Bank Securities Journal Online
SEC Issues Guidance on the Use of Electronic Media by Issuers
While such developments have provided individual investors with greater access to information, the dangers involved with inadequate and often inaccurate dissemination of information over the Internet has created a cause for concern by the U.S. Securities and Exchange Commission ("SEC" or the "Commission"), which published interpretive guidance and requested public comment on the issues.
As the Commission is providing interpretations and proposing rulemaking to curb abuses in connection with public and private offerings over the Internet, management of public companies and companies considering a public or private offering should be aware of several common pitfalls that may be encountered simply by communicating with potential investors on-line. For example, imagine the issuer, preparing for its first registered offering and spending thousands of dollars on its Website only to find that public access to the site prior to and during the registration process may have caused the issuer to engage in "gun jumping" in violation of the Securities Act of 1933 ("Securities Act"). Or, consider members of management in a privately held company, seeking to raise additional capital and eager to educate investors about their company and its products. To this end, management, in connection with a private offering, provides public access to their Website only to find that they have conducted a "general solicitation" within the meaning of the Securities Act, and as such, have lost any available private offering exemption. Both of these violations of the securities laws, though inadvertent, are extremely costly.
Even more startling, consider the third-party, non-registered service provider expanding public access to a company's Website in preparation for an upcoming public offering. If that third party is found to have solicited public interest in the IPO, he has effectively violated Section 15 of the Securities Exchange Act of 1934 by conducting a transaction as an un-registered broker-dealer.
These and numerous other issues facing companies who seek investors using the Internet prompted the SEC to release its recent interpretation on the use of electronic media. The guidelines have been designed to encourage the issuer to be "web friendly" in the quest to communicate and raise capital on the Internet, while at the same time maintaining compliance with the federal securities laws.
Electronic Delivery of Information to Investors
Website Content - Issues Related to Hyperlinked Information
Statements by Issuers that are reasonably expected to reach investors, including those made on the Internet, must be accurate. What about hyperlinks from Issuer's Website to third-party information and reports? Third-party information is attributable to an Issuer, if the Issuer was involved in the preparation of the information (the "Entanglement Theory"), or explicitly or implicitly endorsed or approved the information after its publication by a third party (the "Adoption Theory"). Liability under the Entanglement Theory depends upon the Issuer's level of pre-publication involvement in the preparation of the third-party information. Liability under the Adoption Theory depends upon whether, after its publication, an Issuer, explicitly or implicitly, endorses or approves the third-party information. In determining whether an Issuer adopted information on a third-party Website to which the Issuer has established a hyperlink, the SEC will consider all of the circumstances surrounding the hyperlink, including:
To avoid adoption, access to hyperlinked information should be preceded or accompanied by a clear and prominent statement from the Issuer that it is not responsible for, nor does it endorse, the information. The Issuer should not frame the hyperlink or present the hyperlinked information side-by-side with the Issuer's information, as this may increase the risk of investor confusion.
The SEC noted the following general principles in evaluating whether hyperlinked information has been "adopted":
Including Information on a Website While in Registration
Any information that the Issuer intends to include in the prospectus by a hyperlink in the prospectus to the information, must be filed as part of the registration statement and such hyperlinked information is subject to Section 11 liability. On the other hand, hyperlinking from a non-prospectus source to the prospectus would not result in the non-prospectus document being considered part of the prospectus. The other document may, however, be considered to be additional offering material subject to liability under Section 12.
A preliminary prospectus may be posted on the Issuer's Website. Posting of a prospectus does not act to make all other information on the Website part of the prospectus, unless the Issuer affirmatively makes such information part of the prospectus.
Therefore, Issuers are well advised to carefully scrub their Websites (1) to remove any reference to information that could be considered an impermissible offer and (2) to rectify any Website information that is inconsistent in any way with the Issuer's disclosures in its prospectus.
Other External Issuer Communications While in Registration
This advice should also be followed by non-public Issuers considering an initial public offering. If a first-time Issuer contemporaneously establishes a Website, the Issuer needs to apply this guidance much more strictly. When evaluating Website content, the Issuer may not have established a history of business communications in the ordinary course with the market. Therefore, investors may be unable to evaluate the Issuer's communications in an appropriate context.
Online Public Offerings
To prevent the unwary issuer, underwriter or broker-dealer from falling into a trap, and finding itself in violation of the Securities Act, the SEC reasserted two guidelines to follow, both of which are derived from the old paper-based offering process:
Online Private Offerings
How can one avoid loosing the exemption? The general view of the Commission is that a private offering may be conducted on-line if a registered broker-dealer, as agent for the Issuer, establishes that a substantive, pre-existing relationship existed with each investor to whom an offer was communicated, and confirms that each investor is accredited and sophisticated within the meaning of Regulation D under the Securities Act.
The SEC views the posting of private placement documents on a Website, absent procedures that strictly limit document access solely to accredited investors, as a general solicitation that spoils the availability of the private offering exemption.
Recently, however, third-party service providers who are neither registered broker-dealers nor affiliated with registered broker-dealers, have established Websites that invite potential investors to become "self-accredited" as a prelude to participation in a later offering. In particular, these sites often permitted investors to attain accreditation simply by "checking a box" on a standardized form, rather than completing an extensive questionnaire which would provide information needed to form a reasonable belief as to the investor's accredited status or level of sophistication. The SEC cautioned that Website operators that allow "self "accreditation may be engaged in a general solicitation.
Finally, the Commission cautioned that in addition to the general solicitation issues noted above, website operators must determine whether their activities trigger broker-dealer registration, inasmuch as such activities may constitute "effecting transactions in securities or attempting to induce the purchase or sale of securities". The release discussed certain misconceptions the market may have made regarding recent no-action positions in this area and encouraged Issuers and third-party providers to seek staff advice to resolve issues raised by non traditional activities.
For questions, comments or additional information, please contact Gerard DiFiore directly at email@example.com. Or, you may obtain biographical information at www.reedsmith.com/attorneys/alpha/d/difioreg.html.
*Gerard S. DiFiore and Michael B. Pollack are partners in the Corporate and Securities Group at the law firm of Reed Smith Shaw & McClay LLP. Matthew G. Schwartz is an associate in the Corporate and Securities Group.