Public interest in the wake of Slack Technologies, Inc. v. Pirani

While the U.S. Supreme Court's recent ruling in Slack Technologies, Inc. v. Pirani may be good news for public companies - reducing their potential liability to stockholders in the case of direct listings - the decision leaves a major loophole and resulting exposure for investors acquiring stock in direct listings, where both registered and unregistered securities are available for purchase by the public.

A bit of background

In Slack, the Supreme Court denied Fiyyaz Pirani's standing to sue under Section 11 of the Securities Act of 1933 for alleged material misstatements in the company's registration statement without first proving that his purchase of stock in Slack originated directly from, or could be traced to, shares registered in its initial registration statement.

Section 11 allows investors to bring civil actions against registrants for false or misleading statements or material omissions made within registration statements. The statute states:

"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 (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue" the signatories and parties responsible for the preparation and filing of the registration statement, including experts and underwriters. [Italics and bold are added for emphasis.]

Relying on historical case law, the Supreme Court found that "such security" as set forth in Section 11 references only the securities registered in a given registration statement, as opposed to "such securities" referring more generally to securities issued by the company in question. As a result of this determination, unless a purchaser can directly trace purchased securities to those sold in the registration statement at issue, the investor would be unable to sue under Section 11.

Not your typical listing

Slack was listed on the New York Stock Exchange through a direct listing in June 2019, making available for resale to the public some 118 million registered and 165 million unregistered shares. On its first day of trading, approximately 136 million shares (both registered and unregistered) traded hands on the public market.

Pirani had purchased 30,000 shares on the day Slack went public and then bought another 220,000 shares over the next few months. Of note, he did not provide any evidence that his shares were purchased directly from those sold in Slack's registration statement. During the company's direct listing on June 20, 2019 through Sept. 5, 2019, Slack did not file any periodic reports (as it was not required to), and thus the company did not provide any material guidance to investors other than what was contained in its initial registration statement. As a result, Pirani claimed he had a right to sue under Section 11 because his purchase of Slack shares was made in reliance on the disclosures in the initial registration statement, as there were no other publicly filed disclosures to rely on.

Direct listings v. IPOs

Slack was only the second company to go public through a direct listing on the NYSE, pursuant to a rule made available in 2018. Typically, companies go public and list on one of the national exchanges through an underwritten initial public offering (or IPO). In an IPO, newly issued shares are purchased by an underwriter, usually on a firm commitment basis. These shares are then sold to a number of initial investors at a fixed price the night before trading commences. They are then sold into the public market on the first day of trading, thus raising new capital for the company.

Like in a direct listing, the only initial investor disclosures in an IPO consist of what is filed in the listing company's initial registration statement. However, in conjunction with an IPO, underwriters ordinarily require almost all holders of 1% or more of stock pre-IPO to enter into lock-up agreements. This eliminates any available trading in unregistered shares, as all such stockholders are subject to lock-up agreements for six months or longer after the IPO.

In the case of a direct listing such as Slack's, the issuer does not engage an underwriter and instead registers shares of existing holders through a resale registration statement, thus making shares held by third parties - officers, directors, venture capital and other shareholders - available for sale into the market. No money goes into the company's coffers and, rather, liquidity and an exit strategy are created for existing stockholders through the sale of both registered and unregistered securities.

Public interest mandates investor reliance

Because no new money is generated, direct listings are not a frequently used technique for going public. Yet even if the strategy is rarely employed, adequate investor protection is no less paramount and investors trading in available securities should be able to rely on a company's publicly filed disclosures.

Nevertheless, and in light of the Supreme Court's narrow reading of Section 11 - deeming "such security" to only refer to securities registered under a registration statement - investors in unregistered securities offered in direct listings like Slack's are essentially left to fend for themselves. This is untenable. To make direct listings equitable, all purchasers of shares should be able to rely on a listing company's initial disclosures. This is especially the case for direct listings like Slack's, where both registered and unregistered shares are being immediately sold into the market.

On the heels of the Supreme Court's ruling in Slack, lawmakers and regulators would be wise to take action to ensure that Section 11 is modified - or, at the very least, clarified - to ensure that shareholders, in the case of direct listings, can rely on registration statement disclosures. This is especially critical during the first few months after a company goes public, when there may not be any other SEC disclosures for investors to count on.