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.