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Pedestrians pass the James R. Browning U.S. Court of Appeals Building, home of the 9th U.S. Circuit Court of Appeals, in San Francisco, California February 7, 2017. REUTERS/Noah Berger
(Reuters) - Since 2018, when the U.S. Securities and Exchange Commission cleared the way for corporate insiders to sell their privately issued shares to the public in a new kind of offering called a direct listing, fewer than a dozen companies have done so.
But according to the U.S. Chamber of Commerce and Stanford Law School professor Joseph Grundfest, the 9th U.S. Circuit Court of Appeals has threatened the stability of the entire regulatory framework for public offerings in a decision allowing an investor to sue Slack Technologies Inc for alleged misrepresentations in a direct listing.
In amicus briefs filed on Monday, the Chamber and Grundfest backed Slack’s petition for en banc review of the 9th Circuit’s split decision, arguing that the majority unjustifiably created a new rule for Securities Act liability in direct offerings, based on a false, policy-oriented dichotomy that is at odds with case law from at least eight other federal circuits – including 9th Circuit precedent in cases involving secondary stock offerings.
The issue in the Slack case is traceability. Section 11 of the Securities Act, as you know, imposes strict liability for misstatements in offering documents. But there’s a catch: Ever since the 2nd Circuit’s 1967 ruling in Barnes v. Osofsky, courts have required investors to show that their shares were tied directly to the allegedly misleading registration statement. If a company, for instance, issued shares in an allegedly misleading secondary offering, the only investors with standing to assert Section 11 claims were those who could prove their shares originated in the secondary offering and were sold under that offering’s registration statement.
The wrinkle in the Slack litigation is that its direct listing offered both registered and unregistered shares to the public. In traditional IPOs, all shares are sold under the offering’s registration statement. IPO underwriters typically prohibit insiders, including corporate executives and early investors, from selling their privately issued shares in the midst of the IPO. A direct listing allows those insiders to sell their shares publicly. Some of those insider shares, under SEC rules, are actually exempt from registration requirements, depending on how long they’ve been held and how they’re being sold. Other insider shares are still required to be registered. In Slack’s 2019 direct listing, 165 million shares were exempt and therefore unregistered. Only 118 million shares in the offering were required to be registered.
When investor Fiyyaz Pirani filed a Securities Act class action in federal court in San Francisco, alleging misrepresentations in Slack’s registration statement, Slack’s lawyers at Gibson, Dunn & Crutcher argued that he did not have standing because he couldn’t show that the shares he bought were among the 188 million registered shares, rather than the 165 million unregistered shares.
The 9th Circuit majority cut through the complexities of traceability, holding that the entire offering could not have taken place, under NYSE rules, without Slack’s registration statement.
“Any person who acquired Slack shares through its direct listing could do so only because of the effectiveness of its registration statement,” the appeals court held. “All of Slack's shares sold in this direct listing, whether labeled as registered or unregistered, can be traced to that one registration.”
To hold otherwise, the majority said, would undermine Congress’ intention of protecting investors from misrepresentations in offering documents, creating a loophole that would engulf the entire Securities Act. Why would any company choose a public IPO, the majority opined, if it could avert potential liability via a direct listing? And without the threat of liability, the opinion said, companies selling shares in a direct listing “would be incentivized to file overly optimistic registration statements” to pump up their share price.
Slack’s Nov. 3 petition for rehearing argued that the majority was so blinded by its policy concerns that it ignored the text of the Securities Act and manufactured a distinction between direct listings and every other type of offering. The ruling, Slack argued, not only creates a circuit split on traceability but also contradicts U.S. Supreme Court directives against purpose-based statutory interpretation.
The new amicus briefs expand on those arguments. The Chamber, joined by the Securities Industry and Financial Markets Association and the National Venture Capital Association, asserted in a brief by Latham & Watkins that the 9th Circuit majority failed to understand the business reasons behind companies’ decisions about how they will go public.
Direct listings work only for companies that are more concerned with providing liquidity to holders of their privately issued stock than with raising capital, the brief said. Businesses have known since the first direct listing in 2018 that such offerings reduced the risk of Securities Act liability, the brief asserted, yet only 11 companies have offered shares in direct listings – compared with the 919 businesses that have sold shares through traditional IPOs and the 278 that have gone public in SPAC deals. Those statistics belie the majority’s policy concerns about direct listings, the Chamber said.
The real danger to the market, the Chamber brief said, is from the 9th Circuit’s blurring of the line between registered shares and those exempt from registration under the SEC’s rules. “Uncertainty creates risk, and additional risk will make capital more costly to obtain,” the brief warned.
Grundfest and his counsel at Freshfields Bruckhaus Deringer said the 9th Circuit provided no “limiting principle” for its “dramatic” holding that the sale of exempt, unregistered shares can trigger strict liability under the Securities Act. The brief also asserted that the ruling threatened to magnify Section 11 liability beyond the statutory cap on damages, which are limited to the entire proceeds from the sale of registered securities. By expanding Slack’s potential exposure to the 165 million unregistered shares, as well as the 118 million registered shares, the 9th Circuit “more than doubles Slack’s Section 11 liability over a statutory maximum,” the brief said.
Shareholder lawyer Lawrence Eagels of Bragar Eagel & Squire, who won the case at the 9th Circuit, declined to comment, as did Slack counsel Michael Celio of Gibson Dunn.
Opinions expressed here are those of the author. Reuters News, under the Trust Principles, is committed to integrity, independence and freedom from bias.
Read more:
Slack direct listing investor can sue for misrepresentation - 9th Circuit
Slack urges 9th Circ to end shareholder suit over direct listing
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
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