The Ninth Circuit’s Threat to Direct Listings

Alternatives to traditional IPOs have brought new companies to the public markets that may have otherwise chosen to stay private. Direct listings—through which an issuer lists directly with an exchange to make a company’s existing shares available for public trading—is one such innovation. Direct listings reward early employees and investors for their start‐​up contributions, while avoiding many of the high costs of an IPO. The Ninth Circuit’s ruling in Pirani v. Slack threatens the viability of direct listings by undoing one of the longest standing precedents in federal securities caselaw and subjecting direct listings to liability under Section 11 of the Securities Act of 1933 without requiring a claimant to “trace” his shares to a registration statement.To reduce the incidence of even unintentional falsehoods in a registration statement, Section 11 holds issuers strictly liable for misstatements or omissions in a securities offering’s registration statement. But to prevent this demanding liability standard from chilling innocent market activity, Section 11 requires a claimant to prove that the shares they purchased were those offered in the registration statement. For decades, courts in every circuit have held firm to Judge Henry Friendly’s ruling in Barnes v. Osofsky (1967) that in order to sue under Section 11 for misstatements or omissions in a registration statement, a claimant must be able to “trace” their shares to the allegedly faulty statement. Tracing is always a mighty task—even for a traditional IPO—but the challenges are greater for a direct listing, where registered and unregistered shares trade together from day one. The Ninth Circuit, reaching beyond Section 11’s text and legislative history, jettisoned the tracing requirement when shares are brought to market through a direct listing.The Cato Institute has filed this amicus brief in support of Slack’s effort to have a rehearing (ideally en banc—that is, by a panel composed of all circuit judges) of the 2–1 panel’s erroneous, and economically dangerous, decision. Before any damage can be done to securities markets, it is imperative that the Ninth Circuit align itself with Judge Friendly’s interpretation of Section 11, as have its counterpart courts across the country.The text of Section 11 clearly states that standing is limited to “any person acquiring such security.” The legislative history of the Securities Act further proves the tracing requirement is integral to the Act’s purpose of disclosure to the extent necessary to enable investors to engage in educated speculation. The direct listing should be allowed to sink or swim within the existing regulatory environment, with investors presumably pricing the risk of losing standing into their purchase of shares in a directly listed company. Instead, the Ninth Circuit panel substituted its policy judgment for Congress’s, reading the Act to chill innocuous transactions simply because not doing so seems unfair. That is the danger here.The Ninth Circuit should rehear and reverse its panel’s elimination of tracing for direct listings. Absent legislative amendment (which Congress has avoided despite several opportunities), it is beyond the courts’ authority to rewrite Section 11 simply because an offering type comes along which makes it more difficult than usual for shareholders to recover.