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News from Joshua Mitts regarding the outcome of Supreme Courts decision in the Slack v Pirani case, in which Laura Posner and Joshua Mitts have an interest since they wrote an Amicus Brief to Supreme Court regarding the need for tracing securities.
In short, this could potentially be the opening for Laura Posner to be able to expand the lawsuit NWBO v 7 Market Makers to include naked shorting.
BARD sums it up
This is an article about the feasibility of tracing shares in Section 11 claims after the Slack Techs., LLC v. Pirani case. The article discusses the tracing problem and how it can be solved using accounting conventions. It also discusses the potential impact of the PSLRA on tracing. In the end, the authors argue that tracing is feasible and can be done without the need for new legislation or SEC rules.
The article says that tracing of shares could be possible using accounting conventions like FIFO or LIFO. This would involve tracking the ownership of shares through a chain of transactions. If a company is naked shorting, it is selling shares that it does not own. This could be difficult to trace because the company would not be able to produce the shares if asked. However, if the tracing of shares revealed that a large number of shares were unaccounted for, it could be an indication that naked shorting was taking place.
As we argued in our amicus brief to the Supreme Court, tracing should be required in order to keep the potential liability proportionate to the size of the offering. In our view, the real issue is not whether tracing should be required, but how it should (and can) be done. Unless the tracing problem can be solved at the procedural level, Section 11 seems destined to become a little-used antique.
Clearly, issuers can find multiple ways to mix registered and unregistered securities into a common pool in order to complicate tracing, and courts have shown little or no willingness to accept purely statistical approaches that show only it was highly likely that the plaintiff’s shares were issued under the registration statement. Nonetheless, we believe that tracing is feasible (even though many commentators have scoffed at this possibility). This implies, in turn, that the problem can be solved without legislation or new SEC rules. We explain our answer in an article that we recently posted on SSRN and here summarize.
Conclusion
One of the attractions of our suggested approach is that it does not require legislation or even significant new SEC rules. If the court having a Section 11 action before it can be asked to schedule an early hearing at which it schedules any motion to dismiss that defendants wish to bring (and denies a dilatory defendant the right to file a later such motion), then defendants cannot delay or prevent the plaintiffs from obtaining discovery.
Because a motion to dismiss in a Section 11 case is unlikely to be successful, plaintiffs will experience little delay. The one juncture that remains critical is the readiness of FINRA and the SEC to give litigants access to CAT, and here the SEC can likely encourage FINRA without adopting any rules.
Although the SEC does not have direct regulatory authority over Section 11 claims, Section 28 of the Securities Act grants the SEC general exemptive authority to the extent that any such exemption “from any provision or provisions of this subchapter or of any rule or regulation issued under this subchapter, to the extent that such exemption is necessary or appropriate in the public interest, and is consistent with the protection of investors.”[14] Arguably, the SEC could adopt a rule under this section which explicitly provides that standard accounting methods shall satisfy Section 11’s tracing requirement. Short of that step, a desirable approach would be for the SEC to produce a whitepaper or other interpretive guidance that makes clear its views that accounting methods are appropriate to apply to tracing in Section 11 cases. While courts will ultimately have the decision as to the procedures and conventions to be used, there seems little doubt that the judiciary would benefit from the SEC explaining its views on this topic.
As for discovery, here too the SEC can play a role. While the SEC’s final rules governing the Consolidated Audit Trail do provide that information held by the CAT, including customer identifying information, is discoverable,[15] the SEC could make clear to all (including FINRA) that these records must be produced to private litigants in the course of Section 11 litigation. Similar records are also collected by FINRA in a form known as the Electronic Blue Sheets, which are also subject to subpoena, and the SEC could similarly clarify that these should be produced without delay to private litigants.
These are the examples of the actions that the SEC could take immediately to ensure that Slack and its progeny do not result in a complete loss of standing, thereby leading to the death of Section 11 litigation. Seeking to avoid such an outcome would be fully consistent with the SEC’s mission of promoting investor protection.
Abstract
On June 1, 2023, a unanimous Supreme Court held in Slack Techs. v Pirani that purchasers of securities must “trace” their shares to the registration statement that contains the alleged misstatement or omission in order to be able to assert a claim under Section 11 of the Securities Act of 1933. Here, we consider how tracing is to be performed. Many judges, academics, plaintiffs’ and defense attorneys still subscribe to the myth that it is impossible to trace chain of title for commingled securities in order to establish standing under Section 11. Unfortunately, this is a misguided, out-of-date assumption because enhanced data-reporting requirements and modern computing power can realistically solve this problem. With an accessible (both in terms of record-keeping and computing power) body of transaction records, it is possible to trace the chain of title for securities, using standard accounting methods like first in-first out (“FIFO”) or last in-first out (“LIFO”). We also consider practical litigation issues arising from tracing in Section 11 cases.
