Securities Law Alert
In This Edition:• Ninth Circuit: Plaintiff Who Purchased Shares in a Direct Listing Has Standing Under Section 11 andSection 12(a)(2) Regardless of Whether Shares Were Registered or Unregistered• Delaware Supreme Court: In Overruling Gentile v. Rossette the Court Throws Out the Exception toTooley’s “Simple” Test to Distinguish Between Direct and Derivative Claims• Delaware Supreme Court: Adopts Three-Part Demand Futility Test; Agrees That Exculpated Claims Do
Not Excuse Demand as They Do Not Expose Directors to a Substantial Likelihood of Liability• Southern District of New York: Misleading “Comforting Statements” Not Alleged Even Where
Defendants Speculated About a Potential Positive Impact on Demand
October 2021

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Simpson Thacher & Bartlett LLPNinth Circuit: Plaintiff Who
Purchased Shares in a Direct
Listing Has Standing Under
Section 11 and Section 12(a)(2)
Regardless of Whether
Shares Were Registered or
Unregistered
On September 20, 2021, the Ninth Circuit
affirmed a ruling that a stockholder whopurchased shares of a company that went
public through a direct listing had standing
under Section 11 and Section 12(a)(2) of
the Securities Act even though he could not
determine if he had purchased registeredor unregistered shares in the direct listing.
Pirani v. Slack Techs., 2021 WL 4258835(9th Cir. 2021) (Restani, J.). The court
held that plaintiff had standing because hisshares “could not be purchased without theissuance of [the company’s] registration
statement, thus demarking these shares,

whether registered or unregistered, as ‘such
security’ under Sections 11 and 12 of the
Securities Act.”

Background andPlaintiff’s Allegations
In 2019, plaintiff purchased shares on the day
the company went public through a direct
listing. Following a stock price drop related toservice disruptions, plaintiff brought a classaction against the company, its officers anddirectors, and venture capital fund investors,
based on the company’s registration
statement and prospectus issued in the
direct listing. Plaintiff brought claims forviolations of Section 11 and Section 12(a)(2)of the Securities Act alleging the company’s
registration statement was inaccurate andmisleading. The company challenged whether
plaintiff had statutory standing to sue under
Section 11 and Section 12(a)(2) because
he could not prove that his shares wereregistered under the allegedly misleading
registration statement.

Standing Exists Under Section
11 Because a Direct Listing
Registration Statement
Simultaneously Allows Sales ofBoth Registered and Unregistered
SharesNoting that this is a case of first impression,
the court framed the issue as “what does‘such security’ mean under Section 11 in thecontext of a direct listing, where only one
registration statement exists, and whereregistered and unregistered securities areoffered to the public at the same time, basedon the existence of that one registration
statement[.]”1 The court explained that under
the NYSE’s direct listing rule2 a company
must file a registration statement in order toengage in a direct listing. The court continued
that the SEC “interprets this reference toa registration statement in the rule as aneffective registration statement filed pursuant
to the Securities Act of 1933.” The court
then noted that a direct listing—as opposed
to an IPO—has no bank-imposed lock-up
period during which unregistered shares are
kept out of the market, both registered andunregistered shares are immediately soldto the public at the time of the effectivenessof the registration statement, and the sameregistration statement makes it possible tosell both types of shares.
The court determined that the company’s“unregistered shares sold in a direct listingare ‘such securities’ within the meaning of
1. Section 11 of the Securities Act states, “In case any part of
the registration statement, when such part became effective,
contained an untrue statement of a material fact or omitted tostate a material fact required to be stated therein or necessary
to make the statements therein not mis-leading, any person
acquiring such security . . . may, either at law or in equity, in
any court of competent jurisdiction, sue—(1) every person who
signed the registration statement . . . .” (emphasis added).
2. NYSE Listed Company Manual, Section 102.01B, Footnote E.

Section 11 because their public sale cannot
occur without the only operative registrationin existence.” As there was only one
registration statement here, the court statedthat all of the stock sold in this direct listing,whether labeled as registered or unregistered,
was traceable to that one registration. The
court determined that plaintiff pled facts
sufficient to establish standing under Section
11 and affirmed the denial of dismissal.
Separately, the court stated that “Section 12
liability (resulting from a false prospectus) is
consistent with Section 11 liability (resulting
from a false registration statement).”
Accordingly, statutory standing exists under
Section 12(a)(2) to the extent it parallels
Section 11.

Circuit Judge Miller Dissents
Circuit Judge Miller dissented stating that
he would have reversed and remanded with
instructions to dismiss in full. Judge Miller
explained that plaintiff lacked standing under
Section 11 because he could not show thatthe shares he purchased “were issued under
the allegedly false or misleading registration
statement[.]” If “such security” meant that aplaintiff must have purchased shares “issued
under the allegedly false or misleading
registration statement” in successiveregistration cases, then that is what it should
also mean in direct-listing cases. He cited
similar reasons for concluding that plaintiff
also lacked standing under Section 12.

Delaware Supreme Court: In
Overruling Gentile v. Rossette
the Court Throws Out the
Exception to Tooley’s “Simple”
Test to Distinguish Between
Direct and Derivative Claims
On September 20, 2021, in a unanimousdecision, the Delaware Supreme Court
overruled Gentile v. Rossette, reversing a
Court of Chancery decision holding thatplaintiffs had direct standing to challenge agreen energy company’s private placementof common stock for allegedly inadequate
consideration. Brookfield Asset Management
v. Rosson, 2021 WL 4260639 (Del. 2021)(Valihura, J.). The court agreed with2

defendants that there was a clear conflict
between Tooley v. Donaldson, Lufkin& Jennette, Inc., establishing the test to
distinguish direct claims from derivative
claims, and Gentile which served as an
exception to Tooley. In support of its decision,
the court noted the difficulty that courts
have had in applying Gentile in a logicallyconsistent way and Gentile’s erosion ofTooley’s simple analysis.

Background and Procedural History
The consolidated class action complaint
alleged three counts of breach of fiduciary
duty3 arising from the controllingstockholders of a green energy company
causing it to issue its stock in a private
placement for inadequate value, allegedly
diluting both the financial and voting interestof the minority stockholders. The counts
were putatively brought both derivatively
and directly. Defendants moved to dismiss
plaintiffs’ direct claims on the basis that they
were entirely derivative.
Subsequently, a merger involving the energy
company occurred and the energy company’s
public stockholders ceased to have any
interest in the energy company, and all of
its assets, liabilities, rights and causes ofaction became the acquirer’s property. In
light of the merger, the trial court dismissed
the derivative counts of the complaint. The
Court of Chancery later denied defendants’
motion to dismiss holding that while plaintiffs
failed to state direct claims under Tooley,they did state direct claims to challenge theprivate placement under Gentile, notingthat the claims were predicated on similarfacts. The Delaware Supreme Court accepted
an interlocutory appeal from the Court ofChancery’s opinion.

The Alleged Overpayment
Falls “Neatly” Into Tooley’s
Derivative Category
The court identified the central issue on
appeal as whether plaintiffs had direct
standing to pursue their claims or whether
their claims were entirely derivative. The
court explained that if their claims were only
3. Count I was against an alternative asset manager, and two of
its affiliates as controlling stockholders. Count II was against
certain directors of the energy company and Count III wasagainst the energy company’s CEO.

derivative, then the merger extinguishedthem and they lacked standing to pursue
them. The court stated that Tooley created a“simple” test to distinguish direct claims fromderivative claims.4 The court then held thatthe “claim is derivative because [plaintiffs]
allege an overpayment (or over-issuance)of shares to the controlling stockholder
constituting harm to the corporation forwhich it has a claim to compel the restorationof the value of the overpayment.” The court
stated that “[c]learly, the gravamen of theComplaint is that the Private Placement
was unfair and that [the energy company]
suffered harm.”

In discussing Gentile’s analytical tension with
Tooley, the court summarized the complaint’s
allegations as follows: the private placement
allegedly harmed the energy company by
issuing shares for an unfairly low price andharmed the stockholders indirectly througheconomic and voting power dilution. The
court then concluded that “the harm to thestockholders was not independent of the harmto the Company, but rather flowed indirectly
to them in proportion to, and via their sharesin, [the company].” The court stated that thisalleged corporate overpayment falls “neatly”
into Tooley’s derivative category. The court
also stated that it saw “no practical need for
the Gentile carve-out.”
As to stare decisis, the court pointed out that
15 years was enough time to pass since Gentile
was decided for the court to “properly saythat the practical and analytical difficulties
courts have encountered in applying it
reflect fundamental unworkability and not
growing pains[.]”4. Under Tooley, “whether a stockholder’s claim is direct orderivative must turn solely on the following questions: (1) who
suffered the alleged harm (the corporation or the stockholders,
individually); and (2) who would receive the benefit of any
recovery or other remedy (the corporation or the stockholders,
individually)?” (emphasis in original).
3Delaware Supreme Court:
Adopts Three-Part Demand
Futility Test; Agrees That
Exculpated Claims Do Not
Excuse Demand as They Do
Not Expose Directors to a
Substantial Likelihood of
Liability
On September 23, 2021, the Delaware
Supreme Court affirmed a decision dismissing
a derivative complaint for failing to makea demand on the board of a social media
company under Court of Chancery Rule23.1. UFCW Union & Participating Food
Indus. Emps. Tri-State Pension Fund v.
Zuckerberg, 2021 WL 4344361 (Del. 2021)(Montgomery-Reeves, J.). Notably, thecourt adopted the Court of Chancery’s threepart test for demand futility blending thetests from Aronson v. Lewis5 and Rales v.
Blasband.6 Agreeing with the lower court,
the court held that exculpated care claims do
not excuse demand under Aronson’s second
prong because they do not expose directors
to a substantial likelihood of liability. The
court also determined that plaintiff did notplead with particularity that a majority of thedemand board lacked independence.

Background
Plaintiff stockholder filed a derivativecomplaint in the Court of Chancery seeking
compensation for the money the defendantsocial media company had spent in aprior class action. Plaintiff alleged that thecompany’s directors breached their dutyof care by negotiating and approving apurportedly one-sided stock reclassificationthat had been proposed by the company’s
CEO/controller/chairman. In this case,plaintiff did not make a litigation demand,
pleading that demand was futile because theboard’s negotiation and approval of the stock
5. “Under Aronson, demand is excused as futile if the complaint
alleges particularized facts that raise a reasonable doubt that(1) the directors are disinterested and independent, or (2) the
challenged transaction was otherwise the product of a valid
business judgment.”
6. “Under Rales, demand is excused as futile if the complaint
alleges particularized facts creating a reasonable doubt that,
as of the time the complaint is filed, a majority of the demandboard could have properly exercised its independent anddisinterested business judgment in responding to a demand.”reclassification was not a valid exercise of its
business judgment and because a majority ofthe directors lacked independence from thecompany’s CEO. The company and the otherdefendants moved to dismiss the complaint
under Court of Chancery Rule 23.1 arguingthat plaintiff did not make demand or provethat demand was futile. Plaintiff appealed the
Court of Chancery’s judgment dismissing thecomplaint under Rule 23.1.

Exculpated Care Violations Do Not
Satisfy Aronson’s Second Prong
The court pointed out that the company’s
charter contained a Section 102(b)(7)7
clause, therefore, the directors faced norisk of personal liability from plaintiff’s
allegations. Under these circumstances theissue was whether a derivative plaintiff canrely on exculpated care violations to establishthat demand was futile under Aronson’s
second prong. The court affirmed the Courtof Chancery’s holding that exculpated careclaims do not satisfy Aronson’s second prong.
The court explained that when Aronson was
decided, rebutting the business judgment
rule through allegations of duty of careviolations exposed directors to a substantial
likelihood of liability and raised doubt as
to whether they could impartially consider
demand. However, due to the enactment of
Section 102(b)(7) and other corporate law
developments since Aronson, exculpatedbreach of care claims no longer pose a threatthat neutralizes director discretion.

The Court Adopts the Court ofChancery’s Three-Part Test as the
Universal Test for Demand Futility
In support of its adoption of the Court ofChancery’s test, the court explained that“[b]lending the Aronson test with the Rales
test is appropriate because both address
the same question of whether the board
can exercise its business judgment on thecorporation’s behalf in considering demand;and the refined test does not change theresult of demand-futility analysis.” Thecourt clarified that the purpose of thedemand-futility analysis is “to assess
whether the board should be deprived of its
7. Section 102(b)(7) of the Delaware General Corporation
Law “authorizes corporations to adopt a charter provisioninsulating directors from liability for breaching their dutyof care.”4

decision-making authority because there
is reason to doubt that the directors would
be able to bring their impartial businessjudgment to bear on a litigation demand.”The court observed that this is a different
consideration than whether the challenged
transaction is likely to pass or fail theapplicable standard of review.

Southern District of New
York: Misleading “Comforting
Statements” Not Alleged Even
Where Defendants Speculated
About a Potential Positive
Impact on Demand

Going forward, under the refined test, “courts
should ask the following three questions on
a director-by-director basis when evaluating
allegations of demand futility: (i) whether the
director received a material personal benefit
from the alleged misconduct that is the
subject of the litigation demand; (ii) whether
the director faces a substantial likelihoodof liability on any of the claims that would
be the subject of the litigation demand; and(iii) whether the director lacks independence
from someone who received a material
personal benefit from the alleged misconductthat would be the subject of the litigation
demand or who would face a substantial
likelihood of liability on any of the claims thatare the subject of the litigation demand.” “Ifthe answer to any of the questions is ‘yes’ forat least half of the members of the demandboard, then demand is excused as futile.”

On September 7, 2021, the Southern Districtof New York dismissed a putative securities
fraud class action alleging that a holding
company and certain of its executives mademisstatements and omissions concerningpotential risks facing its subsidiary, a liquidcommodity storage and handling business,and concealed the company’s exposure to
an impending environmental regulation
seeking to largely ban its subsidiary’s single
largest product (No. 6 fuel oil). City of Riviera
Beach Gen. Emps. Ret. Sys. v. Macquarie
Infrastructure, 2021 WL 4084572 (S.D.N.Y.
2021) (Broderick, J.). The court determinedthat plaintiff did not plausibly allege false
statements or omissions. The court held thatplaintiff did not allege that defendants made“comforting statements” while they alreadyknew that the company’s business storing
No. 6 fuel oil was waning, even though one
investor relations email, among other things,
speculated on a potential positive impact onstorage demand if producers started sellingNo. 6 fuel oil where it was not banned.

As to the impact of the test, the court statedthat “because the three-part test is consistent
with and enhances Aronson, Rales, and theirprogeny, the Court need not overrule Aronson
to adopt this refined test, and cases properly
construing Aronson, Rales, and their progeny
remain good law.”

The court summarized plaintiff’s position
on defendants’ affirmative statements tobe that “securities fraud defendants mustbe forthright about the present facts, risks,5and threats facing their company whenaffirmatively disclosing its business andenvironment.” The court explained that
this statement “misse[d] the mark” because
merely speaking on one’s business did not
trigger a duty to disclose all facts an investor
may want to know. The court distinguishedplaintiff’s cases stating that they actually“show[ed] that the duty to be forthrightis triggered when a defendant speaks
with sufficient ‘specificity’ while omitting
information that one would normally expect
the defendant to have included had thedefendant known it.”[their] business storing No. 6 fuel oil was
waning.” The court noted that plaintiff had
asked how the new regulations, banningships from using heavy oils unless improved
scrubbers were installed, would impact
demand. The company’s head of investor
relations replied that plaintiff’s information
was consistent with their understandingof the regulatory changes. The head also
speculated on the potential positive impact onstorage demand if producers started sellingNo. 6 fuel oil where it was not banned andstated that the producing industry would try
to find other uses for it.

For example, in Meyer v. Jinkosolar
Holdings, 761 F.3d 245 (2d Cir. 2014),
the Second Circuit held that it was“misleading for a company to make detailed,
comforting statements about how it handledenvironmental compliance . . . while atthe same time withholding that, at thevery moment it spoke, the company
had known, ongoing issues preventing
substantial violations of particularenvironmental regulations[.]”

The court determined that nothing in that
response amounted to a specific comfortingstatement about the subsidiary’s ability towithstand the new regulation, “much less a
comforting statement made while [the headof investor relations] knew or should have
known that [the subsidiary’s] business had
already been negatively impacted[.]” Thecourt continued that “[f]ar from comforting
Plaintiff, [the head of investor relations]confirmed that Plaintiff, ‘a sophisticatedinstitutional investor,’ correctly understoodthat [the regulation] could prevent the
shipping industry from burning No. 6
fuel oil.”

The court stated that, by contrast, plaintiff did“not allege that Defendants made comfortingstatements while they already knew that

This edition of the
Securities Law Alert was edited by
Sarah L. Eichenberger / +1-212-455-3712
sarah.eichenberger@stblaw.com
Linton Mann III / +1-212-455-2654
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