The U.S. Supreme Court held that purchasers of shares sold to the public through a direct listing cannot sue under Section 11 of the Securities Act of 1933 unless they can trace their shares to an allegedly defective registration statement. The short, unanimous decision in Slack Technologies, Inc. v. Pirani (June 1, 2023) appears likely to increase the difficulty of pleading § 11 claims arising from direct listings, thereby requiring dissatisfied purchasers to resort to the Securities Exchange Act of 1934, which imposes stricter standards for liability. The Court declined to comment on Securities Act § 12(a)(2)’s requirements, leaving the issue for the Ninth Circuit on remand.

Background

In 2018, the New York Stock Exchange issued a rule, which the SEC later approved, allowing companies to go public and sell their shares on a national exchange through a “Selling Shareholder Direct Floor Listing,” known as a “direct listing.” Direct listings offer an alternative to the more common form of going public through an initial public offering.

In a traditional IPO, a company issues new shares under a registration statement that registers the shares with the SEC. Investment banks help the company market those shares and often commit to buy them at a predetermined price. To ensure that the stock price remains stable for some period after the offering, underwriters usually require a lock-up period that restricts pre-IPO shareholders from selling their existing, unregistered shares for several months.

In a direct listing under the 2018 NYSE rule, a company files a registration statement to register pre-existing shares before they can be sold to the public. Shares in a direct listing are sold directly to the public, without any underwriting. Because underwriters are not involved, direct listings do not impose lock-up periods restricting the sale of unregistered shares, so pre-existing shareholders are free to sell their unregistered shares. Accordingly, a direct listing makes both registered and unregistered shares available to the public as soon as the direct listing takes effect.

The Slack Case

Slack Technologies went public in 2019 through a direct listing. Slack filed a registration statement for a specified number of registered shares that it intended to offer. Because the offering was a direct listing rather than an IPO, holders of pre-existing, unregistered shares could also sell their shares into the market.

Over the following months, Slack allegedly experienced some business setbacks, and its stock price declined. A shareholder then sued under §§ 11, 12(a)(2), and 15 of the Securities Act, alleging misrepresentations in the registration statement and prospectus for the direct listing. The shareholder did not assert claims under the Exchange Act.

Section 11 applies to alleged misrepresentations or omissions in registration statements. Section 12(a)(2) applies to alleged misrepresentations or omissions in prospectuses or oral communications relating to a prospectus. Securities Act claims can be more attractive to plaintiffs than Exchange Act claims because the Securities Act imposes strict liability on the issuer without regard to scienter, while the Exchange Act requires proof of fraud. But because the burden of proof is easier under the Securities Act, those claims are available only to plaintiffs who can trace their shares to an allegedly false or misleading registration statement or prospectus.

The Slack defendants moved to dismiss the complaint, contending that the plaintiff had not established that he had purchased registered shares issued pursuant to the registration statement and prospectus, rather than unregistered shares that had entered the market through the direct listing at the same time as the registered shares. (This issue does not normally arise in the initial months after a traditional IPO, in which only the registered shares trade in the market while the unregistered ones remain locked up.) The District Court denied the motion to dismiss, and the Ninth Circuit – in a 2-1 decision – affirmed.

The majority ruled that the plaintiff could sue under §§ 11 and 12(a)(2) because the shares he had purchased – whether registered or unregistered – could not have been acquired without the issuance of the registration statement for the direct listing. That registration statement had enabled Slack and its investors to sell both registered and unregistered shares; conversely, neither type of security would have been available to the public without the registration statement. Accordingly, the majority believed that all shares traded after the direct listing took effect, regardless of their registration status, were effectively traceable to the registration statement.

The majority also expressed concern that, if § 11 were to apply only to registered shares in a direct listing, such an interpretation would essentially eliminate § 11 liability for false or misleading statements as to both registered and unregistered shares. Because Securities Act claims can pose a greater potential threat to issuers than do Exchange Act claims, the majority observed that “from a liability standpoint it is unclear why any company, even one acting in good faith, would choose to go public through a traditional IPO if it could avoid any risk of Section 11 liability by choosing a direct listing.”

Supreme Court’s Decision

The Supreme Court, in a decision by Justice Gorsuch, unanimously vacated the Ninth Circuit’s decision on § 11 and remanded the case for further consideration, including as to § 12(a)(2). The Court held that § 11’s text authorizes suit only when the security at issue was issued pursuant to a registration statement alleged to have been false or misleading.

The Court focused on § 11’s language: “In case any part of the registration statement . . . contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security” may sue (emphasis added). The Court acknowledged that § 11’s language was not entirely clear, because the word “such” in the phrase “such security” does not have a clear referent. But based on context, the Court concluded that “such security” must be a security issued under the challenged registration statement.

The Court rejected the Ninth Circuit’s position that even unregistered shares in a direct listing are traceable to the registration statement in that, “but for the existence of Slack’s registration statement for the registered shares, its unregistered shares would not have been eligible for sale to the public.” The Court opined that the plaintiff had “not explain[ed] what the limits of [this] rule might be, how we might derive them from § 11, or how any of this can be squared with the various contextual clues we have encountered suggesting that liability runs with registered shares alone.”

The Court did not address the Ninth Circuit’s policy concern that, if § 11 were to apply only to registered shares in a direct listing, companies would be encouraged to go public through direct listings rather than IPOs to avoid the risk of strict liability, and that § 11 liability for false or misleading statements would therefore be effectively eliminated.

But the Court did reject the plaintiff’s policy argument that a broader reading of “such security” in § 11 would accomplish the purposes of the Securities Act by expanding liability for false or misleading statements. The Court found it “equally possible” that Congress had sought “a balanced liability regime” under the Securities Act and the Exchange Act:  § 11 “allows a narrow class of claims [i.e., only for securities traceable to a registration statement] to proceed on lesser proof,” while the Exchange Act “requires a higher standard of proof to sustain a broader set of claims,” without any traceability requirement.

The Court did not reach the Ninth Circuit’s ruling as to § 12.  The Ninth Circuit had allowed the § 12 claim to proceed based on its analysis of the § 11 claim, but the Court found the § 11 analysis “flawed.” The Court therefore vacated the judgment as to the § 12 claim and remanded for reconsideration. The Court “express[ed] no views about the proper interpretation of § 12 or its application to the case”; nor did it “endorse the Ninth Circuit’s apparent belief that § 11 and § 12 necessarily travel together.” Instead, the Court “caution[ed] that the two provisions contain distinct language that warrants careful consideration.”

Implications

The unanimous Court’s textualist approach is perhaps not a surprise these days in a case involving statutory, rather than constitutional, interpretation. The Ninth Circuit’s majority had adopted a relaxed definition of traceability – a sort of “but-for traceability” construct – but the Supreme Court rejected that expansive approach, recognizing that “Congress remains free to revise the securities laws at any time, whether to address the rise of direct listings or any other developments.”

The Slack decision will likely increase the difficulty of pleading § 11 claims for securities issued in a direct listing, because purchasers might not be able to establish that they purchased registered shares, rather than unregistered ones. Purchasers might therefore need to resort to the Exchange Act, which would require them to prove that any alleged misstatements or omissions were made with scienter – and also to establish reliance and loss causation.

Whether a traceability requirement for § 11 claims in a direct listing will encourage issuers to go public through direct listings rather than through IPOs – as the Ninth Circuit majority feared – remains to be seen. While the potentially reduced liability risk of a direct listing might be attractive, companies interested in raising significant amounts of new capital might still find the traditional IPO route more realistic from a business perspective.

Attention will now turn to the Ninth Circuit, to see how it will treat the plaintiff’s § 12 claim. The Supreme Court’s decision requires a close textual reading of § 12, but the Court made clear that § 12 has its own “distinct language” and does not necessarily “travel together” with § 11. However, § 12(a)(2)’s language – which makes persons who offer or sell securities “by means of a prospectus or oral communication” liable to “the person purchasing such security from him” – might well require traceability to that prospectus or oral communication under the Slack decision’s rationale.