Supreme Court Case Could Turn Public Offerings Upside-Down

A relatively uncommon type of public offering called a “direct listing” could become a popular way for companies to go public-or could go extinct, depending on the outcome of a Supreme Court case, securities law experts said.

The high court will hear arguments on Monday in Slack vs. Pirani, a complex securities law case that will decide how easy it will be for investors to sue companies over alleged misstatements or omissions in their registration statements during direct listings. 

A direct listing is a way for companies to go public with less red tape than a traditional initial public offering. Instead of creating new shares and having a bank underwrite them, as in a traditional IPO, a direct listing lets management, employees and private investors sell their existing shares on the public market.

Authorized by the Securities and Exchange Commission in 2018 to encourage more companies to go public and reverse a trend of businesses staying privately owned, direct listings haven't flourished. As of last December, there had only been 11 significant direct listing offerings, Bloomberg reported. 

The case hinges on whether Fiyyaz Pirani, a California investor, has “standing,” or the right to sue Slack, the communications company that went public via direct listing in 2019. 

License and Registration, Please

The Supreme Court won’t decide whether Slack actually did anything wrong, just whether lead plaintiff Pirani, who bought shares in Slack’s direct listing, can have his day in court. The court will judge the merits of the case: Whether Slack misrepresented its service disruption policies and other details about its business in the registration statement it filed in connection with its direct listing.

The case hinges on whether that registration statement—a document of legally required disclosures that are supposed to inform potential investors about the risks involved in buying a stock—actually applies to the 250,000 Slack shares that Pirani bought on the day of the direct listing and the following months. 

SEC rules require that certain shares must be sold accompanied by a registration statement, and others are exempt and can go “unregistered.” The trouble is that on the day of its direct listing, Slack shareholders sold a mix of both registered and unregistered securities into the market—118 million were registered and 165 million weren't.

Determining months later which shares are registered and which aren't is almost impossible because of advances in trading technology, said Anat Alon-Beck, a professor of corporate law, and John Livingstone, recently a research fellow, both at Case Western Reserve University.

“You would think that the record-keeping would be better and you would be able to trace much more easily,” Livingstone said. “But the shares are changing hands so rapidly and going through so many shares and are on such a fractional basis, that it's nearly impossible to trace literally hundreds of millions of shares, down to fractional levels, dispersed over tens of thousands of clients.”

Lower courts ruled that because the registered and unregistered shares are functionally identical and were offered at the same time, Pirani is allowed to sue over the registration statement.

The Supreme Court’s ruling is likely to have major implications for direct listings in the future, and is likely being closely watched by companies now considering whether to go public, Beck said.  If it rules in favor of Slack, it could make it nearly impossible for investors to sue over misleading registration statements, making them an appealing option for companies, including those that might intentionally mislead investors.

“You're going to find that companies are flooding to direct listings for the wrong reasons,” Beck said.

If they rule completely in favor of Pirani, companies would find themselves exposed to more legal liability than they had bargained for from direct listings.

“It’s going to kill direct listings,” Beck said.

Beck and Livingstone said the conservative ideological makeup of the court gives Slack an advantage.

There are risks with either approach, Beck said. A ruling completely in favor of Slack could hurt financial markets by undermining the confidence that investors have in the U.S. legal system—that if they are defrauded in a transaction, they have the option of suing. On the other hand, ruling in favor of Pirani would discourage direct listings and lead more companies to stay private.