The Supreme Court has just given companies looking to go public another reason to do it through direct listings.
The federal securities laws impose strict liability for misleading statements made in connection with initial public offering documents. As a result, if a newly public company’s stock price falls below its IPO price, for whatever reason, the company is likely to face a securities class action. In recent years, direct listings have become more popular, in part as a way to avoid litigation and potential liability under Section 11 of the Securities Act of 1933. That is because, under long-standing precedent, only shareholders who purchased securities registered under the challenged registration statement had standing to sue. In a direct listing, registered and unregistered shares are issued simultaneously, making it difficult, if not impossible, for investors to show that the securities they purchased were registered.
In 2021, however, the Ninth Circuit Court of Appeals questioned this well-established principle in the context of direct listings, adopting instead an expansive view of shareholder standing in Pirani v. Slack Technologies. Slack went public through a direct listing in 2019, simultaneously releasing a combination of registered and unregistered shares. Plaintiff, a purchaser of shares, later sued Slack for violations of Section 11 after the company’s stock price dropped. Slack moved to dismiss, arguing that plaintiff could not prove that his shares were issued pursuant to the registration statement. The district court denied the motion; the Ninth Circuit accepted an interlocutory appeal and affirmed. The court of appeals expressed concern that direct listings could “create a loophole large enough to undermine the purpose of Section 11 as it has been understood since inception.” The decision was at odds with precedent from other jurisdictions and made the Ninth Circuit an outlier that was especially plaintiff-friendly for securities class actions asserting Section 11 claims.
In last week’s decision, the Supreme Court rejected the Ninth Circuit’s reasoning and confirmed that only investors who can trace their shares to the registration statement have standing to sue companies under the Securities Act. Looking to “the context [and] circumstances” of the statute, the Court held that “Slack’s reading of the law is the better one.” The Court also declined to entertain plaintiff’s argument that a more lenient reading of the statute’s standing requirements would “better accomplish” the purpose of the Securities Act, stating that it was not the Court’s role to expand the law. In any event, the Court noted, it was plausible that Congress’ intent was to limit strict liability claims by requiring this higher standard of proof.
In a footnote, the Court decided not to weigh in on Plaintiff’s claim under Section 12, which imposes strict liability for a false or misleading statement in a prospectus or oral communication and does not reference registration statements. The Ninth Circuit said its decision to let the Section 12 claim proceed “follow[ed] from” its analysis of the Section 11 claim. The Court explained that because it found the Section 11 analysis flawed, it was also vacating the judgment with respect to Section 12, but it made clear that it does not “endorse the Ninth Circuit’s apparent belief that §11 and §12 necessarily travel together, and instead caution[ed] that the two provisions contain distinct language that warrants careful consideration.” The footnote thus leaves some uncertainty about Section 12 claims in the context of direct listings.
Nonetheless, the Court’s decision provides clarity that traceability is a standing requirement for Section 11 claims, including in the Ninth Circuit, and will make it easier for companies to obtain dismissal of such claims brought by plaintiffs who purchased their shares through direct listings.
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