The Supreme Court has agreed to hear a landmark case regarding Section 11 liability for companies going public on the New York Stock Exchange through direct listings. In 2018, the New York Stock Exchange introduced a new rule, later approved by the SEC, that allowed companies to go public using a “Selling Shareholder Direct Floor Listing,” or a direct listing. Direct listing permits a company to go public for the first time just by filing a registration statement to allow existing shareholders to sell their shares on the exchange. Under the previous method, an initial public offering (“IPO”), companies would go public by filing their registration statement and offering registered shares for public exchange during a “lock-up period,” a period during which no unregistered shares were permitted to be sold. In contrast, through a direct listing, there is no lock-up period, and from the first day of the listing, both registered and unregistered shares are made available to the public.
On June 20, 2019, the popular messaging service Slack went public through a direct listing, releasing 118 million registered shares and 165 million unregistered shares for $38.50 per share. Fiyyza Pirani purchased 30,000 shares on that same day and another 220,000 shares over the next several months. Throughout the next few months, Slack experienced multiple service disruptions, causing the share price to drop below $25.00. Pirani brought a class action lawsuit under Section 11 of the Securities Act of 1933 on behalf of himself and the other shareholders who had bought their shares traceable to Slack’s registration statement in its direct listing. Pirani argued that Slack’s registration statement was inaccurate and misleading due, in part, to its failure to disclose service agreements that require Slack to pay customers for service disruptions.
Section 11 of the Securities Act allows “any person acquiring such security” to bring a lawsuit against a company when, in any part of the registration statement, the statement contained an untrue statement or material fact or otherwise omitted a material fact. The phrase “such security” has been interpreted to mean security issued under a specific registration statement, which, up until this point using IPOs and lock-up periods, has meant a registered share. Therefore, Slack argued that Pirani did not have standing because the class could not prove that it purchased registered shares pursuant to a particular registration statement.
The Ninth Circuit held that “unregistered shares sold in a direct listing are ‘such securities’ within the meaning of Section 11 because their public sale cannot occur without the only operative registration in existence.” Some of the shares purchased were unregistered, but they were purchased in direct response to a registration statement. In the context of direct listings, interpreting Section 11 to apply only to registered shares would eliminate Section 11 liability for a misleading or false statement made in a registration statement. This would only encourage businesses to go public through a direct listing and use overly optimistic and misleading registration statements to entice buyers while also avoiding the risk of Section 11 liability.
Slack called this decision “potentially ruinous” because it “dramatically expanded” the scope of Section 11 and other federal securities laws. Shareholder advocates such as the Council of Institutional Investors, on the other hand, stated that this decision was a “big win for investor rights.” The Supreme Court has stated that it will hear the case to resolve “[w]hether Sections 11 and 12(a)(2) . . . require plaintiffs to plead and prove that they bought shares registered under the registration statement they claim is misleading.” The Supreme Court’s decision will have sweeping implications on the future use of direct listings, whether it upholds the Ninth Circuit’s reasoning or rejects it.