Divided Ninth Circuit Permits Direct-Listing Investors To Assert Securities Act Claims, Despite Inability To Differentiate Between Registered And Unregistered Shares

• Published date: 04 November 2021
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Jason Halper, Ellen V. Holloman, Jonathan Watkins and Adam Magid

On September 20, 2021, in Pirani v. Slack Technologies, Inc.,¹ a divided panel of the U.S. Court of Appeals for the Ninth Circuit held that investors who purchase stock in a "direct listing"-in which pre-existing shares are sold to the public without underwriters-may bring claims based on alleged misrepresentations in a registration statement, even if they cannot demonstrate that they acquired registered shares. In a direct listing the company does not issue any new shares and instead files a registration statement "solely for the purpose of allowing existing shareholders to sell their shares" on an exchange.² For reasons explained below, however, both registered and unregistered shares may be available to the public via a direct listing.

The majority explained that Sections 11 and 12(a)(2) of the Securities Act of 1933 permit such claims, even by purchasers of unregistered shares, because, in a direct listing, a single registration statement allows both registered and unregistered shares to be made available to investors. Further, in the majority's view, negative consequences would result from a contrary ruling, including incentivizing issuers to conduct direct listings, instead of underwritten IPOs, to evade liability for "overly optimistic" registration statements, and upending investors' ability to seek redress under laws in place almost 90 years. That prompted a sharp dissent from Judge Eric D. Miller, who accused the majority of ignoring the statutory text and abandoning precedent in favor of its preferred policy outcome.

Pirani permits direct-listing investors to bring Sections 11 and 12(a)(2) claims for now, but it is unlikely to be the final word on the matter. The Pirani defendants may move for rehearing before an en banc Ninth Circuit. And even if that effort fails, the dissent offers a framework for future defendants to challenge such claims in other circuits. Given the implications for investors and issuers, including how shares come to the public moving forward, Pirani and its aftermath will be worth watching.

Background

Corporations traditionally have issued stock to the public through a firm commitment initial public offering, known as an "IPO." In an IPO, the corporation issues new shares, which it registers with the SEC via a registration statement.³ The corporation also engages an investment bank to underwrite the offering-that is, the bank commits to purchases the shares in the offering and assumes the risk that it can resell those shares to investors. To maintain price stability while that occurs, the investment-bank underwriter typically requires a months-long "lock-up" period in which existing shareholders-those that previously acquired shares pre-IPO through private placement-cannot sell their unregistered shares, i.e., those not being sold in the IPO pursuant to the registration statement. As a consequence, investors who purchase shares in an IPO necessarily acquire registered shares, subject to the registration statement, since no unregistered shares can be sold at that time.

In 2018, the SEC approved an amendment to Section 102.01B of the New York Stock Exchange's Listed Company Manual allowing for the direct listing of shares.⁴ The amended rule permits issuers, among other things, to list pre-existing, outstanding shares on the exchange, without an underwritten offering, "at the time of effectiveness of a registration statement filed solely for the purpose of allowing existing shareholders to sell their shares."⁵ The rule, however, does not require registration of shares exempt from the registration requirement under SEC Rule 144.⁶ The holders of such unregistered shares, thus, may sell their shares at the time of the direct listing, since there is no underwriter to impose a lock-up requirement. As a result, in a direct listing, unlike an IPO, both registered and unregistered shares may reach the public at the same time.

A typical investor cannot know whether the shares it acquires in a direct listing are registered or unregistered. From the investor's perspective, it simply places an order with its broker, who obtains the shares without knowledge of where they originated. This raises an issue under Sections 11⁷ and 12(a)(2)⁸ of the Securities Act, which permit private suits based on alleged misrepresentations...