By Zachary Taylor, an associate, and Genevieve York-Erwin and Doug Greene, partners, with Baker & Hostetler LLP. Mr. Greene leads the firm’s Securities and Governance Litigation Team.

Issuers in U.S. markets know well that their public statements—via SEC filings or otherwise—are subject to great scrutiny by investors, the government, and (particularly) plaintiffs’ lawyers. The U.S. federal securities laws generally regulate issuers’ public statements under the Securities Act of 1933 (“1933 Act”) and the Securities Exchange Act of 1934 (“1934 Act”). The most familiar securities actions filed in federal court against issuers are brought under Section 10(b) of the 1934 Act, the key elements of which include (1) a false or misleading statement (in any public disclosure) that (2) is made with intent to defraud investors (scienter), and (3) caused loss.¹ A claim under Section 11 of the 1933 Act deals with statements made in a registration statement and only requires a false or misleading statement, or omission of a fact required to be disclosed under SEC rules—it does not require any intent to defraud.² In other words, Section 11 imposes strict liability on issuers found to have made false or misleading statements or omissions in a registration statement filed in connection with a registered offering of public securities.

In light of this harsh strict liability regime, Congress limited the category of plaintiffs who have standing to bring Section 11 claims. Section 11 provides:

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 . . . .³

For over fifty years, federal district and appellate courts across the country have interpreted this language as limiting Section 11 standing to shareholders who “acquir[ed] a security issued pursuant to the registration statement” alleged to be misleading.⁴ Stated differently, a Section 11 claim “must be brought by a purchaser of a registered security” and that purchaser must establish that his or her shares were registered and issued through the challenged registration statement (commonly known as the “tracing” requirement).⁵

The “tracing” requirement is not a problem for plaintiffs who challenge statements in a registration statement filed in connection with a company’s initial public offering (“IPO”) and who purchased shares in the IPO before the company issued any additional shares to the market.⁶ The reason for that is simple—there is only one registration statement in existence and the only publicly traded shares are those registered under and issued through it. However, once any additional shares come into the market after the IPO—either through the issuance of shares exempt from registration (“unregistered shares”), or through a subsequent public offering of new registered shares (“secondary offering”)—it becomes nearly impossible for a plaintiff to prove that his or her shares were the very same registered shares issued in the IPO.⁷ Relatedly, if the registration statement alleged to be misleading is tied to a secondary offering, it is extremely difficult for a plaintiff to trace his or her shares to that particular registration statement rather than an earlier one.

A recent 2-1 decision of the U.S. Court of Appeals for the Ninth Circuit eased the traditionally strict standing requirements for Section 11 claims by making tracing easier for plaintiffs to prove. In Pirani v. Slack Technologies, Inc., et al., the Ninth Circuit was faced with a Section 11 claim brought in the context of a Selling Shareholder Direct Floor Listing (known as a “direct listing”), rather than in the traditional Section 11 IPO or secondary offering context. As discussed below, the decision may have implications for standing in those contexts as well.⁸

Direct listings are relatively new phenomena. Created by the New York Stock Exchange in 2018 (and later approved by the SEC), a direct listing allows existing private shareholders of a not-yet-public company (typically early investors and employees) to offer their shares for sale on a public exchange, effectively allowing them to convert their shares into cash.⁹ When conducting a direct listing, the company must register its pre-existing shares unless they are shares exempt from registration under SEC Rule 144.¹⁰ Both the registered and exempt (or, “unregistered”) shares are offered simultaneously in a direct listing.¹¹  By contrast, in an IPO or secondary offering, a company offers new shares to the market to raise capital, and the registered shares are issued first while unregistered shares are typically subject to a “lock-up,” meaning that they cannot be issued to the public for a pre-determined amount of time.¹²

Slack involved a plaintiff who purchased shares in the company’s direct listing but who could not discern whether they were registered or unregistered shares.¹³  The district court, affirmed by the Ninth Circuit majority, rejected application of the traditional tracing requirement and broadened the universe of plaintiffs who can expose issuers to Section 11’s strict liability regime in the direct listings context. The Slack majority determined that because the plaintiff could not have purchased any of the direct listing shares without the filing of the registration statement, and because the registered and unregistered shares were issued at the same time based upon the filing of the same registration statement, the plaintiff had acquired his securities under the registration statement for purposes of Section 11 standing regardless of their formal registration status. The Slack majority’s opinion reframed the operative question of whether a shareholder “acquir[ed] such security” under a registration statement as more a function of causation and timing than one of registration:

We conclude that [plaintiff] had standing to bring a claim under Section 11 . . . because [plaintiff’s] shares could not be purchased without the issuance of Slack’s registration statement, thus demarking these shares, whether registered or unregistered, as ‘such security’ under Section[] 11. . . of the Securities Act.¹⁴

***

Slack’s shares offered in its direct listing, whether registered or unregistered, were sold to the public when ‘the registration statement . . . became effective,’ thereby making any purchaser of Slack’s shares in this direct listing ‘a person acquiring such security’ under Section 11.¹⁵

Indeed, the Slack majority opined that application of the traditional tracing requirement would undermine the purpose of Section 11 in direct listing cases because it would effectively eliminate any issuer liability:

In a direct listing, registered and unregistered shares are released to the public at once. There is no lock-up period in which a purchaser can know if they purchased a registered or unregistered share. Thus, interpreting Section 11 to apply only to registered shares in a direct listing context would essentially eliminate Section 11 liability for misleading or false statements made in a registration statement in a direct listing for both registered and unregistered shares.¹⁶

The dissent in Slack strongly challenged the majority’s reasoning. According to the dissent, the majority strayed too far from the statutory text and well-established precedent. The dissent emphasized the historical rationale for limiting Section 11 standing: “Strict liability is strong medicine, so [Section 11] tempers it by limiting the class of plaintiffs who can sue.”¹⁷ Accordingly, per the dissent, there was no reason to depart from the traditional interpretation of the statute as requiring plaintiffs to establish that they purchased registered shares issued through the challenged registration statement. Indeed, according to the dissent, this was an open-and-shut case:

Because [Plaintiff] cannot show that the shares he purchased ‘were issued under the allegedly false or misleading registration statement,’ he lacks statutory standing to bring a section 11 claim.¹⁸

***

Even if the filing of the registration statement determines when an unregistered security can be offered to the public in a direct listing, the registration statement does not apply to the unregistered securities and therefore is not the means through which it is offered or sold.¹⁹

The dissent also rejected the majority’s policy argument, explaining that such policy concerns should be left to Congress should they desire to amend the statute; it is not for the court to stray from the plain language of the statute or the nearly half-century of legal precedent construing it.²⁰ In sum, the dissent found the key to Section 11 standing to be the requirement that the plaintiff establish that his or her shares were registered and issued through the challenged registration statement, not just that their issuance was somehow dependent on it being filed.²¹

The implications of Slack are significant given that it broadens the category of buyers who can expose issuers to strict liability in Section 11 claims in the Ninth Circuit. At the very least, Slack appears to do away with any tracing requirement in direct listing cases, making any purchaser in a direct listing eligible to bring a Section 11 claim. Potentially more concerning to issuers is the Ninth Circuit’s broadening of the definition of what constitutes “such security” for purposes of other Section 11 claims. As noted above, courts have historically assumed that a plaintiff must have purchased “registered” shares to bring a Section 11 claim. However, under Slack’s reasoning, whether a shareholder “acquir[ed] such security” for purposes of Section 11 may now be a function of “but-for” causation. Could the shares have been issued to the public “but for” the registration statement alleged to be misleading? If not, a plaintiff may have standing regardless of whether his or her shares are formally registered under the registration statement, as courts have previously required. This expansive reading of Section 11 may do away with any tracing requirement in traditional IPO cases even where unregistered shares have also been issued to the market, due to expiration of the lock-up period or otherwise. Under Slack’s reasoning, such unregistered shares could not have been issued “but for” the IPO registration statement, potentially rendering tracing moot in those cases.

The defendants-appellants in Slack have petitioned for rehearing en banc in the Ninth Circuit and that petition is pending. They argue, much in line with the dissent, that the Slack majority favored policy concerns over statutory interpretation and precedent.²²

Notes

1. 15 U.S.C. § 78j(b).
2. 15 U.S.C. § 77k(a).
3. Id. (emphasis added).
4. See Barnes v. Osofsky, 373 F.2d 269, 271, 273 (2d Cir. 1967); Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762, 768 & n.5 (1st Cir. 2011); Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir. 2003); Lee v. Ernst & Young, LLP, 294 F.3d 969, 975–78 (8th Cir. 2002); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999); Joseph v. Wiles, 223 F.3d 1155, 1159–60 (10th Cir. 2000), abrogated on other grounds by California Pub. Emps.’ Ret. Sys. v. ANZ Sec., Inc., 137 S. Ct. 2042 (2017); APA Excelsior III L.P. v. Premiere Techs., Inc., 476 F.3d 1261, 1271 (11th Cir. 2007).
5. See Herman & MacLean v. Huddleston, 459 U.S. 375, 383 (1983); In re Van Wagoner Funds, Inc. Sec. Litig., 382 F. Supp. 2d 1173, 1181 (N.D. Cal. 2004); see also Oct. 26, 2020 Defendants-Appellants’ Opening Brief at 21-22, Pirani v. Slack Technologies, Inc., et al., No. 20-16419 (9th Cir.).
6. Hertzberg, 191 F.3d at 1082.
7. “[O]nce any non-IPO-registered shares come into the market, whether by means of a secondary offering or through sales of shares exempt from registration under the securities laws, courts routinely rejected Section 11 claims asserted by subsequent purchasers since tracing their shares to the offering statement became impossible.” See Laurie Smilan and Nicki Locker, “Courts Cut Shareholders Slack on Section 11 Claims,” Harvard Law School Forum on Corporate Governance, May 17, 2020.
8. Pirani v. Slack Technologies, Inc., et al., 13 F.4th 940 (9th Cir. 2021).
9. Id. at 944.
10. Id.
11. Id.
12. Id. at 943-44.
13. Id. at 943
14. Id. The majority also found its conclusion supported by Section 11’s legislative history. Id. at 947-48.
15. Id. at 949.
16. Id. at 948.
17. Id. at 951 (Miller, J., dissenting).
18. Id. at 952.
19. Id. at 954 (discussing both Section 11 and 12 claims).
20. Id. at 953 (“[W]hatever the merit of the policy considerations, they are no basis for changing the settled interpretation of the statutory text. If we alter our statutory interpretations from case to case, Congress [has] less reason to exercise its responsibility to correct statutes that are thought to be unwise or unfair.”) (citations and quotations omitted).
21. The dissent also discussed the legislative history of Section 11 and concluded that it “plainly refers to registered securities. . . . It does not refer to unregistered securities, even if those securities must wait until a registration statement becomes effective before they can be sold on an exchange.” Id. (citations and quotations omitted).
22. Nov. 3, 2021 Defendants-Appellants’ Petition for Rehearing and Rehearing En Banc, Pirani v. Slack Technologies, Inc., et al., No. 20-16419 (9th Cir.).