On June 1, 2023, the U.S. Supreme Court (the Supreme Court) issued a much-anticipated decision in the case captioned Slack Technologies, LLC, fka Slack Technologies, Inc. (Slack), et al. v. Pirani (the Slack Decision), which may have significant implications on the way technology companies decide to go public. In the Slack Decision, the Supreme Court vacated and remanded a Ninth Circuit decision that denied Slack’s motion to dismiss a securities class-action lawsuit. The suit alleged that Slack violated Section 11 of the Securities Act of 1933 (Securities Act) as a result of materially misleading statements in the S-1 registration statement that Slack filed in connection with its 2019 direct listing. The Supreme Court concluded that a Section 11 claim requires a plaintiff to plead and prove that it purchased shares traceable to the allegedly defective registration statement. As a result of this decision, plaintiffs will have a difficult time successfully pleading and proving Section 11 claims against companies that pursue a direct listing over a traditional IPO, thus making the direct listing structure potentially more attractive than a traditional IPO. Moreover, by extension, traceability would also be difficult to demonstrate in connection with an IPO with an alternative lock-up structure where secondary shares can trade on the listing day.
Slack’s Direct Listing
In the wake of Spotify’s 2018 direct listing, technology companies took note of this alternative way of going public. We’ve written extensively on the topic of direct listings. The first traditional Silicon Valley-based VC-backed company to go public through a direct listing was Slack, which listed its shares on the New York Stock Exchange in June 2019. As part of its direct listing process, Slack filed an S-1 registration statement, which registered for resale a portion of its pre-publicly traded shares. Unlike a traditional IPO, where often the only shares that trade for a period of time following the IPO are the shares registered on the IPO registration statement, in a direct listing both registered and unregistered shares trade in the market on and immediately following the listing.
After Slack’s direct listing, its stock price dropped and a purchaser of Slack stock subsequently sued the company, alleging that Slack’s registration statement was inaccurate and misleading because it did not disclose information about its service disruptions and how it compensated customers for those disruptions.
The Securities Act of 1933: Section 11
The main issue in the Slack case is what a public buyer in a direct listing must allege to successfully sue a company under Section 11 of the Securities Act. For those unfamiliar with the Securities Act, before offering and selling securities in the United States, a company is required to register the securities it intends to sell to the public with the Securities and Exchange Commission (SEC). It does so by filing a registration statement with the SEC, which covers detailed information about the company’s business, management team and financial profile, among other information. Read Slack’s registration statement. When information is materially misleading in a registration statement, private plaintiffs may sue to recover damages. The most common type of claim that plaintiffs bring following an IPO is a Section 11 claim, which is attractive relative to other types of claims because a plaintiff doesn’t need to prove that the company
intended for the registration statement to have a material misrepresentation or omission—only that a misrepresentation or omission in the registration statement was indeed present. Accordingly, Section 11 makes a company strictly liable for any material misstatements or misleading omissions in a registration statement. However, a company’s defective registration statement, in conjunction with an investor’s purchase of shares from that company, is not enough to successfully bring a Section 11 claim. Courts have articulated a traceability requirement, meaning that an investor must show that their purchased shares are traceable to a defective registration statement. More simply, an investor must show that their purchased shares were registered under a defective registration statement. But the relevant language of Section 11 is not clear—it authorizes an individual to sue for a defective registration statement when they purchase “such security.” From the plain language, it is unclear whether “such security” refers to (a) a security registered under a company’s specific defective registration statement, or (b) any security from the company. The central issues up for debate in the case against Slack were the traceability requirement and the meaning of “such security.” As noted above, this traceability requirement is particularly relevant in the context of a direct listing structure where both registered and unregistered shares trade in the market on and following the listing, which makes it difficult to prove whether the shares purchased were registered on the registration statement.
In the Slack case, the plaintiff Pirani purchased 30,000 Slack shares on the day Slack went public and subsequently purchased 220,000 additional Slack shares. Pirani filed a class-action lawsuit against Slack when the stock price dropped, claiming that Slack violated Section 11 of the Securities Act by filing a materially misleading registration statement. Slack claimed that Pirani could not prove that he purchased shares traceable to the allegedly misleading statements included in the registration statement because both registered and unregistered shares were available for sale at the time of the listing, arguing that the reference to “such security” in Section 11 refers only to a security registered on a defective registration statement.
On the other hand, Pirani argued that the District Court should find Section 11 traceability to be broader—that purchased shares need only bear some sort of minimal relationship to a defective registration statement, and that the reference in Section 11 to “such security” may also encompass a security that was not issued pursuant to a defective registration statement. So, what was the minimal relationship that Pirani claimed in the Slack case? He argued that Slack’s unregistered shares would not have been eligible for sale to the public if Slack did not also register shares on the registration statement. Therefore, the unregistered shares were connected to the registration statement in some fashion.
The District Court denied Slack’s motion to dismiss and certified a ruling for interlocutory appeal. The Ninth Circuit accepted the appeal and a divided panel affirmed, holding that an individual may sometimes recover under Section 11 even when the shares they own are not traceable to a defective registration statement. Reversing the Ninth Circuit decision, the Supreme Court adopted Slack’s interpretation of Section 11, holding that “such security” refers only to a security issued pursuant to a defective registration statement.
The Slack Decision will make it difficult for plaintiffs to prove a Section 11 claim on direct listings going forward. While there are several things that companies need to consider when deciding how they want to go public, one advantage that a direct listing may now have over a traditional IPO is the ability to potentially avoid Section 11 claims, and in turn, avoid strict liability for misleading statements or omissions in registration statements. Of course, companies need to keep in mind that plaintiffs may bring other claims for false or misleading statements in a registration statement, so ensuring the accuracy of information in registration statements continues to be important. Moreover, the Slack Decision also has implications for companies considering a traditional IPO. In the last few years, alternative lock-up structures have become common. With some of these alternative lock-up structures, secondary shares can trade as early as the listing day. As a result, the Slack Decision may result in companies implementing these types of modified lock-up structures to potentially avoid Section 11 claims.
*Havyn Quigley contributed to this alert.