On December 13, 2022, the United States Supreme Court granted a
petition for certiorari to review a split decision by the
Ninth Circuit holding that plaintiff-investors had standing under
the Securities Act of 1933 (the "Securities Act") to sue
a workplace communication software company (the
"Company") based on shares purchased through a direct
listing. Slack Technologies, LLC, et al., v Fiyyaz Pirani,
No. 22-200 (U.S. Dec. 13, 2022). The issue before the Supreme Court
is whether Sections 11 and 12(a)(2) of the Securities Act require
plaintiffs to plead and prove that they bought shares that were
registered under the registration statement they claim was
misleading.
As background, in 2019, the Company went public through a direct
listing in which both registered and unregistered shares were sold.
Although plaintiff could not show his shares were registered, the
Ninth Circuit affirmed the district court's holding (albeit
with different reasoning) that plaintiff had standing under
Sections 11 and 12(a)(2). We covered the Ninth Circuit's
decision (the "Decision") in a previous post. As noted by the Ninth
Circuit, in a direct listing, unlike a traditional initial public
offering, a company "does not issue any new shares and instead
files a registration statement 'solely for the purpose of
allowing existing shareholders to sell their shares' on the
exchange." Shares are sold directly to the public and not
through a bank, and there is no lock-up agreement restricting the
sale of unregistered shares (i.e., shares fall within one
of the registration exceptions enumerated in SEC Rule 144).
Accordingly, as acknowledged by the Ninth Circuit, "from the
first day of a direct listing, both unregistered and registered
shares may be available to the public." Section 11 provides
that: "In case any part of the registration statement, when
such part became effective, 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,
either at law or in equity, in any court of competent jurisdiction,
sue . . . ." Section 12(a)(2) requires that a plaintiff
purchase "'such security' from a defendant who
'offers or sells a security . . . by means of a
prospectus.'" Although the Ninth Circuit rejected the
district court's view that the references to "such
security" should be broadly read to include all registered or
unregistered securities rather than those issued under a specific
registration statement, the Ninth Circuit reached the same
conclusion as the district court by finding that "[a]ll of
[the Company]'s shares sold in this direct listing, whether
labeled as registered or unregistered, can be traced to that one
registration," such that "any purchaser of [the
Company]'s shares in this direct listing [would be ] a
'person acquiring such security' under Section 11." As
noted in a dissenting opinion from Judge Eric Miller, however,
"although the [Ninth Circuit majority] asserts that '[a]ll
of Slack's shares sold in this direct listing, whether labeled
as registered or unregistered, can be traced to that one
registration, it does not suggest that all of the shares were
issued under that registration statement. It cannot do so, given
that most of the shares that began trading on the day of the
listing had been issued well before the registration statement was
filed."
The Ninth Circuit made clear that its decision was driven by the
stated concern that, in the direct listing context in which a
purchaser will not know if they purchased a registered or
unregistered share, Section 11 and 12 liability would be
"essentially eliminate" for false statements in a
registration statement and prospectus. The Ninth Circuit expressed
its concern that such an interpretation "would create a
loophole large enough to undermine the purpose of Section 11"
and that "companies would be incentivized to file overly
optimistic registration statements accompanying their direct
listings in order to increase their share price."
In their successful request for Supreme Court review–further
supported by several amici including the U.S. Chamber of Commerce,
the Securities Industry and Financial Markets Association (SIFMA),
the Washington Legal Foundation, and former SEC Commissioner
Professor Joseph Grundfest–petitioners argued that the Ninth
Circuit's decision is directly contrary to the statutory text
and precedent, and, if allowed to stand, would significantly expand
the scope of Securities Act liability. Petitioners noted that prior
to the Ninth Circuit's ruling, for more than 50 years every
court of appeals to consider the issue had held that Section 11
standing requires plaintiffs to prove they purchased shares
registered under the registration statement that plaintiffs claim
is misleading, and that the Supreme Court itself has that Section
12(a)(2) applies only when there is an obligation to distribute a
prospectus, which exists only for registered shares. Petitioners
contended that the Ninth Circuit's decision "might be a
basis for potentially ruinous strict liability" for companies
under the Securities Act. The Chamber of Commerce, SIFMA and the
Washington Legal Foundation amici further emphasized that
the Decision undermines the certainty that capital markets require,
constitutes judicial legislating inconsistent with Congress's
endorsement of the tracing requirement, and/or that the Ninth
Circuit's policy concerns regarding companies using direct
listings as "loopholes" in the securities laws have no
basis in the statutory text or reality. Professor Grundfest argued
in particular that the Decision, if left intact, would expand
Section 11 damages through the inclusion of unregistered shares in
the calculation and impose Section 11 liability on exempt
transactions that do not require registration statements.
The case will be closely watched as the Supreme Court's
decision will have important implications for pleading standards
and liability under Sections 11 and 12(a)(2) and could impact the
manner in which companies decide to go public.
Slack Technologies, LLC, et al., v Fiyyaz Pirani, No. 22-200 (U.S. Dec. 13, 2022)
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