Slack Technologies v. Pirani

Recently, the U.S. Supreme Court issued a unanimous opinion in the case Slack Technologies v. Pirani limiting investors’ ability to sue companies for material misstatements or omissions under Section 11 of the Securities Act of 1933 (the “Securities Act”) in the context of direct listings. Writing for the Court, Justice Gorsuch opined that, just as in the context of any other registered offering, Section 11 liability extends only to shares that can be traced to an allegedly defective registration statement. The Supreme Court remanded the case back to the 9th Circuit to determine whether the shares that the plaintiff, Mr. Pirani, purchased could be traced to the company’s registration statement.

Section 11 of the Securities Act imposes strict liability on issuers who offer and sell securities under registration statements containing a material misstatement or omission. An important implication of Section 11’s strict liability regime is that plaintiffs need not prove that the company intended for the registration statement to contain a material misstatement or omission; instead, they must only show that such misstatement or omission was present at the time of effectiveness, which makes the statute an attractive remedy for aggrieved investors. Section 12 of the Act similarly imposes liability for material misstatements or omissions but applies to prospectuses and oral communications.

Specifically, Section 11 provides a remedy for “any person acquiring such security” in a sale registered under a defective registration statement. Historically, courts have interpreted the key phrase “such security” as a security registered under a specific registration statement,¹ meaning that plaintiffs must be able to trace the shares they purchased to an allegedly defective registration statement in order to pursue a Section 11 claim. In the context of an initial public offering (“IPO”), companies issue new shares pursuant to a registration statement, and preexisting shares held by early investors and insiders are typically subject to a lockup agreement barring them from selling such shares for a specified period of time. In practice, this means that when a company goes public through an IPO, the initial investors who purchased the shares from the underwriters are typically able to “trace” their shares back to the registration statement before the expiration of the lockup agreement allows more sales of shares to occur. However, when multiple offerings have occurred, shares become commingled as most trading is done through brokers and “many brokerage houses do not identify specific shares with particular accounts but instead treat the account as having an undivided interest in the house’s position.”²

Direct listings involve a different process than a traditional IPO. They allow companies to go public by registering the sale of shares directly into the market through a stock exchange without the involvement of an underwriter. Although not a new concept, direct listings occurred infrequently in the past because NYSE rules permitted only “selling shareholder” direct listings in which companies registered only preexisting shares rather issuing than new shares. However, in 2020 the SEC approved new rules proposed by the NYSE allowing companies to conduct “primary” direct listings, whereby companies issue and register new shares and can register preexisting shares as well. Due to the absence of a traditional underwriter, investors and insiders are also not typically subject to a lockup and can sell their shares immediately so long as the sale meets the requirements for an exemption from registration, such as Rule 144.

This presents a potential bar to recovery for plaintiffs suing under Section 11: if shares registered in the direct listing and shares sold pursuant to an exemption from registration enter the trading market simultaneously they become impossible to distinguish, meaning that plaintiffs are not able to trace their shares to an allegedly defective registration statement. This was precisely the issue presented in the Slack case: does the term “such security” only refer to a security issued pursuant to an allegedly misleading registration statement, or can this term sometimes encompass a security not issued pursuant to an allegedly misleading registration statement?

In 2019, Slack went public through a selling shareholder direct listing. To do so, Slack filed a registration statement registering the sale of 118 million shares by selling shareholders and 165 million shares available for sale on the NYSE pursuant to an exemption from registration. Because Slack chose to go public via direct listing rather than an IPO, it did not engage an underwriter and its preexisting shareholders were not subject to lockup agreements. As a result, when Slack’s shares became listed on the NYSE, shares registered under the registration statement and shares sold pursuant to an exemption from registration entered the trading market simultaneously.

Mr. Pirani purchased 30,000 shares on the day Slack went public, and later purchased an additional 220,000 shares. Subsequently, the stock price dropped significantly and Mr. Pirani filed a class action lawsuit, alleging that Slack violated Sections 11 and 12 of the Securities Act by failing to warn potential investors that network outages would force the company to pay a significant sum in customer credits. Slack moved to dismiss the case, arguing that Mr. Pirani did not have standing under Section 11 or 12 “because he cannot prove that his shares were registered under the allegedly misleading registration statement.”

The district court disagreed with Slack’s argument and held that Mr. Pirani had standing under Section 11.³  The court departed from a long line of lower court precedent interpreting the phrase “such security,” finding that Mr. Pirani’s claim could proceed even without meeting the tracing requirement “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.” The court similarly held that Mr. Pirani had standing under Section 12(a)(2) for the same reasons.

On appeal, the 9th Circuit similarly held that Mr. Pirani had standing under Section 11, though it used different reasoning to reach that conclusion.⁴  The 9th Circuit reasoned that a company must file a registration statement to conduct a direct listing and, due to the absence of lockup agreements, “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 Section 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.” It also asserted that to require traceability in the context of direct listings “would undermine this section of the securities law” by “essentially eliminat[ing] Section 11 liability,” noting 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.” The 9th Circuit also held that Mr. Pirani had standing under Section 12(a)(2) “to the extent it parallels Section 11.”

Slack appealed and the Supreme Court granted cert to resolve the circuit split created by the 9th Circuit’s ruling. To interpret the meaning of “such security,” the Court first turned to the language of the statute but found that there was “no clear referent in Section 11(a) telling us what ‘such security’ means.” Turning next to the context and circumstances, the Court reasoned that the statute “imposes liability for false statements or misleading omissions in ‘the registration statement’” and the definite article “the” therefore refers to the specific, allegedly defective registration statement, meaning that a plaintiff must have acquired “such security” under the terms of that specific document. The Court also found that the statute’s repeated use of the word “such” narrowed the focus of the law to particular things or statements; therefore, “when it comes to ‘such security,’ the law speaks to a security registered under the particular registration statement alleged to contain a falsehood or misleading omission.” The Court likewise found support for this interpretation in the text of Sections 5 and 6 of the Securities Act, and reasoned that the damages provision found in Section 11(e), which imposes a cap on Section 11 claim damages for underwriters to the “total price at which the securities underwritten by him and distributed to the public were offered to the public,” limits recovery to “the value of the registered shares alone.”

The Court also rejected Mr. Pirani’s argument that his reading of the statute would “better accomplish the purpose of the 1933 Act” by expanding liability for falsehoods and misleading omissions. The Court reasoned that the Securities Act is “limited in scope,” while the main liability provision of the Securities Exchange Act of 1934 “allows suits involving any sale of a security but only on proof of scienter. Given this design, 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.” Justice Gorsuch further underscored that “Congress remains free to revise the securities laws at any time, whether to address the rise of direct listings or any other development.” Thus, in vacating the 9th Circuit decision, the Supreme Court determined that a plaintiff must prove that the particular shares purchased are directly traceable to the allegedly defective registration statement.

Interestingly, the Court sidestepped the question of whether Section 12(a)(2) liability mirrors that of Section 11, as the 9th Circuit opined, or whether these two statutes should be interpreted differently. The Court did, however, vacate the 9th Circuit’s judgment on Mr. Pirani’s Section 12 claim for reconsideration in light of its opinion, noting that it did “not endorse the Ninth Circuit’s apparent believe that Section 11 and Section 12 necessarily travel together.” Thus, although the Court has determined that tracing will continue to be required for Section 11 claims, it remains unclear whether the same requirement will apply to Section 12 claims.

The Slack decision has several implications for companies planning to go public. First, although there are several considerations involved in deciding how to go public, companies might consider doing so via direct listing rather than an IPO given the potential insulation from strict liability under Section 11 afforded by the difficulty of tracing shares to the registration statement. It must be noted that plaintiffs have other remedies available that do not require tracing and impose liability for misleading statements or omissions made in registration statements, so companies must continue to ensure the accuracy of their disclosures. Additionally, because direct listings allow companies to go public without an underwritten offering, they provide an opportunity for considerable savings on transaction costs incurred with IPOs, such as underwriting commissions and roadshow costs. Further, for companies considering a traditional IPO, the Slack case might increase the popularity of alternative lockup structures that allow secondary shares to trade sooner than the typical 180-day lockup period. These types of structures could also have the effect of insulating issuers from Section 11 claims.

¹ Barnes v. Osofsky, 373 F.2d 269, 272-73 (2d Cir. 1967); Hertzberg v. Dignity Partners, Inc. 191 F.3d 1076, 1080 (1999); In re Ariad Pharmaceuticals, Inc. Securities Litigation, 842 F.3d 744, 755-56 (1st Cir. 2016); Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir. 2003); Lee v. Ernst & Young, LLP, 294 F.3d 969, 976-77 (8th Cir. 2002).

² In re Century Aluminum Co. Securities Litigation, 729 F.3d 1104, 1107 (9th Cir. 2013).

³ Pirani v. Slack Technologies, Inc., 445 F. Supp. 3d 367 (N.D. Cal. 2020).

⁴  Pirani v. Slack Technologies, Inc., 13 F.4th 940 (9th Cir. 2021).