Supreme Court’s Recent Slack Technologies Decision
foreign [Music] [Applause] [Music] welcome to snc's podcast series snc critical insights my name is Jeff Scott I'm co-lead of the firm Securities litigation practice I'm joined today by Julia malkina my partner and fellow co-lead of the firm Securities litigation practice today we'll discuss the Supreme Court's recent decision in the slack case and the potential important implications for Securities litigation let's get started Julia why don't you give our listeners a brief overview of what we'll discuss today I would be glad to Jeff on June 1st the Supreme Court handed down its decision in a case called black Technologies LLC versus Perani the court heard oral argument in slack on April 17th the issue before the court was whether section 11 of the Securities Act of 1933 requires plaintiffs to plead and prove that they purchase Securities registered under the registration statement they allege is materially false or misleading today we will first discuss the background of the slot case and some highlights from oral argument before The Supreme Court then we will discuss the Court's ruling and finally consider the case's implications moving forward let's start with some background Jeff what do we need to know to understand the question sloth presents Julia we should first start with a little background on the Securities Act of 1933. the 1933 act generally prohibits offering or selling a security to the public that is not registered under a registration statement filed with the SEC unless there is an exemption from registration registration statements typically provide a host of information about the company whose Securities are being offered or sold now investors May rely on that information when purchasing a company's securities section 11 of the 1933 act creates a private right of action if a registration statement contains a material misstatement or omission section 12 in turn creates a private right of action against a person who offers or sells the security to the public by means of a false or misleading prospectus or oral communication for our purposes the important feature of section 11 is that the private right of action is available only to a person acquiring such security the key phrase is such security ordinarily the word such refers back to something else that's already been mentioned for Section 11 however it is not Crystal Clear what the words such in such security refers back to the core issue and slack therefore is whether the phrase such security refers to a security registered under the allegedly false or misleading registration statement or whether it refers to unregistered Securities as well like section 11 section 12 of the 1933 act also uses the phrase such security the same question therefore arguably arises that said the language of the two Provisions differs in certain other respects Jeff Howell courts prior to slack interpreted the phrase such security as used in section 11. well Julia the second circuit first interpreted the phrase such Security in section 11 in a case called Barnes versus osavsky in 1967. judge friendly reasoned that the phrase gave rise to two possible competing interpretations the first more narrow interpretation was that such security meant a security issued pursuant to the allegedly false or misleading registration statement the second broader interpretation was that such security included a security of the same nature as that issued pursuant to the registration statement judge friendly concluded that the more narrow interpretation is in his words the more natural meaning of the words based on the statutory scheme the legislative history and other sources now during the next 50 years every court of appeals to consider this issue of statutory interpretation reached the same conclusion as judge friendly including the first 5th 8th 9th 10th and 11th circuits as a result up until the slack case for a plane of the half standing to sue under Section 11 the Securities purchased by the plaintiff had to be traceable to the particular registration statement alleged to be false or misleading now Julia can you explain to our listeners the significance of this tracing rule when companies go public glad to Jeff typically when a company goes public IT issues new Securities pursuant to a registration statement as part of an initial public offering or IPO investment Banks underwrite the offering Often by buying the new registered Securities at a fixed price and then selling them to investors at a higher price existing shareholders whether they be early investors or employees the company are able to sell their pre-existing Securities to the public in addition to the new security it's being issued but if all of the company's pre-existing Securities and its new Securities are sold at the same time the sheer volume of Securities being sold might dilute the market and cause the price of those Securities to fall for that reason Julia when a company goes public through an IPO the underwriter typically negotiates what's called a lock-up period during which persons who hold pre-existing securities which are often exempt from registration agree not to sell those securities for a fixed period of time as a result only the company's new registered Securities are sold during the lock-up period this is important for the section 11 tracing rule generally speaking most Securities trading is done through Brokers however for various reasons Brokers generally do not keep track of whether particular Securities are registered or unregistered thus ordinarily if registered in unregistered Securities are sold at the same time a section 11 plaintiff could find it difficult if not impossible to plead and prove that the Securities they purchased were registered because of the such security language in section 11 that evidentiary issue could mean that the plaintiff cannot prove standing to sue under Section 11.
in a typical IPO the lockup period helps plaintiffs in this regard because until the lockup expiration or other events such as a secondary offering all shares trading will typically have been issued pursuant to the IPO registration statement now Julia can you give a bit of background on how recent rule changes have affected the State of Affairs in this area of the case law although most companies have historically gone public through an IPO in 2018 the SEC approved a new method by which a company Securities can start being publicly traded on the New York Stock Exchange this new method is known as a direct listing through direct listing a company files a registration statement with the SEC and is then permitted to sell shares on the exchange importantly a direct listing does not require an underwriter and generally does not involve a lock-up agreement this means the company's existing shareholders can sell their unregistered Securities on the first day of public trading at the same time as the company's registered Shares are sold direct listings that are potentially significant implications for plaintiff's ability to plead improve standing to sue under Section 11. Jeff can you give a bit of background on how the slot case got to the Supreme Court of course Julia on June 20th 2019 slack used a direct listing to go public the sale involved placing millions of shares into the market with roughly 58 of them being unregistered the plaintiff Mr Perani purchased 250 000 shares of slack on the first day of the offering and over the next several months during that time period the price of slack share has decreased from an initial price of 38.50 eventually dropping below 25 dollars per share in September 2019 the plaintiff filed a putative class action in California District Court under sections 11 and 12 alleging that Slack's registration statement was false and misleading because it purportedly omitted information about Slack's business and downplayed competition slack faced in January 2020 slack moved to dismiss arguing among other things the plaint of lack standing the Sue because he could not prove that the shares he purchased were registered under the allegedly misleading registration statement in October 2020 The District Court denied Slack's Motion in part reasoning that the unique circumstance of a direct listing in which registered chairs and unregistered Shares are sold simultaneously warranted adopting the broad interpretation of the phrase such Security in section 11 that judge friendly in the Barnes case in 1967 had rejected a divided ninth circuit panel affirmed on interlocutory appeal in September 2021 the majority opinion seized on the fact that all shares offered for sale through a direct listing whether those Shares are registered or unregistered can only be offered for sale upon the filing of an effective registration statement accordingly the majority held that Perani shares can be traced to Sox registration statement and should therefore constitute such security under Section 11. the ninth circuit decision
created a split of authority among courts of appeals regarding the scope of section 11. the ninth circuit majority also held that because Perani had sanding the Sioux under Section 11 it followed that he also expanding the Sioux under Section 12. in the sun judge Eric Miller would have reversed the district court and remanded with instructions to Grant facts motion to dismiss in judge Miller's view the interpretation of sections 11 and 12 has been settled for decades with the phrase such Security in section 11 requiring that a point of security have been issued under the allegedly false or misleading registration statement that settled interpretation he wrote ought to resolve the case in Slack's favor since pirani cannot prove that his shares were registered for section 12 judge Miller wrote that it's text unambiguously requires a plaintiff to purchased a registered security to a standing meaning Perani may not bring a section 12 claim as well the petition for a redistration to the Supreme Court which the court granted on December 13 2022. Jeff can you share some of the highlights from the Supreme Court oral argument absolutely Julia the slack was argued before The Supreme Court on April 17th of this year overall the justices questions and comments suggested that the court would reject the ninth circuit section 11 ruling as was widely expected by the defense bar Justice Kavanaugh for example commented that to affirm the ninth circuit ruling we would have to depart on Section 11 from a lot of law starting with judge friendly that's been around for a long time likewise chief justice Roberts characterized the reference in section 11 to such security as a quote big hurdle for plane of the get over end quote well Justice Kagan suggested that the plaintiff has quote A Hard Road a hoe here end quote that said it was less clear how the court would rule understanding issue for section 12. Justice Kavanaugh for
example stated that he was quote a bit concerned about deciding the section 12 issue without the SEC weighing in without more law out there and without knowing more about that issue he asked why the court shouldn't just allow Galore courts to sort out the section 12 issue before the Court gives a definitive ruling on it in the same vein just as Gorsuch aflac's Council whether the sky would fall if the court were to answer the section 11 question Slack's favor wake it and reman without addressing the section 12 question Justice kagan's questions and comments however suggested that she might think there are quote key differences between the language of sections 11 and 12. Jeff how did the Supreme Court ultimately rule on these issues well Julia the Supreme Court unanimously reversed the nine circuits decision and held that section 11 of the 1933 act requires plaintiffs to plead and prove that he purchased Securities registered under the registration statement that he alleged was materially false and misleading in addition the Supreme Court declined to interpret section 12 of the 1933 Act vacating the nine circuits judgment as the plaintiff section 12 claim for reconsideration in light of the Supreme Court's decision while cautioning that the two Provisions contain distinct language that warns careful consideration in doing so the court noted that it was expressing no views about the proper interpretation of section 12 or its application to the case Julia can you explain to our listeners how the court reached its conclusion on the section 11 issue because the court concluded that section 11 can telling us what the phrase such security means the court looked to the contexts and circumstances in doing so the court identified several contextual Clues first section 11 imposes liability for false statements or misleading omissions in the registration statement it uses the definite article the to reference the particular registration statement alleged to be misleading it therefore seems to suggest that the plaintiff must acquire such security under that document's terms second section 11 repeatedly uses the word such for example it speaks of such part of the registration statement containing a misstatement or misleading omission and such untruth or remission found in the registration statement these other uses of the word such suggest that the phrase such security refers to a security registered under the particular registration statement alleged to contain a falsehood or misleading omission third other sections of the 1933 act suggests the phrase such security refers to registered Securities for example section 11e caps damages against an underwriter in a section 11 suit to the total price at which the Securities underwritten by him and distributed to the public were offered to the public it thereby ties the maximum available recovery to the value of the registered Securities alone which would make little sense if section 11 liability extended to unregistered Securities as well collectively these contextual Clues persuaded the court that slacks interpretation of section 11 was the better one I agree with that Julia the court declined to endorse plain as broader interpretation because he failed to explain what the limits of his interpretation would be how those limits could be derived from section 11 and more generally how to square his interpretation with the various contextual Clues suggesting that liability runs with registered shares alone moreover the court rejected plaintiff's policy-based argument that adopting a broader interpretation of the phrase such Security in section 11 would expand liability for falsehoods and misleading omissions thereby better accomplishing the purpose of the 1933 Act in the Court's view plaina's account of the Law's purpose is not altogether obvious rather the 1933 act according to the court is limited in scope it imposes strict liability on issuers for material falsehoods or misleading omissions in a registration statement in contrast section 10B of the Securities Exchange Act of 1934 and SEC rule 10 B5 allows suits involving any sale of the security whether under a registration statement or not but only with proof of sienter the Court held that this design suggests that Congress may have sought to create in their words a balanced liability regime allowing a narrow class of claims to proceed on lesser proof under Section 11 but requiring a higher standard of proof to sustain a broader set of claims under the 1934 Act a narrow interpretation of the phrase such Security in section 11 which had prevailed since Judge Friendly's Barn's decision in 1967 thus would better accomplish the 1933 acts purpose Julia what are some of the implications of the ruling on Section 11 first and foremost the ruling is a win for Securities litigation defendants it reaffirms the long-standing interpretation of section 11 requiring section 11 plaintiffs to plead and prove that their Securities were registered under the registration statement they claim is false or misleading this is a potentially powerful defense in section 11 cases arising from a direct listing as we've discussed broker's current practices mean that plaintiffs may face insurmountable barriers in attempting to trace their Securities to a registration statement in a direct listing were both registered and unregistered Securities were offered for sale on the first day of public Trading that said plaintiffs who cannot prove that their shares were registered under the allegedly false or misleading registration statement may still seek to bring claims under Section 10B of the 1934 act although they will need to plead and prove cyan chart among other elements companies should therefore remain Vigilant in ensuring the accuracy of their public statements relating to direct listing including in registration statements Julie I think it is also important to note that direct listings at least as we sit here today remain rare since 2018 little more than a dozen companies have entered the public market by way of a direct listing conversely there were nearly three dozen IPOs conducted in the first quarter of 2023 alone even though it is widely known that the IPO Market has been quite tepid as a result at this point the universe of plaintiffs and defendants that could be affected by the Court's decision remains Limited now that said Julia the Court's decision could potentially encourage more companies to go public through a direct listing in the future because it confirms that companies choose to go public by direct listing of both registered and unregistered shares have stronger defenses against section 11 liability than do companies who go public by traditional IPOs finally the Court's ruling on Section 11 May encourage legislative efforts to improve tracking of the ownership and registration of Securities including through the use of blockchain Technology these efforts might build off of laws like sections 219 and 224 of Delaware's General Corporation law which permit companies in that state to maintain stock ledgers using blockchain technology by implementing such technology which could potentially track the full ownership history of individual securities it could become much easier to prove whether a plane of Securities were registered or not Julia what are some implications of the Court's ruling on section 12. it remains to be seen Jeff whether courts will interpret the phrase such Security in section 12. in the same way the Supreme Court interpreted that phrase in section 11. oral argument before The Supreme Court suggested that some justices notably Justice Kagan might think that section 12 could be interpreted differently but the Court's discussion of congress's possible intent to create a balanced liability regime may suggest that section 12 which imposes strict liability like section 11 ought to be narrowly interpreted other questions at oral argument also followed in that same vein in the meantime defendants facing section 12 Claims can seek to dismiss such claims where pointers fail to plead that the Securities they purchased are traceable to the registration statement alleged to be false or misleading great thank you so much Julia well that's all we have for today thank you for joining me and Julia for this installment of snc's critical insights for more information about our practice please visit us on the web at www.soulcrom.com thank you [Applause] [Music]