On Thursday, SCOTUS decided Slack Technologies v. Pirani in a unanimous opinion by Justice Gorsuch holding that, even in a registration by direct listing, §11(a) liability extends only to shares that are traceable to an allegedly defective registration statement. As you know, §11 provides statutory standing to sue for misstatements in a registration statement to any person acquiring “such security,” historically interpreted to mean a security registered under the specific registration statement. However, in Pirani v. Slack Technologies, a divided three-judge panel of the 9th Circuit had ruled that the plaintiff could recover under §11 even in the absence of tracing to the registration statement for the direct listing. Now, SCOTUS has reversed and remanded the case for reconsideration in light of the Court’s decision. Given the difficulty of tracing in connection with direct listings, where both registered and preexisting unregistered shares may be sold at the same time, the question put to Slack counsel by Justice Kavanaugh during oral argument in April looms large: does the Court’s determination in this case “essentially transform the ’33 Act into an opt-out regime for direct listings”?
Essentially, a “direct listing” involves a registered sale directly into the public market through an exchange with no intermediary underwriter, no underwriting commissions (just advisory fees), no roadshow or similar expenses and typically, no lock-up agreements with underwriters. In contrast to an underwritten IPO, there is no initial sale to an underwriter or pre-opening sale by the underwriter to the initial purchasers. Instead, initial sales are conducted through the exchange, with initial pricing set during the opening auction, not by agreement among the company and underwriters, as in a traditional IPO. Originally, the NYSE had permitted only selling shareholder direct listings, in which the company does not issue or register any new shares; instead, the company files a registration statement only for secondary sales by existing shareholders, allowing them to sell their shares to the public on the relevant exchange. In December 2020, the SEC approved the NYSE rule proposal to allow primary direct listings, in which the company issues and registers new shares for direct sale on the exchange.
A number of commenters on the NYSE proposal to allow direct primary listings raised concerns about §11. For example, the Council of Institutional Investors contended that the “proposal compounds the problems shareholders face in tracing their share purchases to a registration statement.” In response, the NYSE argued that “the §11 and traceability concerns are due to the potential lack of lockup agreements, which are neither prohibited nor required by the proposal or any other law or regulation, rather than to anything inherent in direct listings themselves or the Exchange rules permitting them to be listed.” In addition, the NYSE contended, the traceability requirement may create difficulties under §11 in many situations that do not involve direct listings, and the SEC agreed that the issue of traceability can arise “anytime securities that are not the subject of a recently effective registration statement trade in the same market as those that are so subject.” Concerns regarding tracing are not unique to primary direct listings, the SEC contended, and courts have denied standing on the basis of lack of traceability in contexts outside of direct listings. In addition, the SEC said, tracing is not set forth in §11, and tracing standards are judicially developed and may vary “depending on the particular facts of the distribution and judicial district.” (See this PubCo post.)
Slack went public in 2019, before the SEC had approved the NYSE’s proposal to allow primary direct listings, through a selling shareholder direct listing. Because, in a direct listing, the shares are not sold in an underwritten offering through an intermediary bank, there are typically no lock-up agreements with a bank that restrict the sale of unregistered shares—as there would be in a typical IPO—allowing both registered and unregistered shares (that are exempt from registration) to be sold to the public. When Slack went public, it registered 118 million shares for sale by selling shareholders, and 165 million unregistered shares were also available at the same time for sale to the public on the NYSE.
Pirani purchased 30,000 shares on day one at $38.50 and 220,000 over the next several months. After several Slack service disruptions, the share price fell below $25, and Pirani brought a class action for violations of §11, §12(a)(2) and §15(a) of the Securities Act. According to the opinion, Pirani alleged, among other problems, that “Slack’s registration statement was inaccurate and misleading because it did not alert prospective shareholders to the generous terms of Slack’s service agreements, which obligated Slack to pay out a significant amount of service credits to customers whenever the service was disrupted, even if the customers did not experience the disruption.” Slack moved to dismiss, contending that Pirani did not have standing under §11 and §12(a)(2) “because he cannot prove that his shares were registered under the allegedly misleading registration statement.”
In the district court. As described by the 9th Circuit, the district court “adopted a broad reading of ‘such security’ within §11,” holding that the plaintiff had standing under §11—even though he did not know whether the shares he purchased were registered or not—“because he could show that the securities he purchased, even if unregistered, were ‘of the same nature’ as those issued pursuant to the registration statement.” Likewise, the district court also held that the plaintiff had standing under §12(a)(2), reading “such security” to include registered or unregistered securities offered in the direct listing.
In the 9th Circuit. The case was appealed to the 9th Circuit, where the lower court’s decision was reviewed de novo, assuming as true the facts alleged in the complaint.
The key issue, as framed by the 9th Circuit, was: “what does ‘such security’ mean under §11 in the context of a direct listing, where only one registration statement exists, and where registered and unregistered securities are offered to the public at the same time, based on the existence of that one registration statement?” The 9th Circuit looked “directly to the text of §11 and the words ‘such security.’” Under the NYSE rule, the 9th Circuit reasoned, “a company must file a registration statement in order to engage in a direct listing.” Because there are no lock-ups with underwriters, “at the time of the effectiveness of the registration statement, both registered and unregistered shares are immediately sold to the public on the exchange….Thus, in a direct listing, the same registration statement makes it possible to sell both registered and unregistered shares to the public. Slack’s unregistered shares sold in a direct listing are ‘such securities’ within the meaning of §11 because their public sale cannot occur without the only operative registration in existence. Any person who acquired shares through its direct listing could do so only because of the effectiveness of its registration statement.” In other words, but for the registration statement, none of the listed shares would be saleable on the exchange, whether they were registered or unregistered.
To Slack’s contention that, under past precedent, the meaning of “such security” in §11 applied only to registered shares and that the court should apply “§11 to direct listings in the same way it has in cases with successive registration statements,” the 9th Circuit countered with a largely public policy rationale, asserting that Slack’s interpretation “would undermine this section of the securities law” by “essentially eliminat[ing] §11 liability” in this context: “[F]rom 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 §11 liability by choosing a direct listing.” The court observed that the point was especially true given that the NYSE now permitted primary direct listings. Affirming the district court’s denial of the motion to dismiss the §11 claim, the court asserted that to hold otherwise would “contravene the text of the statute.” The 9th Circuit employed a similar analysis with respect to standing under §12. In conclusion, in affirming the partial denial of Slack’s motion to dismiss, the Court held that “[s]tatutory standing exists under Sections 11 and 15, and under §12(a)(2) to the extent it parallels §11.”
The dissenting judge viewed the interpretation of §§ 11 and 12 as “settled for decades,” notwithstanding the new context. He would have reversed and granted the motion to dismiss in full. The plaintiff “cannot prove that his shares were issued under the registration statement that he says was inaccurate.” That “failure of proof,” he asserted, was “outcome-determinative.” According to the dissent, because §§ 11 and 12 impose strict liability, the statute “tempers it by limiting the class of plaintiffs who can sue.” The dissent acknowledged that the term “such security” has “no antecedent in §11,” making the statute “ambiguous as to what sort of security a plaintiff must acquire to have standing.” However, that ambiguity was resolved in 1967, “in a landmark decision,” Barnes v. Osofsky. In that case, the dissent observed, Judge Friendly noted that “the phrase ‘any person acquiring such security’ lent itself to both a ‘narrower reading—acquiring a security issued pursuant to the registration statement’ and ‘a broader one—acquiring a security of the same nature as that issued pursuant to the registration statement,’ and it adopted the narrower reading, which it described as a ‘more natural’ interpretation of the text. Until today, every court of appeals to consider the issue, including ours, has done the same…. That principle ought to resolve this case.” “What appears to be driving today’s decision,” the dissent asserted, “is not the text or history of §11 but instead the court’s concern that it would be bad policy for a §11 action to be unavailable when a company goes public through a direct listing.” But, the dissent contended, that issue has been raised as a concern in other contexts. And even so, the company will remain subject to potential liability under Rule 10b-5 for misstatements made with scienter. “More importantly,” the dissent reasoned, “whatever the merit of the policy considerations, they are no basis for changing the settled interpretation of the statutory text.” Rather, the place to make changes is in the legislature.
At the Supreme Court
The decision by the 9th Circuit led to a split of authority in circuits about the scope of liability under §11. As a result, SCOTUS granted cert.
Oral argument. During oral argument, counsel for Slack contended that §§ 11 and 12 of the ’33 Act expressly refer to the registration requirements in §5 of the Act, where “it’s undisputed that ‘such security’ … refers only to shares that are subject to registration, never to exempt shares.” “Respondent’s contrary interpretation” Slack counsel contended, “would run roughshod over the core statutory distinction between registered and exempt shares, which is fundamental to the structure and operation of the ’33 Act, and it would dramatically expand the scope of liability, disrupt the capital formation process, and upset settled expectations by overturning decades of case law and SEC interpretation consistently holding that plaintiffs must prove they purchased registered shares.” Pirani hadn’t identified any cases in the 90-year history of the Act, he contended, where §11 liability was imposed in connection with the sale of exempt shares.
Counsel for Pirani acknowledged that “[e]veryone agrees that ‘such security’ in §11 refers in some ways to the registration statement challenged as misleading. The question here is the precise nature of that relationship. Petitioners say ‘such security’ refers exclusively to what they call registered shares. But the statute doesn’t use that term or provide a definition for it, and neither do Petitioners.” Registration statements, he said, don’t specify individual shares. “Instead, they act at the level of a public offering of securities, not shares, that is, the planned introduction of a group of fungible shares to the market at a particular time. The function of the registration statement is to provide the market the information it needs to value all of those fungible shares in that public offering. And the function of §11 is to provide investors confidence that they can rely on the integrity of that market price, even though some of those shares could have been sold in some other transaction without a registration statement. Accordingly, the better view is that ‘such security’ in §11 refers to all of the shares in the public offering for which the registration statement was a prerequisite.” (See this PubCo post.)
SCOTUS opinion. To anyone listening, during oral argument, Justice Gorsuch, the author of the opinion, spilled the beans on the direction of the decision:
“Gorsuch: ‘I guess another way of asking the question my colleagues are getting at is, would the sky fall should we answer the §11 question in your client’s [Slack] favor, vacate and remand, without addressing the §12 question?’
Slack counsel: ‘Well, certainly, it would fall in this case because the court of appeals answered that question and it answered it wrongly, and’
Gorsuch: ‘And we’re going to vacate its judgment in light of your arguments—supposing we were, in light of your arguments on §11, and maybe it should reconsider its §12 ruling in light of that.’…
Slack counsel: ‘Yes, certainly, that would be better than where we stand right now. Obviously, we think’
Gorsuch: ‘I would have thought.’
Justice Gorsuch’s colloquy during oral argument presaged precisely where the Court landed. To poach Maya Angelou’s aphorism, if the Court tells you how it’s going to decide, believe them the first time.
The question for the Court came down to this: how to interpret “such security,” which has an imprecise referent in the statute? As set out by the Court, §11 “authorizes an individual to sue for a material misstatement or omission in a registration statement when he has acquired ‘such security.’ The question we face is what this means. Does the term ‘such security’ refer to a security issued pursuant to the allegedly misleading registration statement? Or can the term also sometimes encompass a security that was not issued pursuant to the allegedly misleading registration statement? Slack advances the first interpretation; Mr. Pirani defends the second.” The challenge was that there was “no clear referent in §11(a) telling us what ‘such security’ means. As a result, we must ascertain the statute’s critical referent ‘from the context or circumstances.’”
And SCOTUS was able to glean quite a bit from the context—enough to be determinative for a unanimous Court. For example, the statute imposed “liability for false statements or misleading omissions in ‘the registration statement’” and repeatedly used “the word ‘such’ to narrow the law’s focus,” suggesting that it referred to “a security registered under the particular registration statement.” Under §5, the Court said, the term “such security” refers to a registration statement in effect and §6 provides that a “‘registration statement shall be deemed effective only as to the securities specified therein as proposed to be offered.’… It’s an instruction that would seem hard to square with Mr. Pirani’s broader reading of §11(a)….” Further, §11(e) caps damages against an underwriter “to the value of the registered shares alone,” another feature that did not comport with Pirani’s interpretation, in the Court’s view.
“Collectively,” SCOTUS concluded, “these contextual clues persuade us that Slack’s reading of the law is the better one. Nor is anything we say here particularly novel. For while direct listings are new, the question how far §11(a) liability extends is not.” Here, the Court referred to the decision of Judge Friendly in Barnes, over half a century ago, which determined that “‘the narrower reading’ we adopt today is the more ‘natural’ one…. Since Barnes, every court of appeals to consider the issue has reached the same conclusion: To 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.”
Under Pirani’s reading, the Court observed, “such security” would
“include other securities that bear some sort of minimal relationship to a defective registration statement. And, he argues, a reading like that would allow his case to proceed because, 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….Beyond assuring us that the rule he proposes would save his case, however, Mr. Pirani does not offer much more. He does not explain what the limits of his rule would 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.”
Nor did SCOTUS buy into Pirani’s policy arguments—that his reading would “better accomplish the purpose of the 1933 Act.” Given the distinct scopes of liability of the ’33 Act and the ’34 Act (broader but generally requiring scienter), “it seems equally possible that Congress sought a balanced liability regime that allows a narrow class of claims to proceed on lesser proof but requires a higher standard of proof to sustain a broader set of claims.”
In conclusion, the Court noted that, while its “only function lies in discerning and applying the law as we find it,” Congress is certainly free to have at it—it can always amend the securities laws to address the scope of liability in connection with direct listings. In this case, as it now stands, SCOTUS found that “the better reading of the particular provision before us requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement.” Accordingly, the Court vacated the judgment of the 9th Circuit and remanded the case for that court to decide whether Pirani’s “pleadings can satisfy §11(a) as properly construed.”
Can Pirani trace his shares? During oral argument, Slack counsel contended that it was not really possible for Pirani to trace his shares to the registration statement. He noted, however, that there was a pending state case in which plaintiffs claim they can trace, and that was being litigated. In addition, Slack counsel referred to an amicus brief submitted by law and business professors that suggested “that a recent regulatory change after this case, the creation of the consolidated audit trail, may facilitate tracing in the future.” Counsel for Pirani pointed out that they had indicated in the pleadings that the shares were traceable—meaning not every share, but a percentage of them, a question that he thought should be left to the lower courts. Justice Gorsuch agreed that all they would “need to do is plead facts suggesting that you can trace consistent with the Twiqbal standard [Iqbal and Twombly], as my friends like to call it. (Laughter.)… And—and then you’re off to the races and it really just becomes a matter of damages, as I think you also alluded to.” As a result, he continued “if we were to rule against you on what §11 means, it still would enable you to plead…that there are traceable shares.”
Interestingly, the burning question on §12(a)(2) that monopolized a fair amount of the oral argument—whether §12 must necessarily be interpreted in the same way as §11—seems to have escaped mention, other than being smuggled into a footnote in the opinion. During oral argument, some of the Justices stressed differences in the language of the two statutes that would likely lead to different interpretations, contrary to the position of the 9th Circuit. Justice Kavanaugh indicated that he was reluctant to opine on the issue before the SEC and the lower courts had spoken on it: he was “a bit concerned about deciding that issue without the SEC here, without more law out there” about §12. “Why not allow the lower courts to sort out the §12 issue before we give a definitive ruling on that?” he said. While there was a lot on §11, Kavanaugh was “just worried about making a mistake on §12 one way or another because we don’t have the kind of thorough consideration we usually have before we give a definitive opinion on something.” That seems to be the route SCOTUS took here. Although SCOTUS acknowledged that the parties were “sparring” over the best interpretation of §12, the Court found no reason “to reach the merits of that particular dispute.” Because the 9th Circuit had tied its decision on the §12 claim to its analysis of Pirani’s §11 claim, which SCOTUS found to be “flawed,” the Court concluded that “the best course is to vacate its judgment with respect to Mr. Pirani’s §12 claim as well for reconsideration in the light of our holding today about the meaning of §11. In doing so, we express no views about the proper interpretation of §12 or its application to this case. Nor do we endorse the Ninth Circuit’s apparent belief that §11 and §12 necessarily travel together, but instead caution that the two provisions contain distinct language that warrants careful consideration.”
Will there be any steps taken to address the tracing issue? And if so, who will take them? When the SEC was considering the NYSE’s proposal to permit direct listings of primary offerings, one of the frequently raised difficulties related to the potential “vulnerability” of “shareholder legal rights under §11 of the Securities Act”—a “vulnerability” arising out of the difficulty plaintiffs may have in tracing the shares purchased back to the registration statement in question. In approving adoption of the NYSE rule, the SEC said that it did not “expect any such tracing challenges in this context to be of such magnitude as to render the proposal inconsistent with the Act. We expect judicial precedent on traceability in the direct listing context to continue to evolve,” pointing to Pirani v. Slack Technologies in the lower court. As the NYSE had observed, only the court in Slack had addressed the issue, and had concluded that, at the pleading stage, plaintiffs could still pursue their claims even if they could not definitively trace the securities they acquired to the registration statement. However, the NYSE noted at the time, the case was on appeal. (See this PubCo post.) As this decision by SCOTUS shows, evolution in the judicial precedent on traceability has not quite panned out as expected—at least not in the courts at this point.
Now, any action to affect the scope of §11 liability for direct listings may instead fall to Congress or the SEC. During oral argument, Justice Kavanaugh observed that Slack and some amici contended that direct listings were a “new thing,” and that, to take Pirani’s position, “we would have to depart on §11 from a lot of law, starting with Judge Friendly, that’s been around for a long time. And rather than doing that—this is their suggestion—we should leave it to the SEC and/or Congress rather than ourselves, kind of departing from that longstanding body of law.” Of course, that’s exactly what the Court did—specifically pointing out that “Congress is free to address the scope of liability in connection with direct listings by revising the securities laws at any time.” Time will tell if the scope of direct listing liability turns out to be enough of a legislative concern to drive Congress to revise the ’33 Act.
Will the SEC’s original expectation of minimal tracing challenges be borne out? Or will the SEC be moved to take action of some kind? Will the presence of tracing issues outside the context of direct listings dissuade the SEC from acting to address the tracing issue in this particular context or could it encourage the SEC to act more broadly? (According to former SEC Chair Jay Clayton, the assumption that, in the paradigmatic IPO, only registered shares would be sold until the lock-up ended was not a correct one; in fact, he said, many exempt shares are sold. And Justice Kagan made the same point in oral argument. See this PubCo post.)
Some have contended that the SEC has plenty of ways to address the scope of liability. In their amicus brief, Clayton and Stanford Professor and former SEC Commissioner Joe Grundfest suggested three approaches that, should the SEC so choose, it could adopt to address the scope of §11 direct listing liability:
- “First, the SEC can require that registered and exempt shares offered in a direct listing trade with differentiated tickers, at least until expiration of the relevant §11 statute of limitations.” For successive offerings, the same technique could be applied; “[t]hat approach, combined with unique tickers for each registered offering, could resolve all tracing challenges.”
- Or “the SEC could migrate the entire clearance and settlement system to a distributed ledger system or to other mechanisms that would allow the tracing of individual shares as individual shares, and not as fractional interests in larger commingled electronic book entry accounts.”
- “Alternatively, the SEC could adopt a narrower approach that resolves the tracing challenge only for direct offerings by requiring that exempt shares not trade until the day after an initial auction that is limited to registered shares. This would, in effect, impose a regulatory one-day lock-up as a method of preserving issuer §11 liability.”
What comes next, if anything, remains to be seen.