In a much-anticipated opinion, the Ninth Circuit in Pirani v. Slack Technologies, Inc. became the first circuit to weigh in on whether and how an investor purchasing securities in a direct listing can establish standing to bring claims under Section 11 of the Securities Act of 1933, which requires a shareholder to “trace” the shares purchased to the issuer’s allegedly misleading registration statement.

Section 11 broadly imposes strict liability—without any requirement to prove fraud or state of mind—on the issuer, its directors, and others for any material, untrue statement of fact or omission in the issuer’s registration statement. By its terms, however, Section 11 provides a right of action only to persons acquiring “such security,” which circuit and district courts uniformly have held limits standing to those investors who purchased securities that were issued under that registration statement. An investor who cannot determine whether the common stock purchased was registered through the registration statement at issue or through an earlier (or later) registration of identical common stock, for example, would not be able to maintain a Section 11 claim.

Pirani began purchasing his Slack common stock on the day of Slack’s “direct listing”—a new form of offering approved by the SEC in 2018 that allows a company to enter the public market without using underwriters or issuing any new shares, instead permitting all existing shareholders to sell their unregistered shares directly in the public offering simultaneously with the company’s own newly registered shares. More than half of the 283 million shares that became available on the date of Slack’s direct listing were existing shareholders’ unregistered shares, and no purchaser on the open market knew whether the specific shares acquired were registered or unregistered.

The question for the panel was how to reconcile, on the one hand, the Ninth Circuit’s own prior holding that a Section 11 plaintiff “must have purchased a security issued under that, rather than some other, registration statement” with the fact that in a direct listing such as Slack’s, it may be impossible for any plaintiff to ever know (let alone prove) that the shares purchased were among the shares formally registered through the company’s registration statement as opposed to other unregistered shares.

In a 2-1 decision authored by Judge Jane A. Restani, sitting by designation from the U.S. Court of International Trade, the court resolved the issue by finding that “[a]ll of Slack’s shares sold in this direct listing, whether labelled as registered or unregistered can be traced to that one registration [statement].” The court reasoned that “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.” In other words, because the registration statement was what allowed Slack to accomplish its direct listing, the sale of both the registered and unregistered shares in some sense causally flowed from that registration.

The court’s eschewing any strict tracing requirement by deeming all shares traceable to the registration statement is a departure from past precedent. To justify its departure, the majority relied heavily on the perceived policy consequences of reaching an opposite decision, stating, “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 stating in a direct listing for both registered and unregistered shares.”

In a lively dissent, Judge Miller emphasized the well-established precedent uniformly recognizing that “such security” under Section 11 means shares that were actually registered pursuant to the registration statement at issue. Judge Miller likewise rejected the court’s “concern that it would be bad public policy for a section 11 action to be unavailable when a company goes public through a direct listing,” finding the concern “neither new nor particularly concerning,” as investors have other avenues to hold issuers accountable for misleading registration statements. For example, Pirani and others in his shoes could still bring claims under Section 10(b) of the Securities Exchange Act (which, unlike Section 11 claims, require the plaintiff to plead and prove each defendant’s culpable state of mind).

Indeed, plaintiffs have made similar arguments for decades in opposing the tracing requirement in connection with secondary offerings and other circumstances that make tracing shares to a particular registration statement difficult or impossible. Courts have consistently rejected such efforts in the past, noting not only the clarity of the statutory text in imposing the strict tracing requirement, but also the fact that courts have consistently interpreted the statute as imposing this strict requirement since soon after the Securities Act was first passed in 1933. As one court put it, in rejecting a plaintiff’s plea to modify the requirement due to the advent of computerized trading in the 1970s that the court acknowledged made that plaintiff’s burden “now virtually impossible to meet”: “If Congress wishes to ease the burden on security holders such as plaintiffs, it can do so.”

In the nearly thirty years since the court wrote those words, Congress has shown no interest in easing plaintiffs’ burden. It remains to be seen what will become of the Slack court’s decision to do so, whether on further review by an en banc Ninth Circuit or the Supreme Court, or whether other Circuits will adopt its reasoning.

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