Earlier this week, the U.S. Supreme Court heard oral argument in the Slack case, the high-profile securities law case the Court is considering this term. In the following guest post, Joseph Gross of the Wiley firm provides a detailed overview of the legal issues in the case and summarizes the parties’ oral arguments. I would like to thank Joe for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Joe’s article.
On April 17, 2023, the Supreme Court held oral argument in Slack Techs. LLC v. Pirani—a case regarding standing under Sections 11 and 12(a)(2) of the Securities Act of 1933 (the “’33 Act”) that is being closely watched by the D&O bar. The Court will decide whether plaintiffs bringing these claims after buying stock through a direct listing need to prove that they bought registered shares in order to assert that the registration statement and prospectus were misleading. Until a recent Ninth Circuit decision, plaintiffs were typically required to prove purchase of registered shares in order to assert these claims. The Supreme Court seemed inclined to reverse the Ninth Circuit and require that Section 11 plaintiffs prove the purchase of registered shares, though the Justices were sympathetic to the policy implications of such position. However, much of the argument focused on Section 12(a)(2), notwithstanding that the two provisions are typically lumped together. The Supreme Court will issue a decision by the end of June.
The ’33 Act requires companies to make disclosures through a registration statement before offering certain shares to the public. The registration statement must also contain a prospectus. Under Section 11, if a registration statement is materially false or misleading, “any person acquiring such security” can sue. 15 U.S.C. § 77k(a). And under Section 12(a)(2), anyone who offers or sells a security “by means of a prospectus” with a material misstatement is liable “to the person purchasing such security from him.” Id. § 77l(a)(2). These provisions impose near-strict liability even for innocent mistakes on any part of the registration statement or prospectus. However, courts have typically limited these claims to plaintiffs who can plead and prove that they bought securities registered under the registration statement at issue.
Slack Technologies went public through a direct listing in 2019. Direct listings are a relatively new form of initial public offering (“IPO”), which the Securities and Exchange Commission (“SEC”) first approved in 2018. Unlike a traditional IPO, where newly registered shares are traded on an exchange for an initial period before preexisting unregistered shares are traded, a direct listing allows both new (subject to the registration statement) and existing shares (not subject to the registration statement) to be traded immediately. In some instances, a direct listing may consist entirely of existing shares, though a registration statement is still required.
The Proceedings Below:
Fiyyaz Pirani bought shares of Slack on an exchange after Slack went public through a direct listing and brought suit against Slack under Sections 11 and 12(a) of the ’33 Act when the share price dropped. Pirani does not know whether the shares he bought were registered, and, because registered and unregistered shares are comingled from the outset of trading in a direct listing, it would be nearly impossible for Pirani to find out. Slack moved to dismiss Pirani’s complaint on the basis that he lacked standing because he could not prove he bought registered shares. The United States District Court for the Northern District of California denied the motion to dismiss and certified an interlocutory appeal.
The United States Court of Appeals for the Ninth Circuit affirmed, holding that “Slack’s shares offered in its direct listing, whether registered or unregistered, were sold to the public when ‘the registration statement . . . became effective,’ thereby making any purchaser of Slack’s shares in this direct listing a ‘person acquiring such security’ under Section 11.” Pirani v. Slack Techs., Inc., 13 F.4th 940, 949 (9th Cir. 2021) (quoting 15 U.S.C. § 77k(a)). The Ninth Circuit further reasoned that a different interpretation “would essentially eliminate Section 11 liability for misleading or false statements made in a registration statement in a direct listing for both registered and unregistered shares.” Id. The decision drew a dissent which argued that the majority’s decision represented a departure from more than 50 years of jurisprudence requiring Section 11 plaintiffs to prove that they purchased registered shares. Id. at 951 (Miller, J., dissenting).
The Supreme Court Case:
In its briefs, Slack argued that “such security” in Section 11 refers only to registered shares because the ’33 Act pertains to registration statements and the offer of new shares on an exchange. Slack asserted that Sections 11 and 12(a)(2) essentially offer a tradeoff—near strict liability, but only for a limited group that can prove they bought registered shares. Slack claimed that the Ninth Circuit’s decision was an abrupt departure from well-established precedent and was rooted in policy considerations. Such a policy decision, Slack argued, should be made by Congress rather than the courts. And, at any rate, Slack contended that the policy concerns were overstated. While a plaintiff may not be able to pursue an action under Sections 11 or 12(a)(2) when they purchase stock from a direct listing, they still have numerous other remedies available under the securities laws, including under Section 10(b) of the Securities Exchange Act of 1934. Moreover, direct listings are a relatively rare method of making an initial public offering so the concern that companies would use them en-masse to avoid liability under Sections 11 or 12(a)(2) is unfounded.
In his brief, Pirani argued that “such security” in Section 11 does not expressly refer to registered shares and contrasted that with other sections of the ’33 Act. According to Pirani, there must be some connection between the offering of shares and the registration statement but it does not necessarily follow that the statute only applies to registered shares. Pirani observed that the SEC approved the direct listing mechanism of IPO on the condition that the company file a registration statement even if none of the shares offered were registered. Thus, according to Pirani, anybody who purchased shares that “required a registration statement in order to be sold” (i.e. all shares in a direct listing regardless of registration) should have standing under Sections 11 and 12(a)(2). Pirani further noted that it is nearly impossible to discern whether shares purchased in a direct listing are registered, and argued that limiting Section 11 and 12(a)(2) claims to confirmed purchasers of registered shares would effectively allow companies to avoid Section 11 and 12(a)(2) liability by going public through a direct listing. Moreover, to the extent purchasers could prove they purchased registered shares, the availability of the protections of Sections 11 and 12(a)(2) would be random because purchasers could not know what kind of shares they were acquiring at the time they bought them.
At oral argument, Thomas Hungar of Gibson Dunn & Crutcher LLP argued for Slack; Kevin Russell of Goldstein, Russell & Woofter LLC argued for Pirani. The Justices asked tough questions of both sides. The Court seemed inclined to accept Slack’s arguments that “such security” in Section 11 necessarily referred only to registered shares. At one point Justice Kagan suggested that Pirani had a “tough row to hoe” on that point. However, the Justices noted the serious public policy concerns raised by Slack’s position (i.e., that it would be extremely difficult, if not impossible, to bring Section 11 and 12(a)(2) claims in the case of direct listing), with Justice Kavanaugh asking if Congress or the SEC could “fix” the situation if the Court ruled in Slack’s favor.
In the briefing and the opinion below, it was generally accepted that Section 12(a)(2) rose or fell with Section 11. However, at oral argument Justices Thomas, Kagan, Sotomayor, Gorsuch, Barrett, and Jackson all noted differences between Sections 11 and Section 12(a)(2). Justice Barrett suggested the possibility of deciding the case “narrowly,” and Justice Kavanaugh floated the possibility of a remand to let the lower courts focus more on Section 12(a)(2). Justice Kavanaugh noted the relative paucity of cases and SEC guidance substantively interpreting Section 12(a)(2) as compared to Section 11.
Impact of the Decision:
Securities class actions under the ’33 Act represent a significant exposure. Last year alone, there were 43 federal securities class actions asserting Section 11 or Section 12 claims. See NERA Economic Consulting, “Recent Trends in Securities Class Action Litigation: 2022 Full-Year Review” (Jan. 23, 2023), available here. Sections 11 and 12(a)(2) impose a near-strict liability on companies going public. However, it has traditionally been more difficult to establish standing to assert these claims because courts have required proof that the plaintiff purchased registered shares at the initial public offering.
If the Supreme Court affirms the decision below and eliminates the need to prove that plaintiffs purchased registered shares when a company goes public through a direct listing, it will be easier to bring Section 11 and Section 12(a)(2) claims thereby likely increasing the risk of exposure for such claims. However, in that scenario, it is possible—and perhaps likely—that the Court would emphasize that it was issuing a narrow holding that applies only to direct listings. While potential D&O exposure would be increased by such ruling, direct listings still remain relatively rare. Of course, the Court could also overturn the Ninth Circuit’s decision and reinforce the need to prove the purchase of registered shares in order to assert Section 11 and 12(a)(2) claims. Given that this scenario would virtually bar Section 11 and 12(a)(2) claims in the case of direct listings, a ruling like along these lines could spur legislative action.
It is always difficult to read the tea leaves at oral argument, however, the Supreme Court seemed inclined to reverse the decision below and require proof of purchase of registered shares to bring a claim under Section 11. The Court may try to spur action by Congress or the SEC, but of course there is no guarantee any action gets taken. The Court seemed to view Section 12(a)(2) differently than Section 11 and may look for a way to issue a narrow decision that defers ruling on that part of the statute to allow further development. We will continue to monitor this case and update the article when the Court issues its decision sometime before the end of June.