Direct Listings and the Tracing Doctrine: Pirani v. SlackPosted on Mar 14, 2022
On June 20, 2019, Slack Technologies, LLC (“Slack”), a business software company, went public through a direct listing of its stock on the New York Stock Exchange (“NYSE”). In September 2021, the U.S. Court of Appeals for the Ninth Circuit in Pirani v. Slack Technologies became the first circuit to have a say on whether an investor who purchases securities in a direct listing can establish standing to bring claims under Section 11 of the Securities Act of 1933. Before Slack, it had been difficult, if not impossible, for a plaintiff to “trace” their shares to a company’s registration statement in a direct listing, which meant that the plaintiff could not show standing under Section 11.However, the Ninth Circuit shocked the legal community when it held that the plaintiff had standing under Section 11, contradicting decades of precedent.
II. Background on Direct Listings
In a direct listing, a company goes public by listing its stock on an exchange, which enables insiders and early investors to sell their holdings to the public. There are several key differences between the traditional initial public offering (“IPO”) and a direct listing. First, a company conducting a direct listing does not issue new shares to raise capital, which is the principal aim of an IPO. Second, in IPOs, investors agree to a lock-up period in which they agree not to sell their shares for a specified period following the IPO. In direct listings, existing shareholders are not subject to lock-up periods, meaning that shareholders can sell their stock immediately after the direct listing becomes effective.
III. Pirani v. Slack Technologies
A. Slack’s Factual History
When Slack went public, its shares began trading on the NYSE under the ticker symbol “WORK.” In preparing for the direct listing, Slack filed two registration forms with the Securities and Exchange Commission (“SEC”), which constituted its “offering materials.”
For a shareholder to normally sell securities on a public market, those securities must be registered with the SEC. Because no new shares are issued in a direct listing, insiders holding preexisting shares are not subject to a lock-up period and can sell their shares immediately under the relevant registration statement. However, Securities Act Rule 144 provides certain exemptions to this general rule and allows the sale of unregistered securities if the seller meets five conditions. Rule 144 plays a critical role in direct listings and in Slack. In Slack’s direct listing, only 42% or 118,429,640 of its outstanding shares were registered pursuant to the registration statement, while the remaining 58% or 164,932,646 shares were exempt from registration under Rule 144. Thus, after its direct listing, the market for Slack’s shares included a mix of both registered and unregistered shares, which complicates an investor’s ability to establish standing under Section 11 because it is difficult to know whether his or her shares are registered or unregistered ones.
On the day Slack went public, Fiyyaz Pirani (the “plaintiff”) purchased 30,000 shares of Slack’s Class A common stock at $40/share, and from June 21 to September 9, he bought approximately another 220,000 shares.Pirani sued Slack in a securities class action and alleged that he and other investors in the same class suffered losses to the value of their shares due to misstatements or omissions of material facts within Slack’s offering materials.Specifically, Pirani identified statements “regarding service outages and Slack’s Service Level Agreements (“SLAs”) in the case of such outages; competition from Microsoft Teams; scalability and purported key benefits; and growth and growth strategy.”
In his complaint, Pirani asserted claims under Section 11, Section 12(a)(2), and Section 15, and the defendants moved to dismiss all claims. This article focuses solely on the Section 11 claim because the ruling on this issue is the primary one raised on appeal.
B. Section 11 and the Tracing Requirement
Irrespective of the method used to go public, a company can incur liability for wrongdoing, and companies are subject to several generic anti-fraud provisions, including Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act. A plaintiff’s most useful liability provision in the “going public” context is Section 11 of the Securities Act since it imposes strict liability for material misstatements or omissions made in offering documents. To balance the imposition of strict liability, Congress and the courts developed the tracing requirement, which forces plaintiffs to “establish standing by showing that their shares were traceable to the challenged registration statement.” The tracing requirement ensures that only investors who bought shares from the challenged registration statement can sue.
The Second Circuit in Barnes v. Osofsky was the first court to interpret the phrase “acquiring such security,” and Judge Henry Friendly weighed two readings—a narrow and a broad view—of the phrase. The narrow reading defined the phrase as “acquiring a security issued pursuant to the registration statement,” while the broad reading defined it as “acquiring a security of the same nature as that issued pursuant to the registration statement.”Ultimately, Judge Friendly adopted the narrow reading based on the overall statutory scheme, language from the legislative history, dicta from within the Second Circuit, and an amicus brief from the SEC. Following Barnes, other circuits including the Ninth Circuit adopted the narrow reading.
C. Judge Restani’s Majority Opinion
The issue in Slack was whether Pirani could “trace” his purchased shares to Slack’s registration statement. As Part III.A explained, tracing is difficult to prove since after Slack’s direct listing, there was a mixed market of both registered and unregistered securities. Thus, Pirani had no way of knowing whether his shares were registered ones under Slack’s direct listing or unregistered ones exempt from registration.
Judge Jane Restani, writing for the Ninth Circuit, held the plaintiff had standing under Section 11. Unlike the district court, she did not focus her analysis of “acquiring such security” by looking at legal precedent. Instead, she analyzed NYSE Section 102.01B, Footnote E, the regulatory change that allowed companies to perform a direct listing. In her view, the NYSE rule requires a company to file a registration statement to perform a direct listing, and this same registration statement allows it to sell registered and unregistered shares. Thus, she found that “Slack’s unregistered shares 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.”
Judge Restani justified a departure from the narrow reading of “acquiring such security” because such an interpretation would undermine the purpose of Section 11. Under that view, companies would be incentivized to choose a direct listing over an IPO simply from a liability standpoint, which would allow them to file “overly optimistic” registration statements since they know that “they would face no shareholder liability under Section 11 for any arguably false or misleading statements.”
IV. Roadmap to Certiorari and Recommendations
As expected, the legal community was shocked at Judge Restani’s majority opinion. It is believed that Slack warrants the Supreme Court’s review and reversal because the Ninth Circuit’s ruling “disrupts decades of predictable, well-established jurisprudence” and departs from other circuits’ precedent.
Ultimately, the Slack decision and the majority’s interpretation of “acquiring such security” likely misunderstands Rule 144 and expands liability for direct listings, creates inconsistencies within Section 11 including in the calculation of damages, and conflicts with other circuits’ interpretations of the phrase. However, if the Supreme Court were to reverse Slack, such a decision could threaten the adequacy of investor protections in direct listings. Reversing Slack would effectively prevent investors from bringing Section 11 claims because it is impossible to trace shares in a direct listing and prove standing. Thus, neither result—upholding nor reversing Slack—is desirable.
This analysis shows that courts are perhaps unequipped to fix the tracing requirement as applied to direct listings. Thus, until the Supreme Court hears the case, the SEC should investigate ways to make tracing possible in direct listings. For example, the SEC could require corporations to implement blockchain technology in their stock ledgers. If done correctly, a share of stock would have an encrypted record of its ownership history on the blockchain, and stockholders could use this record to determine where their shares came from, which could be used as evidence to establish standing under Section 11. However, given the complexity of blockchain, more research must be done before the SEC can issue regulations requiring it.
 Maureen Farrell, Slack is Second to File for Direct IPO, The Wall Street Journal (Feb. 5, 2019), https://www.wsj.com/articles/slack-files-confidentially-to-go-public-with-direct-listing-11549301336 [https://perma.cc/RDD8-MGBL].
 Grabar et al., Cleary Gottlieb Discusses How Court Allowed Securities Liability for Slack’s Direct Listing, The CLS Blue Sky Blog (May 4, 2020), https://clsbluesky.law.columbia.edu/2020/05/04/cleary-gottlieb-discusses-how-court-allowed-securities-liability-for-slacks-direct-listing/ [https://perma.cc/PZ8T-M9SF].
 Brent J. Horton, Spotify’s Direct Listing: Is it a Recipe for Gatekeeper Failure?, 72 SMU L. Rev. 178, 182 (2019). An average company can raise $100 million, but some companies like Snap, Inc. raised $3.4 billion in its IPO. Id.
 The Rise of Direct Listings: Understanding the Trend, Separating Fact from Fiction, Fenwick (Dec. 5, 2019), https://www.fenwick.com/insights/publications/the-rise-of-direct-listings-understanding-the-trend-separating-fact-from-fiction [https://perma.cc/UHP2-X9QF] [hereinafter The Rise of Direct Listings].
 Pirani v. Slack Technologies, Inc., 445 F. Supp.3d 367, 372 (N.D. Cal. 2020).
 Id. at 373.
 See Rule 144: Everything You Need to Know, upcounsel, https://www.upcounsel.com/rule-144 [https://perma.cc/G844-FAZL] (last updated Oct. 5, 2020).
 See id.
 McConville et al, Slack’s Direct Listing Tests Limits of Securities Act, Law360 (Dec. 10, 2019), https://www.labaton.com/hubfs/Law360%20-%20Slacks%20Direct%20Listing%20Tests%20Limits%20Of%20Securities%20Act.pdf [https://perma.cc/NB6S-EPCE].
 Pirani, 445 F.3d at 373.
 Id. at 373.
 Id. at 373.
 15 U.S.C. § 77k(a).
 The Rise of Direct Listings, supra note 5.
 Barnes v. Osofsky, 373 F.2d 269, 271 (2d. Cir. 1967).
 Id. at 271.
 Id. at 271.
 See id. at 272-274.
 See Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999) (citing Barnes, 373 F.2d 269).
 Pirani v. Slack Technologies, Inc., 13 F.4th 940, 947 (9th Cir. 2021).
 Id. at 947.
 Id. at 947.
 Id. at 947.
 Id. at 948.
 Id. at 948.
 See Feldman et al., Ninth Circuit on Strict Liability for Direct Listings, Harvard Law School Forum on Corporate Governance (Oct. 14, 2021), https://corpgov.law.harvard.edu/2021/10/14/ninth-circuit-on-strict-liability-for-direct-listings/ [https://perma.cc/9DEL-8Y2X]. “Slack represents a significant departure in the imposition of strict liability in securities regulation. . .We believe this decision warrants reversal by the Supreme Court.” Id.
 See id.
 Pirani, 13 F.4th at 948.
 A stock ledger is a type of ledger that shows all transactions in a corporation’s stock including information on the date of the transaction, the number of shares acquired, and more. J. Travis Laster & Marcel T. Rosner, Distributed Stock Ledgers and Delaware Law, 73 Bus. Law. 319, 325 (2018).
 Id. at 326.