By: Hunter Becker
Slack Technologies Inc. (“Slack”), a company acquired by Salesforce and valued at over $25 billion in 2020, is now facing a lawsuit that could find it liable for the statements made in its direct listing. A company can go public a few ways, namely by traditional IPO, direct listing, or reverse merger. Going public provides the company liquidity for existing shareholders by allowing them to freely sell their shares on the public market. In a direct listing, existing stock owned by employees and investors becomes available to the public for purchase and does not require an underwriter or lock-up period, unlike a traditional IPO. The cost of the direct listing process is much lower than the cost of the traditional IPO, as companies avoid hefty fees paid to investment banks. A direct listing still requires certain disclosures to be made in order to protect investors and make accurate representations about the company.
A primary reason a direct listing is used is to deter litigation by restricting the class of persons who have standing to sue under Section 11 of the Securities Act of 1933. Section 11 imposes strict liability for material misstatements or omissions in registration statements. To establish standing under Section 11, a plaintiff must “trace” the shares they purchased to the challenged registration statement. Where both registered and unregistered shares may be sold at the same time, the vulnerability occurs when plaintiffs are trying to “trace” the shares purchased back to the registration statement in question. In 1967, the seminal case of Barnes v. Osofsky stated that Section 11 claims can only be brought by “any person acquiring such security,” defining “such security” to have either a broad meaning or a narrow meaning. The phrase “such security” presents difficulty as “such” has no referent in the statutory language.
The recent Ninth Circuit ruling held that Slack could be liable for alleged misstatements with its own interpretation of “such security.” Pirani v. Slack Technologies Inc. is a case of first impression by the Ninth Circuit, holding that even “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.” The Ninth Circuit pointed not to the language of the statute, but instead to how Slack operated its direct listing. Because there are no lock-ups with underwriters:
“[A]t the time of the effectiveness of the registration statement, both registered and unregistered shares are immediately sold to the public on the exchange….Thus, in a direct listing, the same registration statement makes it possible to sell both registered and unregistered shares to the public. Slack’s 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. Any person who acquired shares through its direct listing could do so only because of the effectiveness of its registration statement.”
The court is saying that but for the registration statement, none of the listed shares would be sellable on the exchange whether they were registered or unregistered, thus fitting the definition of “such security.” The Court explained that, because there is only one registration statement involved, the case does not involve the type of tracing problems typically associated with successive registration statements, thereby allowing this case to go forward. However, as the dissent points out, there is no textual basis for the panel majority’s construction of Section 11 and Section 12.
Now Slack investor Fiyyaz Pirani is suing on several grounds, alleging that the company understated the costs of compensating customers for service outages and failed to account for competition from Microsoft Teams that cut into its business and other factors that caused Slack’s stock to drop. If the Ninth Circuit’s ruling survives any further appeals, companies considering direct listings will have to consider the risks of Section 11 liability. This affects a small but growing number of companies. 12 companies, including cryptocurrency exchange Coinbase Global Inc. valued at $85.7 billion, conducted direct listings in 2021, the most ever in one year. Since direct listings typically do not raise new capital, this option tends to appeal to large private companies that are already well-financed.
On one side of this issue, the Ninth Circuit is attempting to protect investors of direct listings by affording them the same protections as an IPO type of investment. The majority of the panel confirmed that the choice of how to go public should not be influenced by the federal securities law liability rules for those issuers who may make untrue or misleading statements in their registration material. The other side of this issue is that there is no textual support for this ruling, and if the ruling is reversed and investor remedies were limited, then the direct listing method might be more enticing to reduce liability for companies. Alternatively, the SEC could step in and enact a waiting period before unregistered shares could be released for trading, making them easier to distinguish from registered shares and relieving some of the “tracing” issues plaintiffs face in direct listing lawsuits. The legislature could also codify the same type of provision requiring the SEC to enact this waiting period. Slack petitioned the court for rehearing on November 3, 2021. If the petition is denied, Slack could petition for writ of certiorari to the United States Supreme Court.
Student Bio: Hunter Becker is a second-year law student at Suffolk University Law School. He is a Staffer on the Journal of High Technology Law. Hunter received a Bachelor of Arts Degree in Environmental Science and Policy from Florida State University with a minor in Computer Science.
Disclaimer: The views expressed in this blog are the views of the author alone and do not represent the views of JHTL or Suffolk University Law School.
