.
[8] Id. at 947.
[9] Id.
[10] Jay R. Ritter, Initial Public Offerings: Direct Listings Through May 19, 2022 (Univ. of Fla., May 19, 2022), https://site.warrington.ufl.edu/ritter/files/Direct-Listings.pdf.
[11] Jay R. Ritter, Initial Public Offerings: Updated Statistics (Univ. of Fla., 2023), https://site.warrington.ufl.edu/ritter/files/IPO-Statistics.pdf; US De-SPAC & SPAC Data & Statistics Roundup Q3 2022 (White & Case), Q3 2022, https://www.whitecase.com/sites/default/files/2022-11/us-spac-de-spac-data-statistics-round-up.pdf.
[12] 373 F.2d 269 (2d Cir. 1967).
[13] Pirani, 13 F.4th at 952 (Miller, J., dissenting).
[14] See id. at 952 (collecting cases).
[15] The Ninth Circuit rejected the notion that it should require a plaintiff to prove the purchase of registered shares because that would create a "loophole" that "would essentially eliminate [any] Section 11 liability . . . for both registered or unregistered shares" in direct listings. Id. at 948.
[16] 15 U.S.C § 78j(b); 17 C.F.R. § 240.10b-5.