On April 21, 2020, Judge Susan Illston of the U.S. District Court for the Northern District of California denied defendants’ motion to dismiss a securities class action complaint brought by a shareholder of Slack Technologies, Inc. following the company’s 2019 direct listing. Pirani v. Slack Technologies, Inc., No. 19-cv-05857-SI (N.D. Cal. Apr. 21, 2020). Rejecting defendants’ argument that the plaintiff lacked standing to pursue claims under Section 11 of the Securities Act, the court held, in a matter of apparent first impression, that in the unique situation of a direct listing in which shares registered under the Securities Act become publicly tradeable on the same day that unregistered shares become publicly tradeable, a plaintiff does not lack standing to sue under Section 11 even though the plaintiff cannot show that her shares were registered.
The decision has important implications for companies listing their shares through a direct listing, who now may be more likely to face Section 11 claims.
Foregoing a traditional IPO, Slack instead completed a direct listing in June 2019. In a direct listing, a process made available to companies in 2018 following the SEC’s approval of changes to NYSE rules, a company can enter the market without offering new shares directly to the public. Instead, the company’s preexisting investors are able to sell their shares on the open market immediately following a direct listing and are not subject to a lockup period. A company engaging in a direct listing remains subject to the registration requirements of the Securities Act—and thus to potential liability under Section 11.
In the Slack direct listing, the company filed a registration statement which applied to approximately 118 million registered shares made available for resale following the listing. However, approximately 165 million additional, unregistered shares—exempt from registration pursuant to SEC Rule 144—were simultaneously made available for resale together with the registered shares.
The plaintiff filed a securities class action, asserting claims under Section 11 of the Securities Act (among others), alleging that shareholders suffered losses as a result of alleged material misstatements or omissions in the offering materials for the direct listing. Under settled precedent, relief under Section 11 has in recent years been available only to plaintiffs who can establish that their shares were purchased pursuant to, and are traceable to, a specific registration statement. See, e.g., In re Century Aluminum Co. Sec. Litig., 729 F.3d 1104, 1106 (9th Cir. 2013) (holding that plaintiffs must “trace their shares back to the relevant offering” in order to establish Section 11 standing). Citing this precedent, the defendants moved to dismiss, arguing that plaintiff lacked standing to bring claims under Section 11 because the complaint did not and could not plausibly allege that the shares purchased by plaintiff on the open market were traceable to Slack’s registration statement, given that the plaintiff could not establish whether his shares were registered or unregistered. In the alternative, defendants argued that the plaintiff’s Section 11 claim failed because the plaintiff could not identify an “offering price” for the direct listing and therefore could not establish damages.
The Court’s Opinion
Judge Illston rejected defendants’ argument that the plaintiff lacked Section 11 standing. The court acknowledged the Ninth Circuit precedent requiring plaintiffs to “trace their shares back to the relevant offering” in order to establish standing under Section 11. See Century Aluminum, 729 F.3d at 1106. In Century Aluminum, the Ninth Circuit held that when “a company has issued shares under more than one registration statement, the plaintiff must prove that her shares were issued under the allegedly false or misleading registration statement, rather than some other registration statement.” Id.
Judge Illston further agreed with defendants that it was impossible for the plaintiff to trace his Slack shares to the company’s registration statement, given the simultaneous offering of unregistered and registered shares.
Nonetheless, the court found that in the context of a direct listing, a requirement that plaintiffs trace their shares to a registration statement—a task that is likely impossible—would lead to a “result at variance with the policy of this remedial legislation.” In reaching this conclusion, the court considered the text of Section 11, which states that “[i]n case 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 . . . sue . . .” 15 U.S.C. § 77k. The court, “guided by the familiar canon of statutory construction that remedial legislation should be construed broadly to effectuate its purposes,” held that the statutory phrase “any person acquiring such security” should be read to encompass not just any person acquiring securities traceable to a registration statement, but also to any person “acquiring a security of the same nature as that issued pursuant to the registration statement.” While acknowledging the holdings in Century Aluminum and other Ninth Circuit precedent, which adopted a more narrow interpretation of the statutory language, the court found that “applying the narrower reading of ‘such security’ in the context of Slack’s direct listing would cause the exemption provision of Section 4 to completely obviate the remedial penalties of Sections 11, 12 and 15.”
With respect to the defendants’ argument that the plaintiff had not alleged Section 11 damages because he could not establish a “price at which the security was offered to the public,” the court held that it was the defendants’ burden at the pleading stage to show that the plaintiff could not recover damages as a matter of law. The court, citing plaintiff’s argument that he was entitled to assert a “value-based Section 11 damages theory” under which he could show at a later stage of the case that the stock’s price at the time of the listing would have been lower if not for the alleged misstatements, held that the defendants had not satisfied this burden.
As direct listings grow in popularity, we are likely to see additional class action complaints asserting claims under Section 11 in cases arising from direct listings. To date, many practitioners and commentators have assumed that the mixture of registered and unregistered securities made available in direct listings, and the resulting impossibility of tracing shares to a registration statement, would prove fatal to Section 11 claims in these cases. This decision upends that assumption.
Given the court’s recognition that the standing issue is one of first impression, and in light of the questions raised about the applicability of the Ninth Circuit’s Century Aluminum holding in the direct listing context, it seems likely that the court’s decision will be appealed—perhaps even on an interlocutory basis. Unless and until the Ninth Circuit or other Courts of Appeal weigh in on this issue, companies can expect this to be a contested issue in every direct listing case.
 The Ninth Circuit noted that while this tracing requirement is “difficult to meet in some circumstances,” it is nonetheless “the condition Congress has imposed for granting access to the ‘relaxed liability requirements’ § 11 affords.” Id. at 1107.