Nonpublic Internet Offerings.
THE INTERNET AND
THE CYBERSECURITIES MARKETPLACE
Denis T. Rice, July 1998
D. Nonpublic Internet Offerings.
The notion that the World Wide Web can provide a home for private placements exempt from 1933 Act registration may at first sound counter-intuitive. However, there is no reason that the Internet should be an impossible arena for private placements simply because of its global reach. If that potential reach can be in fact limited to a discrete group of sophisticated investors by screening and monitoring technology, the group would be akin to a small restricted club located inside a giant hotel. The SEC has for over a decade sanctioned the use of the Reg. D private offering exemption by pre-qualification of groups of accredited investors who would respond to extensive solicitations by furnishing extensive financial data. In a similar vein, the SEC has taken the position that the pre-qualification of a number of accredited or sophisticated investors on a Web site and electronically notifying them in a secured manner of subsequent private placements would not involve a "general solicitation," and therefore would allow the building of investor data-banks for private offerings under SEC Regulation D.
An early example of an investor data bank is "IPOnet" (www.zanax.com/iponet), which has billed itself as "the only Internet site cleared by the United States Securities and Exchange Commission to sell new Public and Private securities online." This is partly true, since IPOnet did receive a no-action letter with respect to IPOnet's method of facilitating private offerings under Reg. D. However, IPOnet was not alone in obtaining SEC authorization for an investor data bank for private placement.
Under the SEC's no-action letter, IPOnet's site can post notices of Reg. D offerings which only the accredited investors could access. IPOnet identifies four distinct investor types, primarily based upon availability of applicable exemptions under the securities laws, i.e., "General Member," "Accredited Investor," "Sophisticated Investor," and "Foreign Investor." Virtually anyone can apply for the category of General Member. A General Member receives an e-mail notice in turn every time IPOnet posts a new offering. The e-mail notice will be hot-linked to an announcement on the Web site. Only certain viewers can qualify as an Accredited Investor. IPOnet requires completion of an "Accredited Investor Questionnaire" to determine whether the person meets the standards for participation in a non-public offering under federal or state exemptions. Instead of income or net worth tests of the type required for accredited investors, a Sophisticated Investor must have a history of venture capital and restricted investments. Finally, to qualify as a Foreign Investor, a viewer must show facts sufficient to establish identity as a non-U.S. resident. The intention here is to establish a database of persons who might be eligible to participate in an offshore offering under SEC Regulation S.
IPOnet also provides for the sale of securities to viewers through an affiliated NASD member firm. Once an IPOnet viewer opens a participating brokerage account with the NASD firm, he or she may make "electronic indications of interest" directly through the Web site. This allows the viewer to purchase publicly offered securities by electronic confirmation of their purchases on the effective date. No IPOnet member can obtain access to private placements or private placement memoranda except by completing either the Accredited, Sophisticated or Foreign Investor questionnaires.
Over a year after IPOnet began operating, a non-profit entity called Angel Capital Electronic Network approached the SEC with the concept of a Web listing service that would be operated by a group of educational institutions and other non-profits. Like IPOnet, Angel Capital represented that it planned to list on its homepage small offerings exempt from registration under either Reg. A or SEC Rule 504. It would only allow "accredited Investors" meeting the criteria of Reg. D to participate would have to register on the Web site in order to access an offering circular in Form U-7. "Solicitation of interest" documents by which issuers could "test the waters" for an offering pursuant to Reg. A would also be listed. To register as an "accredited investor" and receive a password to access Reg. D private placements, a viewer would be required to certify to financial and other qualifications necessary to accredited investor status. If such an accredited investor wished to purchase stock of a small company listed on the site, the investor would contact the issuer directly. Angel Capital represented that no trading would take place on the "network" operated by the member institutions, and no employee of the site would participate in any sales transaction. However, accredited investors would be able to use a search engine within the Web site to help find the types of companies in which they would be interested. The search engine would also be able to notify an investor via the Internet if a company that listed its securities on the site has characteristics that would correlate to that particular investor's interests. The SEC determined that the Angel Capital group would not have to register as a broker-dealer or as a national securities exchange.
As of February 1998, Angel Capital Electronic Network had gone online with the home page acronym "ACE-Net" (ace-net.sr.unh.edu). The site provides online questionnaires for both prospective investors and prospective issuers. The latter must use a SCOR or U-7 Form for either a Rule 504 or a Reg. A offering (with additional requirements on the case of Reg. A).
Another example of a site generating a data bank of potential investors for exempt securities offerings, including private placements, is "INVBank" (www.invbank.com/). INVBank aims to help issuers involved in both private and public exempt transactions contact appropriate persons in its data base. It lets viewers register at one or both of two levels: (1) "SAVVY INVESTOR," or (2) member of the "INVestor's CIRCLE for Accredited Investors." The INVestor's CIRCLE is limited to those who would qualify as "accredited investors" under Regulation D. Their registration allows them to occupy a position in INVBank's "Private Placement Arena" and review various Reg. D offerings. A SAVVY INVESTOR does not have to meet the qualifications of an accredited investor. The SAVVY INVESTOR is able to access a list of companies planning to make public offerings and allowed to give any company feedback and to submit indications of interest. By clicking a link to any such issuer, the SAVVY INVESTOR receives a short and bullish description of the issuer's business.
The same principles that allowed building a secured base of accredited investors for IPOnet have been invoked in the case of private investment funds: If a fund were deemed to be making a public offering on the Internet, it would not only be subject to registration of the offering under the 1933 Act, but would have to register as an investment company under the 1940 Act. The SEC in a no-action letter agreed that an operator could post information regarding funds on a home page and other linked pages on the World Wide Web that is password-protected and accessible only to subscribers who are predetermined by the operator to be accredited investors. The private funds could post descriptive information and performance data on the site. There would be a 30-day wait after an investor became qualified before he would be allowed to purchase securities in a hedge fund.
Another form of exempt offering is one pursuant to SEC Rule 144A. Rule 144A facilitates a private placement of debt securities by a U.S. issuer (or equity or debt securities of a foreign issuer traded offshore by allowing securities that are sold to "qualified institutional buyers" (such as pension and mutual funds with at least $100 million under management or broker-dealers with at least a $10 million securities portfolio) to be exempt from registering the securities under the 1933 Act even though the securities are resold quickly to other qualified institutional buyers. Because there are no holding periods required as among such purchasers, the Rule 144A market takes on certain aspects of a public market, and Rule 144A offerings are in some ways similar to public offerings, with preliminary offering memoranda being circulated to purchasers and "roadshows" often conducted before the offering material is finalized. Such roadshow-type presentations to sophisticated investors have been a marketing tool under Rule 144A.
In January 1988 the SEC pushed the Internet envelope further out by allowing roadshows for offerings made under Rule 144A. The SEC's no-action position was conditioned on the issuer taking each of the following steps: (1) denying access to its Web site for viewing of a particular road show to all persons or entities, except those institutions for which the seller has confirmed its reasonable belief regarding their qualified institutional buyer status; (2) assigning confidential passwords to each qualified institutional buyer which will be unique to a specific road show, and expire no later than the date of termination of the related offering; (3) receiving confirmation from each seller that such seller is a qualified institutional buyer within the meaning of Rule 144A(a)(1), there exists an adequate basis for such seller's representations of its "reasonable belief" that each entity to which it has assigned a confidential password is a qualified institutional buyer, and the offering to which the particular road show relates is not subject to registration under the 1933 Act; (4) having no actual knowledge, or reason to believe, that a seller is not a qualified institutional buyer, any of the entities to which the seller has assigned a confidential password is not a qualified institutional buyer or the securities offering to which a particular road show relates is subject to registration under the 1933 Act; and (5) not being an affiliate of any seller or issuer of a security that is the subject of a particular road show.
Additional Internet use by large and sophisticated institutions involves the paperless syndication of loans by groups of lenders. IntraLinks, Inc. (www.intralinx.com) is a New York-based firm operating networks that bring together large financial institutions, using Lotus Notes technology and security and encryption protocols. The issuer pays a fee to have information on a specific loan transaction posted. Access is free to investors. Banks who are chosen for a loan syndication receive a password and user identification that enable them to log onto the lead bank's page at the IntraLinks site. They can access details of a syndication in real time. Royal Bank of Canada led one of the first "cyber-syndications in early 1996. Bank of America took the Internet loan syndication one step further in September 1997 when it used IntraLinks to syndicate a refinancing of National Semiconductor. Unlike prior loan syndications which used IntraLinks on the Internet alongside traditional paper syndication systems and paper documentation, the National Semiconductor deal was paperless. It was syndicated entirely over the electronic service.