Court Cuts Investor Some Slack
In 2018, the New York Stock Exchange introduced a rule, which the SEC approved, authorizing companies to go public through a Selling Shareholder Direct Floor Listing, better known as direct listing.  Unlike an initial public offering, a direct listing does not involve an issue of new shares by means of a registration statement. Instead, a company files such a statement “solely for the purpose of allowing existing shareholders to sell their shares” on the exchange. A direct listing also differs from an initial public offering in that no bank underwrites the shares, and there is no lock-up agreement restricting the sale of unregistered shares.
The company must register the shares before they can be sold to the public unless the unregistered shares fall within a registration exemption enumerated in SEC Rule 144. On the first day of a direct listing, both registered and unregistered shares may be on offer.
On June 20, 2019, Slack Technologies, Inc., which designed a messaging app for business,  went public through a direct listing, releasing 118,000,000 registered and 165,000,000 unregistered shares into the public market. One investor, Fiyyaz Pirani, bought 30,000 Slack shares that day and another 220,000 over the next several months.
The initial offering price for the Slack shares was $38.50. Over a period of a few months, service disruptions caused Slack’s share price to fall below $25.00. As a result of the share decline in price, Pirani brought a class action suit against Slack for violation of Section 11 of the Securities Act of 1933.
Pirani alleged that Slack’s registration statement was inaccurate and misleading because it failed to alert prospective shareholders of the terms of Slack’s service agreements, which obligated Slack to pay out a significant amount of service credits to customers whenever service was disrupted, even if those customers did not experience the disruption. Slack also did not disclose, according to the allegations of the suit, that the service credits were frequently issued, in part because Slack guaranteed 99.99% up time. Pirani alleged as well that the registration statement downplayed Slack’s competition in the market, specifically from Microsoft.
Although Pirani brought his suit under other statutes, his Section 11 claim was particularly important since the law provides for strict liability—in other words, liability irrespective of fault.  Section 11 provides in part:
in case in 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 – (1) every person who signed the registration statement ….
The operative phrase is “such security.” Over the course of more than 50 years, a long line of decisions has held that the term means a security issued under a specific registration statement, not an earlier or later one. Those cases were decided in the context of successive registrations. Plaintiffs, in each instance, were required to identify the particular registration statement relied upon. If a purchaser of shares was unable to establish that those shares were registered under a statement deemed materially misleading, he did not have standing to bring a Section 11 claim.
Pirani’s case in the context of a direct listing presented a novel problem since Slack issued but one registration statement, under which 42% of the outstanding shares were registered and 58% unregistered. And because there was a single registration statement, Pirani did not face the traceability problem encountered by litigants where there are successive statements. His problem was a different one: answering Slack’s contention that he had to establish that he had purchased registered shares.
How then could Pirani prove that the shares he bought were the registered ones? Or did he even have to? As a practical matter, he couldn’t, since there was no realistic way for him to trace his shares to determine registration status and thus no way to demonstrate standing under a narrow reading of the term “such shares.”
The United States Court of Appeals for the Ninth Circuit took issue with Slack’s reliance on such a restrictive interpretation.  The question the Court had to answer was about the meaning of the term “such security” in Section 11 in the context of a direct listing, where a single registration statement exists and where registered and unregistered shares are offered to the public at the same time. In contrast to an IPO, where there is a bank-imposed lock-period during which unregistered shares are excluded from the market, at the time Slack’s registration statement became effective, both registered and unregistered shares were immediately sold to the public on the exchange. So the same registration statement authorized sale of both registered and unregistered shares.
The court found these differences compelling. For one thing, public sale of all Slack shares could not occur without the single registration statement. So, any person who acquired the stock could do so only as a consequence of the effectiveness of that statement.
What is more, where there is no lock-up period which might indicate to a purchaser whether shares were registered or unregistered, interpreting Section 11 to apply only to registered shares would realistically foreclose recovery under Section 11 for false and misleading statements in a direct listing where both registered and unregistered shares are available on the exchange. Such a reading, according to the court, would create a loophole that served to undermine the investor protection purpose of Section 11 in particular and our securities laws in general. A person acquiring unregistered shares would have relied on the registration statement in the same way as another who purchased registered shares.
There is certainly a large measure of equity in the Ninth Circuit’s interpretation. It appears to further the legislative purpose of the Securities Act and is the type of investor protection Congress likely envisioned, although there were no direct listings until the SEC authorized them in 2018. And a reversal of the decision would, in circumstances such as Pirani’s, effectively bar shareholders from bringing a Section 11 claim, since it is virtually impossible to prove standing where tracing shares in a direct listing is a requirement.
The Supreme Court has decided to review the case and may beg to differ. It is likely that a majority of the justices will not be swayed by the legislative purpose the Ninth Circuit found compelling and may view that court’s decision as policy driven. That’s to say that the court will probably opt for the narrower view of the term “such security,” under which standing to file a Section 11 claim is dependent upon a litigant’s ability to demonstrate the shares in question are the registered ones. The Supreme Court’s preference for narrow, textually-based interpretations of statutes may well be predictive of the result here.
So if you’re placing a wager on the ultimate outcome, we recommend that you bet that the Ninth Circuit’s decision is going to be short-lived. And if you bought your shares as a result of a direct listing and suspect a material misstatement or omission in the registration statement, you may need to find a different basis for recovery or look to Congress for help.
 SEC Approval 2018, 83 Fed. Reg. at 5653-54.  SEC Approval 2018, 83 Fed. Reg. at 5651.  17 C.F.R. §230.144.  Slack was acquired by Salesforce, Inc. in July 2019.  15 U.S.C. §77k(a).  For example, Pirani also sued under 15 U.S.C. §78j(b), under which proof of an intent to deceive is a predicate for recovery.  15 U.S.C. §77k(a) (emphasis supplied).  The first such case was Barnes v. Osofsky, 373 F.2d 269 (2nd Cir. 1967).  Pirani v. Slack Technologies, Inc., 13 F.4th 940 (9th Cir. 2021).  Slack Technologies v. Pirani, Docket No. 22-200 (cert. granted Dec. 13, 2022).