On June 1, 2023, the United States Supreme Court ruled that a plaintiff bringing a claim under Section 11 of the Securities Act of 1933 arising from a direct listing must trace their shares to the registration statement. As discussed below, this is a favorable ruling for companies considering going public via direct listings.

The Securities Act of 1933

The Securities Act of 1933 requires a company to register securities it intends to offer to the public with the Securities and Exchange Commission. As part of that process, a company must prepare a registration statement that includes detailed information about its business and financial health, so buyers can assess whether to invest. The law imposes strict liability on companies when their registration statements contain material misstatements or misleading omissions.

As a counterbalance to strict liability, Section 11 requires a plaintiff to plead and prove that they purchased securities registered under the defective registration statement. This is the “tracing”’ requirement. In a traditional IPO, this is relatively straightforward. However, in a “direct listing,” this becomes more complicated.

What is a Direct Listing?

Direct listings are the result of a regulatory development approved by the SEC in 2018:

[T]o provide a means for a category of companies with securities that have not previously been traded on a public market and that are listing only upon effectiveness of a selling shareholder registration statement, without a related underwritten offering, and without recent trading in a Private Placement Market, to list on the exchange.

Unlike a traditional IPO, in a direct listing, the company does not issue any new securities. Rather, insiders and early investors sell their preexisting shares to the public, some under a registration statement but some not. And because the preexisting shares are not subject to a lockup period like an IPO, both the registered and unregistered shares flood the public market at the same time.

The Slack Decision

In 2019, Slack Technologies, Inc. decided to go public. However, Slack opted for a direct listing instead of an IPO. On June 20, 2019, insiders and early investors released 118 million registered shares and 165 million unregistered shares into the public market at the same time. After later developments suggested that Slack’s registration statement may have contained misstatements or omissions, a shareholder brought a Section 11 claim.[1]

Slack argued that the plaintiff could not establish standing under Section 11 because the plaintiff’s purchased shares must be traceable to the defective registration statement, which is nearly impossible to do here. Both the district court and the Ninth Circuit held that Section 11’s tracing requirement does not apply to direct listings. Slack appealed.

On June 1, 2023, in a rare unanimous decision, the Supreme Court ruled in favor of Slack. The legal issue was whether the phrase “such security” as used in Section 11 includes not only securities registered under a defective registration statement but also other, unregistered securities that bear a relationship to the registration statement. The plaintiff argued that but for the existence of Slack’s registration statement for the registered shares, Slack’s unregistered shares would not have been eligible for sale to the public. The Supreme Court disagreed, noting that the plaintiff’s argument would expand the scope of Section 11 and would be inconsistent with other provisions of the statute, including that the “[d]amages cap in the statute would . . . make less sense.” The Supreme Court concluded: “While direct listings like the one here are new, the Court’s conclusion is not” and “the better reading of §11 requires a plaintiff to plead and prove that he purchased shares traceable to the allegedly defective registration statement[.]”

The Supreme Court’s decision in Slack does not necessarily mean that shareholders who purchase securities in a direct listing will have no remedy for misrepresentations in the registration statement. For example, there may still be remedies available under the common law. However, it does appear to shut the door on strict liability under Section 11.

[1] Pirani v. Slack Technologies, Inc. et al., United States District Court, Northern District of California, Case No. 19-CV-5857.