The Internet As A Means To Market New Securities.
THE INTERNET AND
THE CYBERSECURITIES MARKETPLACE
Denis T. Rice, July 1998
The Internet credits two main changes in the issuance of new securities. First, investment bankers can post new underwritings of stock issues on the World Wide Web and thereby expose them to vast numbers of prospective investors at very low cost. Second, issuers can now bypass traditional underwriters and make direct public offerings ("DPOs") of securities using the Web bulletin boards and push technology. DPOs thus far have typically involved modest amounts of capital sought essentially by small issuers, but the ease of creating Web sites will encourage the growth and maturity of the DPO as the digital marketplace evolves. The increased role of the Internet in the issuance of new securities has been accompanied by efforts of federal and state regulators to adapt existing rules to fit this dynamically changing marketplace.
B. The Regulatory Framework For Cybersecurities.
1. Federal Regulation.
The issuance of new securities in the United States is primarily governed by the Securities Act of 1933 (the "1933 Act"). The 1933 Act generally requires registration with the Securities and Exchange Commission ("SEC") of securities that are publicly offered. The Securities Act of 1934 (the "1934 Act") generally requires registration of broker-dealers and national securities exchanges with the SEC. Both of these Acts regulate securities fraud, the 1933 Act focuses on securities issuance while the 1934 Act deals broadly with both issuance and after-market trading. Narrower in their coverage are the Investment Advisers Act of 1940 ("Advisers Act"), which generally affects investment advisers having $25 million or more under management or advising mutual funds, and the Investment Company Act of 1940 ("1940 Act"), which governs both open and closed-end investment companies that offer their securities to the public.
Since 1995, the SEC has sought by rule and interpretive release to mesh these Acts and the regulatory framework built up around them with the new Internet world. Its efforts have produced two October 1995 interpretive releases and a 1996 concept release, which constitute its principal guides to issuers and attorneys regarding delivery of information on securities by electronic means. The foregoing releases reflect an SEC effort to encourage electronic delivery of information to investors. At the same time, they also reflect a residual regulatory preference for paper delivery and a preference for directed Internet communication (e-mail) over Web site postings. The SEC also published in 1998 an interpretive release on the application of U.S. federal securities laws to offshore offering and sales of securities and investment services over the World Wide Web.
a. Importance of Consent of the Recipient to Electronic Transmission of Information.
The SEC has analogized electronic distribution of information to the print medium, stating that it "would view information distributed through electronic means as satisfying the delivery or transmission requirements of the federal securities laws if such distribution results in the delivery to the intended recipients of substantially equivalent information as these recipients would have had if the information were delivered to them in paper form." However, unlike information transmitted in paper form, an issuer must obtain the investor's informed consent to the receipt of information through the Internet. Moreover, the SEC makes such consent revocable at any reasonable time before electronic delivery of a particular document has actually commenced.
b. Importance of Timely Notice, Effective Access, and Reasonable Assurance of Delivery of Information.
Electronic disclosure of information must provide adequate and timely notice to investors, afford effective access to the information, and give reasonable assurance that the information in fact has been delivered. For example, merely posting a document on a Web site will not constitute adequate notice, absent evidence of actual delivery to the investor. Separate notice by two paper methods--letter or postcard--or a directed Internet message (e-mail) can satisfy such actual delivery requirements. If an investor consents to electronic delivery of the final prospectus for a public offering by means of a Web site, but does not provide an electronic mail address, the issuer may post its final prospectus on the site and mail the investor a notice of the location of the prospectus on the Web along with the paper confirmation of the sale.
It is also necessary that investors have access to required disclosure that is "comparable" to postal mail and that the investor must have the opportunity to retain the information or have ongoing access equivalent to personal retention. A document posted on the Internet or made available through an on-line service should remain accessible for so long as any delivery requirement under SEC rules applies. If a preliminary prospectus is posted on a Web site, it should be updated "to the same degree as paper."
The SEC requires issuers to make paper versions of their documents available where there is computer incompatibility or computer system failure or where consent to receive documents electronically is revoked by the investor.
Issuers should have reasonable assurance, akin to that found in postal mail, that the electronic delivery of information requirement is satisfied. The delivery requirements can be satisfied by the investor's informed consent to receive information through a particular electronic medium coupled with proper notice of access. Sufficient evidence of delivery can also include an electronic mail return receipt or confirmation that a document has been accessed, downloaded or printed; the investor's receipt of transmission by fax; the investor's accessing by hyperlink of a required document; and the investor's use of forms or other material that are available only by accessing the document.
There are practical questions that arise in determining whether an e-mail delivery has actually taken place. E-mail differs from mail sent via the U.S. Postal Service in that posting an e-mail message does not yet raise a legal presumption that it was received. In most states, however, and for federal purposes, a letter is presumptively received if it is deposited in the mails with full postage prepaid. There are steps that can accomplish proof of receipt of e-mail in much the way as a recipient of a registered letter signs upon delivery. The e-mail recipient can hit a reply button upon receipt of the electronic document. Moreover, there are systems that will verify the delivery of electronic materials and their opening by recipients, such as the Prospectus.Net service offered by InUnity Corp. Some institutions selling securities, particularly mutual funds, are concerned over identifying the true identity of a customer who given electronic consent to delivery of a prospectus or other disclosure documents over the Internet.
2. State Regulation.
The role of the states in the issuance of securities has shifted in the past few years for reasons having nothing to do with the Internet. When an issuer is listed or authorized for listing on the New York Stock Exchange or American Stock Exchange, or is included or qualified for inclusion in the Nasdaq National Market System, the states play a diminished role, since their ability to require registration of such securities at the state level has been largely preempted by Congress. Congress has also preempted state regulation of those security issuances which are exempt from 1933 Act registration by virtue of SEC exemptions adopted pursuant to Section 4(2) of the 1933 Act (the exemption for private offerings). In effect, this deprives the states of authority over private placements, including those made in reliance on SEC Rule 506 in Regulation D. However, the states have retained authority to regulate most other kinds of exempt small offerings, particularly those under SEC Rules 504 and 505. Moreover, states retain authority to regulate broker-dealers within their jurisdiction, notwithstanding the 1934 Act.
Application of state "blue-sky" law is traditionally based on location, i.e., the laws of a given state seek to regulate transactions occurring within the state's boundaries. Section 414(a) of the Uniform Securities Act ("USA") thus provides that its jurisdiction reaches all persons offering or selling securities when "(1) an offer to sell is made in this state, or (2) an offer to buy is made and accepted in this state." As discussed later in more detail, determining whether any event takes place "in" and "within" a given jurisdiction raises new questions in the online world, since anyone with a PC and modem can access a Web site anywhere on which a securities offering is posted. State regulators have sought to enhance marketing on the Web by creating jurisdictional safe harbors. However, they have not yet adopted separate rules or interpretations dealing with what kind of electronic delivery will satisfy existing disclosure requirements under their blue-sky laws.