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.
Whether the SCOTUS holding – and the ultimate outcome of this case – will change the dynamics for public offerings remains to be seen. Please participate in this anonymous poll to share your thoughts:
Cboe Global Markets – which, as the “rebranded” Chicago Board Options Exchange, continues to be one of the world’s largest option exchanges – announced last week that it is going to begin listing corporate stocks in the US. All Cboe-listed stocks in the US and Canada can also be made available for trading in the Netherlands and the UK, with Australia to follow.
Cboe has been around for 50 years as an options exchange, but when it comes to listing company stocks, it is a new player. It joins upstart national securities exchanges like the Long-Term Stock Exchange (all 24 national securities exchanges are listed on the SEC’s “Self-Regulatory Organizations” page). It says it is not aiming to compete with the existing large exchanges – rather, it wants to focus on the “purpose-driven innovation economy.” Here’s more detail:
Uniquely focused on powering the purpose-driven Innovation Economy, Cboe Global Listings aims to serve growth companies – particularly those with novel business models operating in nascent, high-growth industries – and innovative investment products that are addressing world challenges and shaping the economies of tomorrow.
Abaxx Technologies, a fintech company, will be the first issuer listed on Cboe’s global platform. Abaxx went public on Cboe Canada in December 2020.
Hang on to your hats! In advance of the more detailed disclosure requirements that will apply to share repurchases conducted later this year and in the future, a 6-page order posted last week shows that the SEC’s Enforcement Division is already on the lookout for shortcomings under the disclosure rules as they currently exist. The Commission instituted cease-and-desist proceedings and reached a $600k settlement with a regional bank based on its purported findings that:
1. FGBI failed to disclose repurchases of its common stock on the open market in its Forms 10-Q and 10-K in connection with an employee stock grant program (“Stock Grant Program” or “Program”) for employees of its wholly-owned subsidiary, First Guaranty Bank (“FGB”), and for annual stock bonus awards made to FGB executives, including FGB’s Chief Executive Officer (“CEO”) and Chief Financial Officer, (“CFO”).
2. From September 2016 through February 2021, FGB used an outside third party, who was not an employee of either FGB or FGBI, to purchase shares of FGBI common stock each quarter on the open market using his own brokerage account. Once the shares were purchased, the third party worked with FGB’s administrative personnel to effectuate the sale of shares to FGB. FGB never took possession of the shares, instead distributing them directly from the third party’s account held at FGB to select employees for that quarter and to its senior executives at year-end. In total, the third party purchased 119,020 shares of FGBI common stock for approximately $2.5 million under these programs.
3. Pursuant to Item 703 of Regulation S-K, 17 C.F.R. § 229.703, FGBI was required to disclose these quarterly and annual purchases made by the third party in FGBI’s Forms 10-Q and 10-K filed with the Commission between March 30, 2017 and May 10, 2021. However, FGBI never disclosed this required information in its quarterly and annual filings. Moreover, FGBI failed to implement controls, policies, or procedures designed to ensure compliance with the disclosure requirements under Item 703.
4. As a result of the conduct described above, FGBI violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-13, and 13a-15(a) thereunder.
Although this order involves a corner of the market that’s been under significant scrutiny this year, there’s no reason to think that the Enforcement Division isn’t also watching for compliance issues at companies from other industries. In addition to the specific repurchase disclosures that resulted in the alleged violation, the order also says that the company lacked appropriate disclosure controls – which has been an enforcement theme as of late. Here’s an excerpt:
Although FGBI maintained written procedures and checklists pertaining to disclosures required by the federal securities laws, FGBI had no controls or procedures in place for FGBI’s annual filings designed to ensure FGBI disclosed the quarterly share purchases in its Forms 10-K under Item 703. With respect to FGBI’s quarterly filings on Forms 10-Q, FGBI maintained a Form 10-Q checklist that had only the one question pertaining to Item 703. However, FGBI’s controls and procedures were not designed to ensure that the quarterly purchases made by the third party, an affiliated purchaser of FGBI, would be disclosed under Item 703.
Since the share repurchase disclosure requirements are only going to get more detailed & complex from here, now is the time to revisit disclosure controls and ensure that all checklists and form checks are broad enough to capture all repurchases covered by the rules. Check out the memos – and our recent webcast – about the new rules that we’ve posted in our “Buybacks” Practice Area, to make sure that you and your clients are prepared.
Speaking of control deficiencies, Dave blogged in April about the Commission’s improved transparency around its own issues. At that time, the SEC announced that they had determined that Staff in the Division of Enforcement had been able to access a database that contained certain memos prepared by the Adjudication Group. That access is not supposed to be possible, and the SEC has been conducting a review and implementing remedial measures.
On Friday, continuing its communication on this matter, the SEC released a lengthy statement from the review team, as well as 5 exhibits detailing 28 affected matters. Here’s an excerpt that summarizes findings so far:
In all instances, the review team found that the Enforcement administrative staff accessed the Adjudication memoranda as part of an effort to track and upload to the Enforcement Centralized Database all Enforcement memoranda recommending Commission action in enforcement proceedings. Consistent with this effort, the overwhelming majority of the memoranda accessed by the Enforcement administrative staff were memoranda to the Commission submitted by Enforcement staff. But because the OS databases were not configured to prevent Enforcement staff from accessing Adjudication memoranda—and the Enforcement administrative staff did not distinguish between Enforcement and Adjudication memoranda—those administrative staff included some Adjudication memoranda in their effort to continually upload relevant materials into the Enforcement Centralized Database.
As part of the review, the SEC’s investigative staff from the Division of Examinations, under the supervision of the Commission’s General Counsel and with support from a consulting firm, interviewed more than 250 current & former staff members and considered over 500,000 pages of emails and attachments, as well as hundreds of case files and 25 million rows of data from access logs of various systems. The Commission says that it will release additional findings from the review team as appropriate.
The S&P Dow Jones recently announced its latest quarterly rebalance, which becomes effective in about two weeks – at market open on Tuesday, June 20th. The rebalance includes changes to the S&P 500 as well as the S&P MidCap 400, and the S&P SmallCap 600 indices.
While only a handful of companies are affected by these rebalancings each quarter, it’s a reminder that index inclusion (or exclusion) can impact the voting & investment policies that apply to a company. So, if your company is on the cusp of any index, there are many reasons to monitor that and keep your team apprised of whether you are now subject to different policies. This blog has more detail on what drives turnover.
The SEC has scheduled an open meeting for next Wednesday to consider three rulemakings from the Division of Trading and Markets, and one of them is the removal of credit ratings in Regulation M. Regulation M is the set of rules designed to prevent the manipulation of securities prices at the time of a distribution. The removal of credit ratings from SEC rules is yet another legacy of the Dodd-Frank Act. Section 939A of the Dodd-Frank Act directed the SEC to review its rules that use credit ratings to assess the creditworthiness of a security or money market instrument, remove any reference to or requirement of reliance on credit ratings and substitute such standard of creditworthiness as the SEC determines to be appropriate.
The SEC’s efforts to remove credit ratings from Rules 101 and 102 of Regulation M has been a bit of an odyssey. The SEC proposed amendments in 2008 and 2011 to remove references to credit ratings from Regulation M and replace them with alternative measures of creditworthiness, but those proposed amendments were never adopted. In March 2022, the SEC again proposed changes to Regulation M. Under the latest proposal, the SEC would replace the investment grade exception in Rule 101 of Regulation M with two alternative standards. For nonconvertible debt securities and nonconvertible preferred securities, the proposed standard is based on the issuer’s probability of default, while for asset-backed securities, the proposed amendments would except asset-backed securities that are offered pursuant to an effective shelf registration statement filed on Form SF-3. In addition, the SEC proposed to eliminate the investment grade exception in Rule 102 entirely and not replace it with any alternative standard.
The adoption of final rules would represent another example of Chair Gensler’s effort to clean up the outstanding Dodd-Frank Act rulemakings as we approach the thirteenth anniversary of the enactment of that legislation.
If you were perusing filings on EDGAR yesterday as I was, you no doubt found that, when you pulled up some filings, the screen was blank and no information was presented. It seemed evident that the filing was there on EDGAR, but you just could not see it. The SEC IT Staff was on top of this issue quickly and issued a statement acknowledging that EDGAR was experiencing a technical issue displaying certain iXBRL files, and they provided instructions for a work-around to access the filings. The notice indicated that the Staff expected to have the problem fixed by 6:00 am this morning, but I am still encountering the message “An Error has occurred within the Inline XBRL Viewer” when trying to access some filings.
It dawned on me as my frustration grew trying to access filings yesterday that I should really be more grateful for EDGAR. It is a tool that I use almost every day that usually works pretty flawlessly. Despite the onslaught of iXBRL, which makes using EDGAR even more wonky than ever, it does get the job done on a technology platform that appears to be straight out of the 1990s. I can certainly say that having started practicing at the dawn of EDGAR when we accessed ASCII-formatted filings internally at the SEC using our huge PCs running the OS/2 operating system (remember that?), EDGAR has really come a long way. So, I will take a deep breath and wait for the SEC IT Staff to sort out this latest glitch and not be so critical of my old friend EDGAR.
While the early bird rate that I was shamelessly touting earlier this week expired at the end of May, you still have time to sign up for our “Proxy Disclosure & 20th Annual Executive Compensation” Conferences – which take place virtually on September 20th – 22nd, as well as our “2nd Annual Practical ESG Conference,” which takes place virtually on September 19th.
While I somehow reached a Zen state with regard to EDGAR glitches, I am still pretty stressed about all of the recent SEC rulemakings and all of those yet to come. If you are feeling the same way, our conferences are the best way to get caught up on all that is happening with the SEC that is affecting public company disclosure and corporate governance. We have assembled an outstanding group of panelists that will provide the latest thinking on the burning topics of the day. So be sure to sign up today.
When I first began speaking at conferences as an SEC employee back in the 1990s, it was ingrained in me that, before making any remarks, I must first give the “standard disclaimer,” or else some terrible consequences would be visited upon me. My early training worked, because invariably I would say the disclaimer, and even to this day when I am on a panel with someone from the SEC, I will prompt them to give their disclaimer or stop the discussion to give the person an opportunity to state the disclaimer if they forget to do so. Over the years I have even poked fun at the SEC disclaimer, as in this puppet show from the 2015 Proxy Disclosure Conference. Who knew puppets had disclaimers?
The one unusual thing about the standard disclaimer is that it stayed the same for as long as I can remember. In the almost three decades that I have been practicing, SEC speakers have been saying pretty much the same disclaimer: “The views I express today are my own and do not necessarily reflect the views of the Commission, the Commissioners or the Staff.” Even when I was engaged in the rote recitation of this disclaimer, it always struck me as odd that, as a representative of the SEC at the program, I was saying that I only expressed my own views, even though obviously the views I discussed on the panel were very much aligned with SEC policy at the time. Perhaps the disclaimer made more sense for the Commissioners, who in their speeches often express political or ideological views that are not necessarily aligned with the views of the Chairman or the other Commissioners. In any event, the disclaimer was what it was, and I did not dare to alter it out of fear of suffering the unknown consequences.
That all leads us to a curious development that has emerged in just the past month that was recently highlighted by Professor Benjamin Edwards on the Business Law Prof Blog. Professor Edwards notes that the disclaimer has changed in very recent speeches made by SEC Chair Gensler and others at the SEC. For example, in remarks at the Municipal Securities Disclosure Conference in May, Chair Gensler stated: “My views are my own as Chair of the SEC, and I am not speaking on behalf of my fellow Commissioners or the staff” (emphasis added). Further, in a speech last week to the Investment Company Institute, Chair Gensler stated: “As is customary, I’d like to note that my views are my own as Chair of the Securities and Exchange Commission, and I’m not speaking on behalf of my fellow Commissioners or the SEC staff” (emphasis added). The change is also evident in speeches by the SEC Staff, as I noted in recent remarks by the Director of the Division of Investment Management: “I must remind you all that my remarks today are provided in my official capacity as the Commission’s Director of the Division of Investment Management but they do not necessarily reflect the views of the Commission, the Commissioners, or members of the staff” (emphasis added). Professor Edwards indicates that this overall change in approach to the disclaimer likely arises from some recent litigation developments:
The changed language likely results from discovery disputes in SEC vs. Ripple Labs. Some news reports have covered the SEC being forced to turn over documents related to a 2018 Speech by William Hinman, then the SEC’s Director for the Division of Corporation Finance.
I poked around the docket in that case and found an order finding that internal discussions about the Hinman speech were discoverable and not protected by the Deliberative Process Privilege (DPP) because Hinman was communicating his own opinions and they did not “relate to some form of agency position, decision, or policy”.
At least with these recent changes the disclaimer makes more sense, in that the speaker acknowledges that they are speaking in their official capacity and not just expressing their own personal views. Now I need to think about whether my puppet disclaimer needs to change going forward.
