Slack Ruling

POMERANTZ MONITOR | MAY JUNE 2023

By Christopher Tourek

On June 1, 2023, the Supreme Court decided Slack Technologies, LLC v. Pirani – a much-watched case in the securities litigation field – and overturned the Ninth Circuit’s holding that would have dramatically lowered the bar for plaintiffs to bring Section 11 and 12(a) claims involving direct listings. In doing so, the Court upheld the “tracing requirement” for Section 11 claims, while also signaling a de-coupling of Section 11 and Section 12(a) (2) claims.

The Securities Act of 1933 requires companies to make disclosures through a registration statement and a prospectus before they can offer certain shares to the public for sale. Under Section 11 of the Securities Act of 1933, anyone who acquired a security that was sold in connection with that registration statement and prospectus can sue if the registration statement was materially false or misleading and that investor lost money. Similarly, under Section 12(a)(2) of the Securities Act of 1933, anyone who acquired a security that was sold in connection to a prospectus that contained a material misstatement can sue if they suffered a loss. Unlike actions brought under Section 10(b) of the Securities Act of 1934, Section 11 and 12(a) (2) actions impose strict liability on defendants, meaning that defendants can be guilty even if the misstatements were unintentional. However, because of this strict liability, courts have generally limited the availability of Section 11 and 12(a)(2) claims to plaintiffs who can plead and prove that they bought securities registered under the registration statement at issue. This requirement is known as the “tracing requirement.”

It was against this legal backdrop that the securities litigation against Slack arose. Slack is a software company that went public in June 2019 through a direct listing of its shares, rather than a traditional Initial Public Offering (“IPO”). Unlike in an IPO where newly registered shares are traded on an exchange for an initial period before pre-existing unregistered shares are traded, a direct listing allows both new shares subject to the registration statement and existing shares not subject to the registration statement to be traded immediately. In pursuing this direct listing, Slack filed a registration statement registering 118 million shares which were offered simultaneously with 165 million unregistered shares.

In September 2019, investor Fiyyaz Pirani, filed suit against Slack and a number of its directors and officers under Sections 11 and 12(a)(2) of the Securities Act of 1933, alleging misrepresentations in connection with Slack’s direct listing. Slack moved to dismiss Pirani’s complaint, arguing that Pirani had no standing because he could not satisfy the tracing requirement. In effect, Slack argued that Pirani was unable to show that he purchased some of the 118 million registered shares, and not some of the 165 million unregistered shares. In making its argument, Slack focused on language found in Sections 11 and 12(a) specifying that liability claims under those sections may be brought by a person acquiring “such security” – a phrase Slack argued referred to a security registered pursuant to a registration statement. The Northern District of California District Court ultimately denied Slack’s motion to dismiss despite Slack’s tracing requirement argument. Slack subsequently appealed this decision to the Ninth Circuit.

In September 2021, the Ninth Circuit, in a 2-1 opinion, affirmed the District Court’s holding and stated 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.” The Ninth Circuit added that were the Court to adopt Slack’s reasoning, the outcome “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.” The dissent argued that the majority’s holding reflected a departure from more than 50 years of jurisprudence applying the tracing requirement. Unsurprisingly, Slack appealed the Ninth Circuit’s decision to the Supreme Court.

In its briefs, Slack argued that only persons who could definitively trace their shares to the June 2019 registration had standing to assert claims under Sections 11 and 12(a)(2) and that the Ninth Circuit’s holding undercuts the longstanding application of the tracing requirement. Slack also argued that Sections 11 and 12(a)(2) offer the plaintiff a tradeoff – the benefits of strict liability if a plaintiff can meet the sometimes high standard of the tracing requirement. Slack further dismissed policy concerns that its position would provide companies de facto immunity from Section 11 claims for direct listings, arguing that there are several other avenues for justice, including Section 10(b) of the Securities Act of 1934.

In rebuttal, Pirani argued that the Ninth Circuit was correct in holding that he had standing to sue under Sections 11 and 12(a)(2) because the registered and unregistered securities were sold at the same time, under and pursuant to Slack’s first and only registration statement. Pirani also argued that while there must be some connection between the offering of shares and the registration statement, Section 11 does not necessarily apply only to registered shares. Instead, Pirani contended that anyone who purchased shares that required a registration statement in order to be sold (which would include both registered and unregistered shares in a direct listing) could bring suit under Sections 11 and 12(a)(2). Pirani also emphasized that it is nearly impossible to discern whether shares purchased in a direct listing are registered or not, thus creating an impossible hurdle when trying to establish standing.

The implications of the parties’ arguments were clear enough. Slack’s position would essentially grant immunity from Section 11 and 12(a) claims for anything stated (or misstated) in a registration statement or prospectus connected with a direct listing. Pirani’s position would essentially abolish the tracing requirement entirely and allow Sections 11 and 12(a) claims to be brought by anyone who purchased a security that needed a registration statement in order to be sold, regardless of whether that security was registered to the (misleading) registration statement.

During oral arguments, the Supreme Court appeared open to Slack’s view of Section 11, with Chief Justice Roberts telling Pirani’s counsel, “The statute says, ‘such security.’ I mean that’s a big hurdle for you to get over.” Additionally, Justice Kagan told Pirani’s counsel, “It does seem to me like you have a hard row to hoe here.” Nevertheless, the Court appeared hesitant to endorse Slack’s position on claims under Section 12, saying that there is little case law and the SEC has not weighed in on the issue. Highlighting this reticence was Justice Kavanaugh, who told Slack’s counsel, “[t]hat strikes me as a big issue for these direct listings and something that I’m not sure we’re fully equipped at this moment to chime in on.” Indeed, both Justices Kavanaugh and Gorsuch suggested that they might side with Slack on the Section 11 claim but return the case to the Ninth Circuit to revisit the Section 12 claim. Justice Kavanaugh made a point that he was “worried about making a mistake” given that neither the lower courts nor the SEC had extensively analyzed the Section 12 issue.

Ultimately, the Supreme Court held that plaintiffs bringing claims under Section 11 of the Securities Act are still required to satisfy the tracing requirement, even when the case involves a direct listing. In reaching the decision, Justice Gorsuch wrote that the better reading of Section 11 “requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement.” The Court then remanded the case back to the Ninth Circuit. However, the Supreme Court did not expressly apply this ruling to the Section 12 claim, and instead admonished the Ninth Circuit for its previous belief that Sections 11 and 12 “necessarily travel together,” instead cautioning that “the two provisions contain distinct language that warrants careful consideration.”

What this ruling will mean for plaintiffs is unknown, but it will likely increase the difficulty for plaintiffs attempting to sue a company that sells shares pursuant to a direct listing, since distinguishing between registered and unregistered shares sold at the time of a direct listing could prove impossible. Because of this difficulty, a cottage industry may be created of experts whose sole purpose is to identify whether a share was registered or unregistered when purchased. Finally, while it is unknown how the Ninth Circuit (and Supreme Court) will interpret Section 12 in light of this ruling, the Court’s opinion at least signals a divergence between Section 11 and Section 12 jurisprudence.