- U.S. Supreme Court resolves circuit split created by Ninth Circuit decision which had held that traceability not required in the context of a direct listing.
- By requiring traceability, the Supreme Court cabins strict liability of Section 11.
On June 1, 2023, a unanimous U.S. Supreme Court held in Slack Techs., LLC v. Pirani that Section 11 of the Securities Act of 1933 requires “a plaintiff to plead and prove that [they] purchased shares traceable to a defective registration statement.”1 In addition to resolving a circuit split created by the Ninth Circuit, which had held that a plaintiff could sometimes recover even if unable to trace the shares they purchased to a defective registration statement, the Court rejects the plaintiff’s attempt to expand the limited circumstances in which the strict liability of Section 11 could apply.
Most companies go public through initial public offerings (“IPO”), in which securities are sold to investors on a public exchange. In connection with the IPO, the company files a registration statement with the Securities and Exchange Commission (“SEC”). The company typically sells the newly registered shares directly to the underwriting investment banks, who in turn sell the shares to the investing public. As a condition of underwriting the IPO, the investment banks often require the insiders to lockup their shares and not sell for a fixed time until after the IPO. Therefore, only registered shares are sold to the public.
Companies also may go public through a “direct listing” where existing shareholders—such as founders, employees, and seed investors—may sell shares on a public exchange. In 2019, Slack Technologies, LLC went public by a direct listing on the NYSE. Slack filed a registration statement with the SEC. Because Slack went public by a direct listing, there was no intermediary investment bank and not all of the shares were sold pursuant to the registration statement. As a result, 118 million registered shares and 165 million unregistered shares were sold.
The plaintiff purchased 30,000 Slack shares on the day the company went public and an additional 220,000 shares over the following months. When the share price dropped, the plaintiff filed suit under Section 11 and Section 12 of the Securities Act of 1933. Unlike the anti-fraud provisions of the Securities Exchange Act of 1934 which require scienter, Section 11 of the 1933 Act imposes strict liability on issuers for misleading misstatements or omissions in their registration statements.
Slack moved to dismiss on the grounds that Section 11 and Section 12 only permitted actions by those shareholders who purchased shares pursuant to a false and misleading registration statement. Slack argued that, because the shareholders could have purchased any number of the 165 million unregistered shares, the plaintiff had failed to plead that he could trace his share purchases to the registration statement. The United States District Court for the Northern District of California denied Slack’s motion to dismiss, but certified its decision for interlocutory appeal. The Ninth Circuit affirmed, thereby creating a circuit split regarding whether Section 11 requires a plaintiff to trace his or her shares to a false and misleading registration statement.
The Supreme Court granted certiorari. In a unanimous decision, the Supreme Court vacated the Ninth Circuit’s decision and remanded for further consideration.
The Supreme Court’s Decision
In an efficient five pages, the Court conducted a straight-forward analysis of the text of Section 11 to hold that the statute requires a plaintiff to trace his or her shares to a false and misleading registration statement. Section 11(a) provides in part that where “any part of the registration statement . . . contained an untrue statement of a material fact . . . , any person acquiring such security” may bring suit. The question then was what Section 11(a) means by the term “such security.”
The Court found the answer in surrounding context of the statute. The Court observed that the statute referred to “the registration statement”, meaning “such security” suggests the security must be acquired as a result of “the registration statement.” Likewise, other uses of “such” in the statute referred to the registration statement, indicating that Congress intended the same reading in Section 11(a).
The Court further noted the framework of Section 11, which ties the maximum recovery under Section 11 to the value of the registered shares. If “such security” did not refer to shares sold pursuant to the registration statement, then that limitation would have no effect.
Given these “contextual clues,” the Court held that Section 11 requires a plaintiff to trace his or her shares to a false and misleading registration statement. Indeed, the Court noted that, for over fifty years—and until the Ninth Circuit’s decision—every Court of Appeals to address the requestion had reached the same conclusion.2 The Court thus vacated the Ninth Circuit’s decision and remanded the case for further consideration as to whether the plaintiff could satisfy Section 11.
The Supreme Court’s decision reflects a straightforward exercise in statutory interpretation. Indeed, the Court recognized that “Congress remains free to revise the securities laws at any time, whether to address the rise of direct listings or any other development.” The Court’s function, however, “lies in discerning and applying the law as we find it”—which in this case, resulted in imposing upon plaintiffs the difficult burden of pleading and proving they could trace their purchase of shares in the open market to a misleading registration statement.
- 598 U.S. _ (June 1, 2023).
- Because the Ninth Circuit stated that its analysis of the plaintiff’s Section 12 claim followed from its analysis of the Section 11 claim, the Supreme Court deferred addressing the scope of Section 12 until the Ninth Circuit had a chance to revisit its decision in light of the Supreme Court’s analysis. In so deferring, however, the Supreme Court cautioned that Section 11 and Section 12 contain distinct language “that warrants careful consideration.” Slip Op. at 10, n.3.