U.S. Supreme Court upholds tracing requirement for Securities Act Section 11 claims

Slack restores traditional approach to Section 11 standing, makes claims against direct listings more difficult

In a decision restoring a key limitation on U.S. securities law liability, the U.S. Supreme Court has confirmed that plaintiffs must plead and prove that they purchased securities under a materially misleading registration statement in order to have standing to bring a claim under Section 11 of the U.S. Securities Act of 1933 (the “Securities Act”). 

The Slack v. Pirani decision resolved a circuit split by vacating the Ninth Circuit’s 2021 holding that plaintiffs do not need to “trace” their shares back to a registration statement in a direct listing where registered and unregistered shares were publicly tradeable at the same time, in order to have standing under Section 11. The Ninth Circuit’s rejection of the longstanding tracing requirement had raised concerns about the effect on direct listings but also about the potential for expanded Section 11 liability for securities offerings in general. 

The claims were made in connection with Slack’s direct listing on the NYSE, which involved a listing but not an underwritten offering. The plaintiff bought 30,000 Slack shares on the day Slack listed, and additional shares over the next few months. He sued the company and other defendants under Section 11 and Section 12(a)(2) of the Securities Act, alleging that the registration statement contained material misrepresentations and omissions.

The defendants argued that the plaintiffs did not have standing under Section 11 because the purchased shares must be traced to the defective registration statement, a difficult undertaking when unregistered and registered securities become publicly tradeable simultaneously. By contrast, in a traditional IPO, the registered shares would be sold first, and the unregistered shares would become available for sale after the lockup period, making it easy to distinguish which shares came from the registration statement. 

The Ninth Circuit held that because the Slack listing only involved one registration statement, it did not present the traceability problem of successive registrations and thus any securities purchased after the effective date are within the reach of Section 11. The Ninth Circuit followed a similar analysis to find that the plaintiffs had standing to sue under Section 12(a)(2). 

The Supreme Court unanimously rejected the Ninth Circuit’s analysis, upholding as a “better” reading of the law the traditional approach that Section 11 only covers securities that are registered under the specific registration statement on which the plaintiff has sued. Thus, to bring a claim under Section 11, the securities held by the plaintiff must be traceable to the particular registration statement alleged to be false or misleading. The court vacated the Ninth Circuit’s judgment and remanded the Section 11 issue to the appellate court to determine whether the plaintiff’s allegations satisfy the tracing requirement as construed by the Supreme Court. 

The court declined, however, to reach the merits of the Section 12(a)(2) claim, noting in a footnote that the Ninth Circuit had allowed the Section 12(a)(2) claim to proceed based on its analysis of Section 11. Consequently, the Supreme Court decided to vacate the Ninth Circuit’s judgment with respect to the Section 12(a)(2) claim for reconsideration in light of the Supreme Court’s Section 11 holding. In doing so, the Supreme Court did not express any views about the interpretation of Section 12(a)(2) or its application to the case. It also expressly refused to endorse the Ninth Circuit’s belief that Section 11 and Section 12 “necessarily travel together,” instead cautioning that “the two provisions contain distinct language that warrants careful consideration.”

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For issuers in general, and not just those who have engaged in direct listings, Slack v. Pirani provides important certainty as to the limits on liability in connection with Section 11 claims. The Ninth Circuit ruling had upended decades of understanding that standing for Section 11 claims is limited to those who purchased securities under the misleading registration statement. Not only would the Ninth Circuit ruling have expanded the number of potential plaintiffs, it could also have significantly expanded the liability cap. As the Supreme Court noted, Section 11(e) caps damages against an underwriter in a Section 11 suit to the maximum available recovery to the value of the registered shares alone. If Section 11 liability extended beyond registered shares, presumably available damages would have as well.

What does the decision mean for direct listings? Certainly, it will be more difficult to bring Section 11 claims in connection with direct listings. A number of court cases have already rejected the use of statistical evidence to prove tracing, and it is not clear what approach plaintiffs will try next to demonstrate standing. Under the decision, however, the door still remains open to Section 12(a)(2) claims in connection with direct listings, and like Section 11, Section 12(a)(2) imposes liability without requiring proof of either fraud or reliance. But a 1995 Supreme Court decision limiting Section 12(a)(2) liability may provide a basis for dismissing or limiting such claims in connection with direct listings. 

Plaintiffs also have the option of making claims based on Rule 10b-5 under the U.S. Securities Exchange Act of 1934, but Rule 10b-5 requires proof of reliance on the misleading statement or omission, as well as scienter.  

We will continue to monitor developments in this area and welcome any queries you may have.