The Securities and Exchange Commission ("SEC") recently issued an interpretive release to provide guidance on the use of electronic media under the federal securities laws. The interpretative release addresses three primary areas: (i) electronic delivery of documents; (ii) an issuer's liability for web site content; and (iii) the conduct of securities offerings via the Internet medium. The interpretations became effective on May 4, 2000. The SEC also seeks comments on or before June 19, 2000 concerning a number of technology concepts to determine if further regulatory action is necessary.
Electronic Document Delivery
The interpretative release clarifies some of the open questions that resulted from the SEC's published statements from 1995 and 1996 on the use of electronic media to deliver information to investors.
Telephonic Consent. The SEC clarified that an issuer or market intermediary may satisfy evidence of electronic delivery by obtaining informed consent telephonically from an investor to receive information through a particular electronic medium. As with written and electronic (e-mail) consent, telephonic consent must be obtained in a manner that assures its authenticity, and a record of such consent must be retained.
Global Consent. The SEC stated that an investor may give a global consent to the electronic delivery of documents relating to any issuer or multiple issuers, as long as the consent is informed and the individual has the ability to revoke it at all times.
Portable Document Format ("PDF"). The SEC explained that issuers and intermediaries may deliver documents in PDF if it is "not so burdensome as effectively to prevent access," i.e., if persons delivering PDF documents inform investors of the requirements to download the document when obtaining consent to electronic delivery and provide the necessary software and technical assistance for such downloading at no cost.
"Envelope Theory." Finally, the SEC provided clarification on the "envelope theory," under which documents in close proximity on a web site or hyperlinked from another web site may be considered as if sent in the same paper envelope.
- The SEC stated that the close proximity between information on a web site and a prospectus under Section 10 of the Securities Act of 1933 (the "Securities Act") does not, by itself, make such information an "offer" or an "offer to sell" within Section 2(a)(3) of the Securities Act. The SEC explained, however, that information on a web site will be part of a Section 10 prospectus if an issuer or an issuer's agent acts to make it part of the prospectus by embedding a hyperlink in the prospectus. In such instance, the hyperlinked information must be filed as part of the prospectus in the effective registration statement and will be subject to liability under Section 11 of the Securities Act.
- In contrast, the SEC stated that an external hyperlink to a Section 10 prospectus results in both documents being delivered together, but the non-prospectus document will not be considered part of the prospectus. Such non-prospectus material, however, may be subject to liability under Section 12 of the Securities Act if the external document constitutes a prospectus itself or is part of another prospectus.
Issuer Liability for Web Site Content
The interpretative release also addresses an issuer's liability for statements communicated in the Internet medium, including third-party information which has been hyperlinked from an issuer's web site, and issuer communications during a registered offering.
Issuer Responsibility for Hyperlinked Information. According to the SEC, whether third-party information is attributable to an issuer for purposes of the antifraud provisions of the federal securities laws depends on whether the issuer (i) involved itself in the preparation of the information, commonly referred as the "entanglement theory," or (ii) explicitly or implicitly endorsed or approved the information, known as the "adoption theory." While the SEC explained that it was not establishing a "bright line" test, it stated that the following non-exclusive factors are relevant to the analysis:
- what the issuer says about a hyperlink or what is implied by the context in which the issuer places the hyperlink;
- the presence or absence of precautions against investor confusion about the source of the hyperlinked information, such as disclaimers or warnings; and
- the presentation of the hyperlink itself, such as the layout of the screen, prominence of the hyperlink in size or location and the attempt to draw investor's attention to the hyperlink, such as by different color or font.
Issuer Communications During a Registered Offering. The SEC stated that when an issuer is in the process of conducting a registered offering of securities, its web site and any hyperlinks contained therein should be reviewed to determine what information might constitute a violation of the federal securities laws' communications scheme. The SEC explained, however, that an issuer in registration should continue to communicate with the public in the ordinary course of its business and that the following communications may not be considered an offer to sell securities:
- advertisements concerning the issuer's products and services;
- reports under the Securities Exchange Act of 1934 (the "Exchange Act") required to be filed with the SEC;
- proxy statements, annual reports to security holders and dividend notices;
- press announcements concerning business and financial developments;
- answers to unsolicited telephone inquiries concerning business matters from securities analysts, financial analysts, security holders and participants in the communications field who have a legitimate interest in the issuer's affairs; and
- security holder meetings and responses to security holders' inquiries relating to these matters.
Online Offerings
The interpretive release also provides guidance on both online public offerings and online private offerings under Regulation D.
Online Public Offerings. The SEC emphasized that two fundamental legal principles should guide issuers, underwriters and other offering participants in the online offering context: (i) offering participants can neither sell, nor make contracts to sell, a security before effectiveness of the related Securities Act registration statement; and (ii) until delivery of the final prospectus has been completed, written offers and offers transmitted by radio or television cannot be made outside of a Section 10 prospectus, except in connection with a business combination. Although the SEC cautioned that it was not prescribing any specific procedures to be followed in the Internet offering context, it stated that it will continue to analyze online offerings with a view toward possible regulatory action in the future.
Online Private Offerings. In the context of private offerings pursuant to Regulation D under the Securities Act, the SEC focused on the need to avoid general solicitation or advertising by offering securities in the Internet medium and stated that the absence of a general solicitation could be established by "pre-existing, substantive relationship" between issuer, or its underwriter, and offeree or qualification of such an investor by an affiliated broker-dealer. The SEC warned that merely checking a box on a web page as to accredited investor status might not satisfy the need to determine accredited status and suggested that the use of questionnaires and passwords in the Internet medium might be appropriate to form a reasonable belief as to an investor's accredited status. Furthermore, the release stated that web site operators in the online offering context may need to consider whether their activities would require them to register as broker-dealers under the Exchange Act.
Technology Concepts
The SEC also requested comments on the following technology concepts:
- whether there are circumstances in which, consistent with investor protection, an "access-equals-delivery" concept -- i.e., where investors are assumed to have access to the Internet, thereby allowing delivery to be accomplished solely by an issuer posting a document on its or a third party's web site -- would be appropriate;
- whether changes in the sophistication and expectations of Internet users as well as advances in Internet technology warrant re-evaluation of the SEC's position on whether electronic notice, or account messages on an Internet web site, provide sufficient notice to investors;
- whether there are particular circumstances under which an implied consent model -- i.e., where an issuer could rely on electronic delivery when an investor does not affirmatively object when notified of the issuer's/intermediary's intention to deliver documents in an electronic format -- would be appropriate;
- whether a paper back-up system should be required for offerings where participation is conditioned upon electronic-only delivery;
- how access to historical information on the Internet can be facilitated consistent with federal securities laws;
- how an issuer in registration can comply with its obligations under Section 5 of the Securities Act while maintaining communications to the marketplace related solely to its legitimate business activities; and
- any issues relating to Internet discussion forums.*
Use of Electronic Media, SEC Interpretive Release Nos. 33-7856, 34-42728, IC-24426; File No. S7-11-00 (April 25, 2000).