Slack Direct Listing Lawsuit Partially Dismissed

The California Northern District Court has issued an order partially granting Slack’s motion to dismiss a class action complaint against it. The court also granted leave to amend. Lead plaintiff Fiyyaz Pirani has until May 6 to amend the complaint, if he desires.

Pirani filed the class action securities complaint against Slack, an online collaboration and workspace platform. The plaintiff purchased 30,000 Slack common shares for $40 per share on the first day of Slack’s public listing, which was June 20, 2019. He purchased an additional 220,000 shares from June 21 to September 9, 2019 at various prices. The Class is defined as others that purchased Slack stock during that period.

Once Slack was listed publicly, the venture capital defendants “sold more than 12,5 million shares for gross proceeds of more than $484 million.” Slack did not have an Initial Public Offering (IPO), but rather “insiders and early investors of the company were able to sell their preexisting shares to the public.” This practice is known as a direct listing. These shares were not subject to an initial lockup period that an IPO would usually be subject to. Slack filed the Offering Materials to the Securities Exchange Commission (SEC) for the 118,429,640 shares up for trading.

The plaintiff claims that he and other Class members “suffered losses to the value of their purchased shares as a result of misstatements or omissions of material facts in the Offering Materials.” This information includes statements about “service outages and Slack’s Service Level Agreement (SLAs) in the case of such outages; competition from Microsoft Teams; scalability and purported key benefits; and growth and growth strategy.” For example, Slack reports indicate that “revenue was negatively impacted by $8.2 million of credits related to service level disruption in the quarter” and that “GAAP operating loss was $363.7 million, or 251% of total revenue, compared to a $33.7 million…or 37% of total revenue” loss for the same period the year before. As a result, share prices dropped from around $40 to below $20, with the lowest at $19.53. The plaintiff brought the action for securities violations and defendants move to dismiss.

Slack argues that “Section 11 damages cannot be established in the case of a direct listing” and that plaintiff lacks standing under sections 12 and 15. They claim that plaintiff has not alleged “material misstatements or omissions.” In response, the plaintiff claims that “because of the unique regulatory framework of Slack’s direct listing this case ‘presents a matter of first impression that, if decided in Defendants’ favor, will provide a blueprint for companies to evade liability under Section 11 for filing a misleading registration statement.’”

Typically, plaintiffs must show they “can trace their shares back to the relevant offering,” however, if there are multiple registration statements, it must be proven that the “purchased shares were issued under the allegedly false or misleading one.” New SEC rules allowed Slack’s direct listing of old shares without a lockup period, but subject to Section 11 liability. Further, “[i]n a direct listing, the impossibility of tracing begins on the very first day of listing due to the simultaneous offering of unregistered and registered shares.” The court believes that this unique scenario requires the broader Section 11 reading for the phrase “such security,” meaning that: “acquiring a security of the same nature as that issued pursuant to the registration statement.” Additionally, the court finds that defendants “have not met their burden at the pleading stage to show that plaintiff cannot recover damages as a matter of law.” However, the plaintiff has met his burden. As a result, the court denies “defendant’s motion to dismiss for lack of damages under Section 11.” The court also rejects Slack’s argument that Section 12 liability is only for directly traceable shares and that the plaintiffs adequately alleged to “support an active solicitation theory against the Individual Defendants.”

The plaintiff also alleges material misrepresentations and omissions regarding Slack’s: “(A) outages and SLAs, (B) scalable architecture, (C) competition with Microsoft, (D) key benefits, and (E) growth and growth strategy.” The plaintiff claims that the Offering Materials “misled investors regarding known vulnerabilities related to outages and omitted to inform investor of the highly unusual and punitive SLAs the company had entered into with many of its customers.” The company’s “reliability problem was not simply hypothetical but a known issue to defendants and the company was automatically paying out significant amounts of service credits regardless of whether customers were affected or requested a refund. The plaintiff alleges that the Offering Materials did not disclose that the SLAs guaranteed an uptime of 99.99%, which is significantly stricter than the 99.9% promised by competitors; moreover, Slack did not disclose that the SLAs provided that failing to meet the guarantee would cost Slack a credit payout multiplier of 100 times what each customer paid, regardless of whether the customer complained or was even affected by the outage.” The court found the plaintiff’s plea adequate.  

Shortly after the listing, Slack experienced two outages, as the company “continue[d] to hit limits that [it] didn’t realize were built into the system.” However, Slack claims it “built [its] technology infrastructure using a distributed and scalable architecture on a global scale.” They state that they have not misled investors. Slack disclosed that it “may be unable to maintain service uptime for exactly the reason stated in the September 4, 2019 call: ‘especially during peak usage times and as our user traffic and number of integrations increase.’” Therefore, the Court grants the defendants’ motion to dismiss as to claims that Slack misled regarding its scalable architecture.

The plaintiffs alleged that while Slack identifies Microsoft as its main competitor, it downplayed this threat. Slack stated “we are uniquely positioned to more rapidly innovate and respond to new technologies and customer requirements than our competitors.” This downplaying allegedly misjudged “the impact…Microsoft in particular was already having on [Slack’s] expansion into enterprise customers prior to the offering.” The court finds the allegations immaterial because of Slack’s disclosure. Slack is not required to give figures and market powers of competitors. As a result, the court grants defendants’ motion on this ground.

The plaintiff challenged the validity of Slack’s “Summary of Key Benefits,” with statements such as: “’People love using Slack and that leads to high levels of engagement”; “Slack increases an organization’s ‘return on communication’”; “Slack increases the value of existing software investment” and “An organization’s archive of data increases in value over time.” The plaintiff states that the statements and Offering Materials “implied that the Slack App was a market leader with unique advantages over its competitors and that the Company possessed the ability to scale up its services to reach more lucrative enterprise customers.” However, the plaintiff states that some of the statements in the Offering Material were materially false because: “(1) Microsoft Teams had already overtaken Slack as the market leader at the time of the Offering; (2) the Slack App’s reliability was regularly below the promised  99.99% uptime; and (3) Slack  was  facing difficulty  in  scaling  globally  and  attaining enterprise customers due to problems in maintaining and expanding its infrastructure as evidenced by the Slack App’s widespread downtime.” Slack countered that the plaintiff did not show how this relates to misstatements about Slack’s “key benefits.” The court finds the statements in the “Key Benefits” portion unactionable. Additionally, the plaintiff does not allege that a specific statement is false or misleading, and is rather relying on an implied meaning.

Slack has also moved to dismiss the complaint as to individual and venture capital defendants brought under Section 15, stating that the plaintiff fails to “plead both an underlying violation and to adequately plead that the VC Defendants controlled Slack.” However, the court finds that the plaintiff states and adequate claim for violations. The plaintiff claims “that the three VC Defendants are controlling persons because they: infused capital into Slack before its direct listing; owned respectively 23.8%, 13.2%, and 10.1% of Slack’s supervoting shares at the time of the direct listing; each has a director on the Board, who reviewed and signed the Offering Materials… ‘caused Slack to effectuate the Offering’ because they ‘wished to cash in their early investment and stake in [Slack] as soon as possible’; and sold their shares in the direct listing respectively earning $329 million, $116 million, and $39.6 million.” The court states that being a beneficiary is not enough to allege control, but concludes that the plaintiff adequately pled through “the traditional indicia of control” and “that a direct listing primarily enables the resale of existing shares by insiders and early investors such as the VC Defendants.”

The plaintiff is represented by Bragar Eagel & Squire. Slack is represented by Gibson, Dunn & Crutcher.