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Your next IPO may be a direct listing, thanks in part to a unanimous opinion issued by the US Supreme Court last week in Slack Technologies v. Pirani. In the ruling, which we’ve been anticipating for a long time (here’s Meredith blog from last month about the case’s insurance implications), the Court determined that a plaintiff pursuing a liability claim under Section 11 of the Securities Act for alleged misstatements in an offering must be able to trace their shares to issuance under a registration statement in order to move forward with the claim.

That may be difficult in the context of the “direct listing” process that Slack used to go public back in 2019. When Slack began trading, a portion of the newly listed shares were registered for resale (restricted securities held by affiliates and others) – but an even larger portion of the newly listed shares were not registered and simply became available for secondary transactions. This Morrison Foerster memo gives a refresher on the implications of this case for IPO-related liability:

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.

This isn’t the end of the road for this particular case or the broader issue of liability in direct listings. For one thing, the Court noted that Congress could change the language of the statute if it wanted to allow claims to proceed – potentially, the SEC could even adopt interpretive rules to clarify the issue. (And of course, even if that didn’t happen, plaintiffs can sue companies for securities fraud at any time under Section 10 of the Exchange Act without the tracing requirement – but those claims are more difficult because they require a showing of scienter).

Here, SCOTUS remanded the case to the 9th Circuit to decide whether the plaintiff’s pleadings can satisfy Section 11(a) as construed by the Court, as well as whether the plaintiff’s Section 12 claim can move forward. As Cooley’s Cydney Posner blogged, the plaintiff may be able to plead that some of his purchased shares can be traced to the registration statement:

Can Pirani trace his shares? During oral argument, Slack counsel contended that it was not really possible for Pirani to trace his shares to the registration statement. He noted, however, that there was a pending state case in which plaintiffs claim they can trace, and that was being litigated. In addition, Slack counsel referred to an amicus brief submitted by law and business professors that suggested “that a recent regulatory change after this case, the creation of the consolidated audit trail, may facilitate tracing in the future.” Counsel for Pirani pointed out that they had indicated in the pleadings that the shares were traceable—meaning not every share, but a percentage of them, a question that he thought should be left to the lower courts. Justice Gorsuch agreed that all they would “need to do is plead facts suggesting that you can trace consistent with the Twiqbal standard [Iqbal and Twombly], as my friends like to call it. (Laughter.)… And—and then you’re off to the races and it really just becomes a matter of damages, as I think you also alluded to.” As a result, he continued “if we were to rule against you on what §11 means, it still would enable you to plead…that there are traceable shares.”

On the Section 12 claim, which looks at false or misleading statements in a prospectus or oral communication rather than a registration statement, the Court said:

The Ninth Circuit said that its decision to permit Mr. Pirani’s §12 claim to proceed “follow[ed] from” its analysis of his §11 claim. 13 F. 4th 940, 949 (2021). And because we find that court’s §11 analysis flawed, we think the best course is to vacate its judgment with respect to Mr. Pirani’s §12 claim as well for reconsideration in the light of our holding today about the meaning of §11. In doing so, we express no views about the proper interpretation of §12 or its application to this case. Nor do we endorse the Ninth Circuit’s apparent belief that §11 and §12 necessarily travel together, but instead caution that the two provisions contain distinct language that warrants careful consideration.

If you need to get up to speed on the mechanics of direct listings, we’ve got a “Direct Listings” Practice Area for that. Or, as Bloomberg’s Matt Levine pointed out, some companies might also take this holding as a reason to loosen lockups for traditional IPOs:

One possible conclusion here is that, if you are a company considering an IPO, a direct listing reduces your potential liability (and that of your underwriters): If you do a direct listing, no one can sue you under section 11 for misstatements in your prospectus; they have to meet the higher bar of proving fraud.

Another possible conclusion here is that, if you are a company considering an IPO, and you don’t want to do a direct listing, you can maybe get these benefits anyway? Just don’t sign a lockup! Let some of your employees or other existing shareholders sell stock immediately, as soon as the IPO prices. Then anyone who buys stock after the IPO can’t prove that they bought stock from the IPO, instead of from your employees.

– Liz Dunshee