Confusion and Uncertainty about the Section 12(a)(2) Claim at Slack Oral Argument

The Supreme Court recently held oral argument in Slack Techs., LLC v. Pirani (No. 22-200) to consider whether a buyer of securities in a direct listing needed to prove that he bought shares covered by an allegedly misleading registration statement to be a proper plaintiff under either section 11 or 12(a)(2) of the Securities Act. The case was mainly about the “tracing” requirement of section 11, but the oral argument unexpectedly spent an inordinate amount of time on section 12.

The Slack direct listing used a registration statement to authorize 118 million shares to trade on a stock exchange. Trading on the exchange eased the way for 165 million additional shares to be sold freely under an exemption from the registration requirement in section 4 of the Securities Act and an SEC rule. Buyers of Slack shares on the exchange such as Pirani asserted claims for misstatements against the company under sections 11 and 12(a)(2) but did not know whether purchased shares were covered by the registration statement or were not registered.

The defendant company argued that a plaintiff could not use a cause of action under either section 11 or 12(a)(2) unless the plaintiff could prove that purchased shares were covered by the registration statement. Section 11 applies to misstatements in an effective registration statement, which includes a prospectus, and section 12 applies to misstatements in a sale “by means of a prospectus or oral communication.” The plaintiffs argued that they were proper plaintiffs for both claims because the registration statement and accompanying prospectus were the offering materials that allowed the sale of both registered and unregistered shares to the public.

The questions and answers at the oral argument revealed confusion and uncertainty about section 12(a)(2) and one of its main precedents, Gustafson v. Alloyd Co., 513 U.S. 561 (1995). The purpose of this post is to dispel some of the fog and suggest that Gustafson answers some but not all of the questions the justices had.

1. Justice Sotomayor wondered why section 12 did not apply to sales exempted from registration by section 4 (Tr. 9). Similarly, Justice Kagan said section 12 does not refer to registration (Tr. 16, 37).

Gustafson answered this question. The plaintiffs in that case alleged that the defendants used misstatements in a share purchase contract to sell shares in a private transaction exempt from registration by section 4. The question for the Court was whether the stock purchase agreement met the requirement in section 12 for a sale by means of a prospectus. The Court considered the broad definition of prospectus in section 2(a)(10), which is a writing that offers a security for sale, or the narrower conception of a section 10 prospectus that contains the information in a registration statement. The majority reasoned that the word prospectus in section 12 must have the section 10 meaning of a prospectus for a registration statement. The majority held that the word prospectus in section 12 relates to public offerings by issuers and their controlling shareholders and concluded that the stock purchase agreement was not a section 10 prospectus and hence did not incur liability under section 12(a)(2).

The reasoning and conclusion in Gustafson strongly favor the defendant company’s position in the Slack case. A claim under section 12(a)(2) must rely on a prospectus in a registered public offer, and general effects on the share price in the market from a contemporaneous prospectus and registration statement should not be a sufficient connection. The Gustafson majority connected section 12(a)(2) liability with the obligation in a registered offering to issue and distribute a prospectus. The sellers in Slack had an obligation to issue and distribute a prospectus to buyers in the registered offering but not to buyers of the unregistered shares.

2. Justices had questions about how section 12(a)(2) worked for the sales of securities exempted from the Securities Act by section 3 (Tr. 17, 24-27, 37). Section 12(a)(2) states that it applies to section 3 exempted securities with exceptions not relevant here.

The analysis in Gustafson did not fully resolve these questions. The majority opinion in Gustafson at points tried to accommodate the exemption for section 3 securities. It acknowledged that section 12(a)(2) applied to securities exempted by section 3 but did not explain how the liability section would work for a sale of exempted securities if the sale did not involve the use of a prospectus meeting registration statement requirements. That lacunae could be important in a future case about a security exempted by section 3, but it did not matter in Gustafson, which involved a section 4 exemption from registration, and should not matter in Slack, which also involved sales under a section 4 exemption.

3.  Some of the justices thought that section 12 extended more broadly than a false prospectus because the statute refers to a misstatement in an oral communication (Tr. 17, 22, 37).

Again Gustafson by and large resolves this issue because it approved the view that an oral communication must relate to a prospectus, even though the majority did not strictly speaking decide the meaning of the reference to oral communications. Any remaining question about the language on oral communications in section 12 does not matter in Slack because the allegations in the case concerned statements in the registration statement and associated prospectus.

4.  Twice at oral argument, Justice Kagan listed differences between the private rights of action in section 11 and section 12(a)(2) (Tr. 16-17, 37). She did so to suggest that the two claims targeted different things and to question the Gustafson links among the prospectus in section 12(a)(2), the section 10 prospectus that is part of a registration statement, and the section 11 claim.

Justice Kagan was correct that many differences between section 11 and section 12(a)(2) exist. For example, Justice Kagan noted that the class of potential defendants under the two sections differs (Tr. 37). Section 12 makes liable the person from whom the plaintiff purchased, as the Supreme Court construed that phrase in Pinter v. Dahl, 486 U.S. 622 (1988), while section 11 has an explicit list of potential defendants, such as the issuer, the members of the issuer’s board of directors, and the underwriter.

The differences might matter in other cases or possibly even in parts of the Slack case not presented to the Supreme Court at the moment, but they do not affect the question now presented in Slack because Gustafson addressed and resolved that issue. The defendant company was correct that, for Slack’s direct listing, the prospectus and the delivery of the prospectus were solely for the registered shares. Liability under section 12(a)(2) arises solely for the registered shares and not for the sale of shares exempt from registration by section 4.

A remand should not be necessary for the Supreme Court to reach that conclusion about Gustafson, but, if justices have doubts, the Court could remand to the lower courts for further discussion and analysis of the section 12 questions, as Justices Kavanaugh and Gorsuch proposed (Tr. 14-15, 19-20, 68). The lower courts could ask the SEC for views (Tr. 68).

One concern about a remand is that further attention from the lower courts might not be able to resolve the justices’ questions about Gustafson. The problem could be that Gustafson was wrongly decided and that Justice Thomas’s dissent, joined by three other justices, was correct that the word prospectus in section 12(a)(2) has the broad definition from section 2(a)(10).

Much of the edifice for the Securities Act and registered public offers depends on a broad definition of the types of writings that qualify as a prospectus. For example, section 5 makes clear that the word prospectus generally carries the broader section 2(a)(10) definition and not the section 10 definition. Section 5 refers to the use of a prospectus before filing a registration statement (5(c)), a prospectus meeting the requirements of section 10 (5(b)(1)), and a prospectus meeting the requirements of section 10(a) (5(b)(2)).

Lower courts could make some of these points but could not alter the majority position in Gustafson. That is only for Congress or the Supreme Court, and many justices on the Court would want to give appropriate weight to the precedential value of Gustafson.