Secured with SHA-256 EncryptionJurisdiction of Blue-Sky Laws Over Internet Transactions
THE INTERNET AND THE CYBERSECURITIES MARKETPLACE
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Denis T. Rice, July 1998
V. Internet Securities and the Jurisdiction Reach of Securities Laws. Continued
D. Jurisdiction of Blue-Sky Laws Over Internet Transactions.
1. Issuance of Securities.
As discussed in subsection II.C.2.a. above, the Uniform Securities Act applies a state’s jurisdictional reach to persons offering to buy or sell securities “in [a given] . . . state.” In fact, the constitutionally permissible reach of a state’s in personam jurisdiction is even broader than those words suggest. Under a typical long-arm statute, even if a defendant does not have substantial or continuous activities within a State, personal jurisdiction can still be based on purposeful direction of activities toward the State.
The USA tightens the jurisdictional inquiry by providing that an offer to sell or buy is made “in this state, whether or not either party is then present in this state, when the offer (1) originates from this state or (2) is directed by the offeror to this state and received at the place to which it is directed . . . .” Whether an Internet offer “originates” from a given state should not be based on the physical location of the essentially passive circuits carrying the message. Regardless of the multiplicity of networks and computers that an electronic message may traverse, the place where information is entered into a Web site or into e-mail is the point of origination.
Whether an Internet-based offer to buy or sell is “directed” into a given state is a more complex factual inquiry. If an offer to sell securities were mailed or communicated by telephone to a person in a forum state, personal jurisdiction in that state should apply. By like token, an e-mail offer by Internet directly to the a resident of a state would similarly constitute a basis for jurisdiction in that state. So would acceptance by an out-of-state issuer of an e-mail from person in the forum state, subscribing to a general offering posted on the World Wide Web. However, mere posting of the existence of an offering on the World Wide Web, without more, is different. Standing alone, it constitutes insufficient evidence that the offer is specifically “directed” to persons in every state. The offer may, indeed, not be intended to be accepted by persons in certain states.
In order to reconcile technology, practicality and due process concerns, the North American Securities Administrators Association (NASAA) adopted a model rule to clarify jurisdiction over Web-based securities offerings. Under the NASAA policy, states will generally not attempt to assert jurisdiction over an offering if the Web site contains a disclaimer essentially stating that no offers or sales are being made to any resident of that state, the site excludes such residents from access to the purchasing screens and in fact no sales are made to residents of that state.
As of January 1998, 32 states had adopted the NASAA safe-harbor, either by statute, regulation, interpretation or no-action letter. Commonly, the disclaimer is contained in a page linked to the home page of the offering. In late 1997 the Arizona Corporation Commissioner proposed a stricter version which would require that the disclaimer be placed on the home page, rather than through hypertext links. A preferred technique is to request entry of the viewer’s address and ZIP code before the viewer is allowed to access the offering materials. If the viewer resides in a state in which the offering has not been qualified, access is denied. Of course, the viewer might choose to lie, but it can be argued with some logic that a Website operator cannot reasonably “foresee” that viewers would lie.
2. Broker-Dealers and Investment Advisers.
Because communications posted on the World Wide Web are accessible to anyone with a personal computer and an Internet service provider, new types of jurisdictional questions arise as to how state blue-sky laws should apply to on-line securities transactions. A practical approach to jurisdiction over broker-dealers and investment advisors was adopted in 1997 by the North American Securities Administrators Association (NASAA). NASAA’s policy exempts from the definition of “transacting business” within a state for purposes of Sections 201(a) and 201(c) of the Uniform Securities Act those communications by out-of-state broker-dealers, investment advisers, agents and representatives that involve generalized information about products and services where it is clearly stated that the person may only transact business in the state if first registered or otherwise exempted, where the person does not attempt to effect transactions in securities or render personalized investment advice, uses “firewalls” against directed communications, and also uses specified legends. NASAA’s approach should facilitate the use of the Web by those smaller or regional securities professionals who focus their activities in a limited geographical area.
E. Applying Federal Securities Laws To Foreign Web Sites.
1. Jurisdictional Basis.
The SEC in 1998 articulated an approach to jurisdiction over Internet transactions that resembles the NASAA approach, although in the context of a broader statutory scheme. 1933 Act jurisdiction is broadly defined to embrace “any means or instruments . . . of communication in interstate commerce” to sell securities that are not either registered or exempt from registration. 1934 Act jurisdiction likewise applies to any broker or dealer (including any foreign broker or dealer), who makes use of any “instrumentality of interstate commerce to effect transactions in, or induce or attempt to induce the purchase or sale” of any security an instrument of communication in interstate commerce, the issue determining application of the federal securities laws is whether the off-shore resident is using that instrument simply by posting on the World Wide Web.
The SEC has in the past interpreted the 1934 Act broadly, so as to require an off-shore broker or dealer to register under that Act where its only U.S. activity is execution of unsolicited orders from persons in the U.S. This interpretation is not inconsistent with either concepts of due process or international law. It will be recalled that, under international law, a country may assert jurisdiction over a non-resident where the assertion of jurisdiction would be reasonable. The standards include, among others, whether the non-resident carried on activity in the country only in respect of such activity, or whether the non-resident carried on, outside the country, an activity having a substantial, direct, and foreseeable effect within the country with respect to such activity. Under these rules, a court in one country could assert jurisdiction over a foreign company under the “doing business” or “substantial and foreseeable effects” tests where financial information is directed by e-mail into the country. The accessibility of a Web site to residents of a particular country might also be considered sufficient to assert personal jurisdiction over an individual or company running the Web site.
In April, 1998 the SEC issued an interpretive release on the application of federal securities laws to offshore Internet offers, securities transactions and advertising of investment services. The SEC’s release sought to “clarify when the posting of offering or solicitation materials” on Web Sites would not be deemed activity taking place in the United States for purposes of federal securities laws. The SEC adopted a rationale that resembles that used by the NASAA in determining the application of state blue-sky laws. Essentially, the SEC stated that it will not view issuers, broker-dealers, exchanges and investment advisers to be subject to registration requirements of the U.S. securities laws if they are not “targeted to the United States.
Thus, the SEC generally will not consider an offshore Internet offer made by a non-U.S. offeror as targeted at the U.S. if (1) the Web site includes a prominent disclaimer making clear that the offer is directed only to countries other than the U.S., and (2) the Web site offeror implements procedures that are “reasonably designed to guard against sales to U.S. persons in the offshore offering.” For example, the offeror could ascertain the purchaser’s residence by obtaining the purchaser’s mailing address or telephone number (including area code) before sale. If the offshore party receives indications that the purchaser is a U.S. resident, such as U.S. taxpayer identification number or payment drawn on a U.S. bank, then the party is on notice that additional steps need to be taken to verify that a U.S. resident is not involved. Offshore offerors who use third-party Web services to post offering materials are subject to similar precautions, and also may have to install additional precautions if the third-party Web site issued to generate interest in the offering. For example, using a third-party site that has a significant number of U.S. subscribers or clients would require the offeror to limit access to the materials to those who could demonstrate that they are not U.S. residents.
If the off-shore offering is made by a U.S. issuer, stricter measures would be required. The U.S. residents can obtain access to the offer. If offerings are made by a foreign investment company, similar precautions must be taken not to target U.S. persons in order to avoid registration and regulations under the 1940 Act. When an offer is made offshore on the Internet and with a concurrent private offer in the U.S., the offeror must guard against indirectly using the Internet offer to stimulate participants in the private U.S. offer.
By like token, the SEC will not apply exchange registration requirements to a foreign exchange that sponsors its own Web site generally advertising its quotes or allowing orders to be directed through its Web site so long as it takes steps reasonably designed to prevent U.S. persons from directing orders through the site to the exchange. Regardless of what precautions are taken by the issuer, the SEC will view solicitations as being subject to federal securities laws if their content appears to be targeted at U.S. persons. As an example, the SEC cited offshore offers that emphasize the investor’s ability to avoid U.S. taxes on the investment.
2. Enforcement Activities, Federal and State.
Notwithstanding federal and state securities laws, investors within the U.S. can log on freely to off-shore cybersecurities sites, since there are no technological barriers to prevent an American from investing directly via the Internet in the securities of a foreign issuer at a foreign site. For example, U.S. viewers in 1997 could access the site of the first Australian DPO, Linear Energy Corporation Limited (www.linearenergy.com.au). The Australian company claimed to have developed an engine using compressed air to generate electricity. However, a U.S. viewer could not access the offering document without making a misrepresentation, because the Australian Securities Commission required that a viewer first confirm residence in Australia on the screen as a condition of accessing the prospectus.
Not all offshore issuers will show the restraint of the Australians, which raises the practical question as to how the SEC or state regulations will be able to police offerings to U.S. residents. Despite difficult practical issues facing the SEC in such regulation, it intends to try. The SEC has stated that it might attempt to regulate entities that “provide U.S. investors with the technological capability to trade directly on a foreign market’s facilities,” which could be construed to embrace any U.S. internet service provider or any U.S. Web site with a link to a foreign stock exchange or bulletin board.
The SEC has on a number of occasions taken steps to enforce the federal statutes with respect to the Internet. For instance, several offshore Internet sites who were not as fastidious as Australia’s Linear Energy encountered problems with the SEC. A viewer could in early 1997 click to “FreeMarket” at www.freemarket.org/. The viewer could not have advanced much beyond the home page, which advised that “[a]t the demand of the United States Securities and Exchange Commission, FreeMarket Foundation will discontinue operations immediately.” Contending that “FreeMarket was founded upon the central tenet of America that everyone is free to transact business.” FreeMarket said that the SEC was “killing” its dream of allowing companies to establish a secondary market for their own shares on the Internet. What was needed, said FreeMarket, was “an unfettered flow of ideas on the Internet,” because “[i]t is unlikely that an Internet surfer will be scammed the same way a person receiving a telephone solicitation will.” The SEC apparently saw things differently, since Freemarket went off its Web site after February 1997. By June 1997, the domain name and address had been acquired by WinNET, a web hosting and design firm having no activity in the securities business.
As late as early June 1997 a Web surfer still might have accessed another foreign Web site, “Offshore Capital Resources” (www.ocr-ltd.bs/). Offshore Capital claimed to be a Bahamian International Business Corporation all of whose operations and all of whose transactions were outside the U.S. It was offering, through what it called an “Offshore Placement Memorandum,” shares of its common stock. The SEC also ordered this site to discontinue operations immediately, with the termination notice to be posted until June 30, 1997. Offshore Capital apologized on the screen that “[w]e won’t be able to continue with this leading-edge investment concept,” because the SEC wanted assurance that U.S. citizens would not participate in the transactions. By late 1997, its Web address was blank.
The SEC has used U.S. federal courts to bring proceedings against foreign-based securities sellers. For example, on May 28, 1997 the United States District Court of the District of Columbia permanently enjoined Wye Resources (in a default judgment) from violating U.S. securities laws. Wye, a Canadian corporation, claimed to own mining interests but had no recorded mining earnings. Wye also allegedly issued false press releases and public information. The default nature of the proceeding meant that the jurisdictional issue went uncontested, probably because Wye’s former President had earlier consented to a permanent injunction against him in the same action. Similarly, the SEC took the default of a German resident obtained a permanent injunction against her, together with a court order that she pay more than $9.3 million in penalties. She had used the Internet to solicit U.S. investors in building a fraudulent prime bank scheme.
State regulators are likewise putting intensive efforts into cracking down on Internet-based securities frauds. For example, the California Department of Corporations in June 1998 issued cease-and-desist orders as part of a new initiative aimed at on-line frauds. The scams ranged from investments in a time machine to mining gold inside a volcano. A number of those sent such cease-and-desist orders were non-California companies, such as a Kansas issuer of time share interests in a yet-to-be-built floating condominium complex. The NASD has announced a program called “Nerwatch” what would monitor chat rooms and investment sites on the Web for improper activity.
Because the World Wide Web is a borderless new medium, it is too early to predict a logical worldwide regulatory scheme. Assumably, regulators in the economically advanced nations will try to establish coordination agreements to help enforce antifraud laws. Moreover, they may try to use the Internet as a tool against its abusers by posting and publicizing on the Web the identities of suspected abusers. It is also conceivable that sophisticated electronic screening mechanisms will be developed which would allow regulatory agencies to block or impede the transfer into the United States of offering materials that avoid compliance with U.S. registration requirements.
VI. Conclusion.
Digital communication and electronic commerce are still in their infancy. The ultimate impacts they will have on public offerings, secondary trading and capital formation are impossible to predict so early in their evolution. A few things are clear.
First, big and small issuers can reach more potential investors faster, reducing the advantages of intermediaries.
Second, smaller financial institutions have instant access to vast amounts of complex financial data, creating a leveling influence.
Third, despite a more level playing field in terms of information access and outreach to viewers, the sheer volume of people, places and data on the World Wide Web may ultimately spur midsized non-niche operators to combine. It remains to be seen whether the cost to build software systems that will allow for larger and more sophisticated securities offerings in the future will be so substantial that it will limit the number of “players.”
Fourth, because of the global and instantaneous nature of the World Wide Web, jurisdictional barriers are more vulnerable than ever.
Finally, the individual investor will be increasingly empowered by access to types of information previously available to only large institutions. By the year 2000, the landscape of corporate finance will have changed dramatically from what existed as recently as two years ago.
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