Last week, the U.S. Supreme Court solidified the “tracing” requirement for private plaintiffs to be able to assert Section 11 claims pursuant to the Securities Act of 1933, holding that plaintiffs asserting such securities fraud claims must show that they own stock that was issued pursuant to an allegedly misleading registration statement—even though such tracing may be impossible in the context of a direct listing. In effect, the decision likely protects future direct listings from Section 11 liability so long as the direct listing does not involve a “lock-up period” pursuant to which unregistered and registered shares enter the market at different times.
On June 20, 2019, Slack Technologies, Inc. (“Slack”) went public by conducting a direct listing on the New York Stock Exchange. In doing so, Slack offered 118 million new shares to the market pursuant to a registration statement, together with 165 million shares that had previously been issued without a registration statement. While in an initial public offering (“IPO”), unregistered shares are typically prevented from entering the market for a “lock-up period” of 90 to 180 days, a direct listing allows previously private shareholders, such as employees and initial investors, to sell their shares on the market at the same time as the newly issued registered shares (if any newly-issued shares are offered at all). One major benefit of direct listings is they carry lower transaction costs, as no underwriters are involved. Direct listings are most likely to make sense for a company that is looking to become public but does not have the capital needs of a typical IPO candidate. In order to become public via a direct listing, the private company must be in a financial position that it does not need the assistance of investment bankers to raise capital or assurances that a certain amount of capital will be raised. For this reason, direct listings are relatively unusual.
Fiyyaz Pirani, who bought 250,000 shares of Slack following its direct listing, later sued the company under Sections 11 and 12 of the Securities Act of 1933, alleging that Slack’s registration statement downplayed the competition it was facing from Microsoft Teams and the difficulty Slack faced in scaling its operations internationally, and failed to disclose the frequency of its service disruptions or its policy to pay its customers service credits whenever their service was disrupted.
Section 11 of the Securities Act provides, in relevant part, “In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security [may sue certain enumerated parties].” Section 12 provides, in relevant part, that any person who “offers or sells a security . . . by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading” may be held liable for such misstatements or omissions.
Lower Court Decisions
Slack moved to dismiss Pirani’s lawsuit, contending that Pirani had failed to show that he had acquired “such security” registered pursuant to Slack’s registration statement in that his Slack shares might well have been among the 165 million shares issued before Slack’s registration statement became effective. Prior to this time, the courts of appeals had uniformly held (albeit, not in the direct listing context) that the phrase “such security” in Section 11 required a plaintiff to demonstrate that it could trace the shares it purchased to the offending registration statement and was not an unregistered or previously registered share obtained on the market. On April 21, 2020, the U.S. District Court for the Northern District of California denied Slack’s motion to dismiss, finding that “in this unique circumstance [of Slack’s] direct listing,” “the phrase ‘such security’ in Section 11 warrants a broader reading” than shares of stock directly traceable to an allegedly misleading registration statement. The district court held that because all of Pirani’s shares were “of the same nature” as the shares issued pursuant to the registration statement, Pirani had standing under Section 11. Slack then requested the district court certify its order for interlocutory appeal, which the Ninth Circuit Court of Appeals granted on July 23, 2020.
In 2021, a split Ninth Circuit upheld the lower court’s decision to allow Pirani’s case to proceed over Slack’s motion to dismiss, finding that a rigid tracing requirement was not required in the context of direct listings. The Ninth Circuit held: “Slack’s unregistered shares sold in a direct listing [were] ‘such securities’ within the meaning of Section 11 because their public sale cannot occur without the only operative registration statement in existence” and that Section 12 liability also “followed from” this reasoning. In reaching this conclusion, the Ninth Circuit relied heavily on policy concerns, reasoning that, if it were to rule in Slack’s favor, companies would be incentivized to go public via direct listings in order to avoid potential Securities Act liability.
The Supreme Court Vacates the Ninth Circuit
The Supreme Court granted certiorari to address “[w]hether Sections 11 and 12(a)(2) of the Securities Act of 1933 require plaintiffs to plead and prove that they bought shares under the registration statement they claim is misleading.” In doing so, the Supreme Court sought to settle the Circuit split created by the Ninth Circuit’s decision which, as noted, rejected the strict tracing requirement for a Section 11 plaintiff to demonstrate standing. As addressed below, the Supreme Court ultimately addressed Section 11’s tracing requirement only, as the appealed-from Ninth Circuit’s decision spent little—if any—time addressing the language of Section 12(a)(2).
In the unanimous decision authored by Justice Gorsuch, the Supreme Court vacated and remanded the Ninth Circuit’s ruling, finding that Section 11’s language required shares be traced to the allegedly false registration statement. In reaching its decision, the Supreme Court did not address the Ninth Circuit’s policy-based concerns. Instead, the Supreme Court honed in on the key textual question:
Does the term ‘such security’ [found in § 11(a) of the Securities Act] refer to a security issued pursuant to the allegedly misleading registration statement? Or can the term also sometimes encompass a security that was not issued pursuant to the allegedly misleading registration statement?
The Supreme Court, focusing on the language in Section 11 and throughout the Securities Act, reasoned that the use of the definite article in Section 11(a), the repeated use of the word “‘such’ to narrow the law’s focus[,]” the structure of the statute, and Section 11’s damages cap, which ties recovery to “the value of the registered shares alone,” demonstrated that Slack’s view that “such security” must be traced to a registration requirement was “the better” reading. Justice Gorsuch further noted that this conclusion was consistent with prior Second and Ninth Circuit decisions.
In closing, the Supreme Court acknowledged that “Congress remains free to revise the securities laws at any time, whether to address the rise of direct listings or any other development. Our only function lies in discerning and applying the law as we find it.” The Supreme Court also left open the possibility that the lower court might find that plaintiffs pursuing a Section 12 claim may not need to satisfy the tracing requirement, instructing the lower court only to “vacate its judgment with respect to Mr. Pirani’s [Section] 12 claim . . . for reconsideration in  light of our holding today about the meaning of [Section] 11.” As Justice Kagan and others hinted during oral argument because the somewhat different language of Section 12 could be a more plausible avenue for claims in Slack’s context, it is possible that the lower court will not apply the same rigid tracing requirement to Pirani’s Section 12 claim on remand.
The Supreme Court’s decision in Slack v. Pirani undoubtedly bolsters Section 11’s tracing requirement, including in cases involving direct listings. As a result, direct listings may effectively become immune from potential Section 11 liability. Section 10(b) of the Securities Exchange Act of 1934, however, which allows claims against companies for fraudulent misstatements made in connection with the purchase or sale of securities more generally, can still be applied to misrepresentations made in direct listings and does not require that a plaintiff demonstrate that it can trace its shares to a registration statement. When a company chooses to go public, there are multiple factors that will go in to the decision of whether an underwritten IPO or a direct listing is best. As a result of the Slack decision, at least at the margins, however, the more favorable legal landscape for companies pursuing the direct listing route may encourage companies to forego a traditional IPO in favor of a direct listing.
 Pirani v. Slack Techs., Inc., 445 F. Supp. 3d 367, 381 (N.D. Cal. 2020).
 Pirani v. Slack Techs., Inc., 13 F. 4th 940, 947 (9th Cir. 2021).
 Petition for Writ of Certiorari, Slack Techs. Inc. v. Pirani, 598 U.S. __ (2023) (No. 22-200).