Ninth Circuit Requires Traceability for Securities Act Claims Arising From Direct Listings

The U.S. Court of Appeals for the Ninth Circuit recently held that purchasers of shares sold to the public through a direct listing cannot sue under section 12(a)(2) of the Securities Act of 1933 unless they can trace their shares to an allegedly defective prospectus.  The decision in Pirani v. Slack Technologies, Inc. (Feb. 10, 2025) was issued after a remand by the U.S. Supreme Court, which had held in June 2023 that section 11 of the Securities Act requires plaintiffs to trace their purchased shares to an allegedly false or misleading registration statement and had remanded the case so the Ninth Circuit could reconsider the § 12(a)(2) claim.

The Supreme Court and Ninth Circuit decisions will likely increase the difficulty of pleading Securities Act claims arising from direct listings.  Disgruntled purchasers will be left only with claims under the Securities Exchange Act of 1934, which imposes stricter standards for liability. The two decisions thus could highlight the policy concern that the Ninth Circuit had raised in its first ruling in Slack:  the possibility that companies might choose to go public through direct listings rather than initial public offerings to avoid the risk of strict liability under the Securities Act, thereby undermining or eliminating Securities Act liability for false or misleading statements in public offerings.

Background

In 2018, the Securities and Exchange Commission began to allow certain companies to go public through direct listings.  As the Ninth Circuit explained, “[a] direct listing differs from an initial public offering in that the company does not issue any new shares; it simply lists already-issued shares so that existing shareholders can sell them on the exchange.”

In a traditional IPO, a company seeking to offer new shares files a registration statement and then sells the shares issued under that document.  Investment banks often underwrite the offering by agreeing to buy the shares at a predetermined price.  To ensure that the stock price remains stable for some period after the offering, underwriters usually require a “lock-up period” that restricts pre-IPO shareholders from selling their existing, unregistered shares for several months.  “Anyone purchasing shares on the stock exchange during the lock-up period can therefore be certain that the shares were issued under the registration statement.”

In a direct listing, a company files a registration statement to register pre-existing shares before they can be sold to the public.  The newly listed shares are sold directly to the public, without any underwriting – and without a lock-up period.  A direct listing thus makes both registered and unregistered shares available to the public as soon as the direct listing takes effect.

The Slack Case

Slack Technologies went public in 2019 through a direct listing.  Slack filed a registration statement and prospectus for a specified number of registered shares that it intended to offer.  Because the offering was a direct listing rather than an IPO, holders of pre-existing, unregistered shares could also sell their shares into the market.

Slack’s stock price subsequently declined, and a shareholder sued under §§ 11, 12(a)(2), and 15 of the Securities Act, alleging misrepresentations in the registration statement and prospectus for the direct listing.  The shareholder did not assert claims under the Exchange Act.

Section 11 applies to alleged misrepresentations or omissions in registration statements.  Section 12(a)(2) applies to alleged misrepresentations or omissions in prospectuses and in oral communications relating to a prospectus.  The Securities Act imposes strict liability on the issuer, while the Exchange Act requires proof of fraud.  But because the burden of proof is easier under the Securities Act, those claims are available only to plaintiffs who can trace their shares to an allegedly false or misleading registration statement or prospectus.

The Slack defendants moved to dismiss the complaint, contending that the plaintiff had not established that he had purchased registered shares issued pursuant to the registration statement and prospectus, rather than unregistered shares that had entered the market through the direct listing at the same time as the registered shares.  The District Court denied the motion to dismiss even though the plaintiff had conceded that he could not trace his shares to those issued under the registration statement and prospectus.  The Ninth Circuit – in a 2-1 decision – affirmed.

The Supreme Court unanimously vacated the Ninth Circuit’s ruling on the § 11 claim.  The Court held that § 11 authorizes suit only when the security at issue was issued pursuant to a registration statement alleged to have been false or misleading.  The Court focused on § 11(a)’s language:  “In case any part of the registration statement . . . 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 (emphasis added).  The Court conceded that this language was not entirely clear because the word “such” in the phrase “such security” lacks a clear referent.  But the Court concluded that “such security” must be a security issued under the challenged registration statement.

The Court remanded the case for further consideration of whether the plaintiff had sufficiently pled traceability under § 11 “as properly construed.”  The Court also directed the Ninth Circuit to reconsider its ruling on § 12(a)(2) in light of the Court’s construction of § 11.

Ninth Circuit Decision on Remand

The Ninth Circuit first held that the plaintiff had effectively conceded that he could not trace his share purchase to the allegedly defective registration statement.  Although the complaint had alleged without elaboration that the plaintiff and other class members had purchased shares “‘pursuant and/or traceable to’” the registration statement, the plaintiff’s “subsequent concessions expressly waived any allegation of traceability.”

In opposing defendants’ motion to dismiss, the plaintiff had argued that “‘the concept of “tracing” a share of stock . . . is a concept that no longer exists in today’s market and is not possible.’”  The litigation had proceeded on that basis, and the district court had concluded that the plaintiff’s “‘inability to trace [is] undisputed.’”  The Ninth Circuit held the plaintiff to his prior concessions and rejected his attempts to evade them.

The Ninth Circuit next held that the Supreme Court’s traceability requirement for § 11 applied as well to § 12(a)(2):  that section “requires tracing a plaintiff’s shares to an allegedly false or misleading prospectus.”  The court found the analysis even clearer under § 12(a)(2).  While § 11(a)’s use of the phrase “such security” arguably lacks a clear referent, a clear referent exists in § 12(a)(2), where “[t]he phrase ‘such security’ refers back to the ‘security’ that was offered or sold ‘by means of a prospectus or oral communication.’”  “Thus, a plaintiff can establish a section 12(a)(2) claim only by showing that the purchased shares were offered or sold by such means.”

Implications

The Slack decisions will likely increase the difficulty of pleading Securities Act claims for securities issued in direct listings because purchasers might not be able to establish that they purchased registered shares, rather than unregistered ones.  If they cannot plead and prove traceability, purchasers will be left with Exchange Act claims, which require proof of scienter, reliance, and loss causation.

Time will tell whether the strict traceability requirement will encourage issuers to go public through direct listings rather than through IPOs – as the Ninth Circuit majority had feared in its first opinion.  While the potential for the reduced liability risk of a direct listing might be attractive, companies hoping to raise significant amounts of new capital might still view the traditional IPO route as more realistic from a business perspective.

It is tempting to speculate whether the Ninth Circuit might have taken a different view of the Slack plaintiff’s complaint at the pleading stage had the plaintiff not subsequently undercut the complaint’s allegations that the shares had been purchased “‘pursuant and/or traceable to’” the registration statement and prospectus.  The court observed that, “[if] that were all [the plaintiff had] said, we would have [had] to decide whether his allegation was sufficient to make the conclusion of traceability a plausible one” under operative pleading standards, which require only that a pleading “‘state a claim to relief that is plausible on its face’” to survive a motion to dismiss.  One wonders whether the complaint would have had a better chance of surviving at the pleading stage had the plaintiff not attacked the continuing viability of traceability and effectively conceded his inability to trace.

But even if the plaintiff might have increased his odds of surviving the first round, he likely would have been knocked out at a later stage in light of the difficulty of tracing shares in a direct listing and the Ninth Circuit’s rejection of his argument for “statistical tracing” based on the number of registered and unregistered shares trading at the time of the plaintiff’s purchase.  The court noted that the Fifth Circuit had also rejected the concept of “statistical tracing” for § 11 claims.  Tracing shares to a challenged registration statement or prospectus will likely remain a formidable hurdle in a direct listing.