Securities Disclosure Implications on the Net and Other Electronic Media

The Internet offers several important opportunities to enhance the capital formation process by (i) reducing the marginal cost of distributing information; (ii) creating more liquid and transparent secondary markets; (iii) broadening the geographic reach of issuer information; and (iv) enabling the desegregation of traditional gatekeeper functions. (See Footnote 1.)

The Securities and Exchange Commission (the "SEC") and its staff have issued three significant interpretive releases, technical rule amendments and a number of no-action and interpretative letters relating to use of the Internet. (See Footnote 2.) The SEC also has brought a number of enforcement proceedings that involved allegations of fraudulent statements and/or practices over the Internet.

In light of the heightened regulatory awareness, care must be taken in your company's use of the Internet or other electronic media (e.g., electronic mail, bulletin boards, computer networks, etc.) to avoid violation of the federal or state securities laws.

This article discusses several areas in which the federal securities laws have direct applicability to communications on the Internet and by electronic mail.

Delivery Requirements

The SEC has stated that it believes that delivery of information through an electronic medium generally could satisfy delivery or transmission obligations under the federal securities laws. The SEC positions are grounded in the belief that the question whether delivery through electronic media has been achieved is most easily examined by analogy to paper delivery procedures. For example, as in the case with paper delivery, there should be an opportunity to retain a permanent record of the information, information required to be presented in a certain order should be presented in that order electronically, and procedures should be in place to ensure that delivery has taken place.

Failure to effect proper delivery may have adverse consequences under the Securities Act of 1933, as amended (the "Securities Act") and/or the Securities Exchange Act of 1934, as amended (the "Exchange Act") (i.e., rescission remedy for investor if a prospectus is not properly delivered, improper solicitation of stockholders, etc.).

The SEC has articulated the following specific areas of concern.

• Notice -- When an issuer delivers a paper document through the postal mail, the investor will most likely be made aware that new information exists and that the investor might have to take some action within a certain period of time. Issuers providing electronic information should consider the extent to which the electronic communication provides timely and adequate notice to investors that information is available for them and, if necessary, consider supplementing the electronic communication. For example, simple posting on the Internet would not provide adequate notice that new information is available while e-mail delivery with a confirmation feature most probably would provide adequate notice.

• Access -- Recipients who are provided information electronically should have access to such information in a non-burdensome way. For example, the investor should not have to proceed through a confusing series of menus to access a required document.

• Evidence of Delivery -- Issuers and others providing electronic delivery of information should have reason to believe that any electronic means selected will result in the satisfaction of delivery requirements. Examples offered by the SEC include (i) obtaining an informed consent from an investor to receive the information through a particular electronic medium coupled with assurances of appropriate notice and access; (ii) obtaining evidence that an investor actually received the information (e.g., by electronic mail return-receipt or confirmation of accessing, downloading or printing); (iii) disseminating information through certain facsimile methods (e.g., investor has requested the prospectus and provided the telephone number of the fax machine); (iv) an investor's accessing a document with evidence of hyperlinking to a required document; and (v) using forms or other material available only by accessing the information.

Violations of the Registration Requirements of the Securities Act/Private Placements

Special care should be taken to avoid solicitation of investors without either (i) registering the securities under federal, and any applicable state, securities laws or (ii) falling within an available exemption from such registration requirements. (See Footnote 3.)

A company's use of the Internet during a private offering must be analyzed with care. One of the principal issues to consider is that of compliance with the "general solicitation" prohibition under Rules 505 and 506 of Regulation D promulgated under the Securities Act. The SEC has indicated that a company's placement of its offering materials on its Web site constituted a violation of Rule 502(c) of Regulation D (which prohibits general solicitation and advertising in the making of private offerings exempt from registration under Regulation D) because anyone using the Internet could access the offering materials. The SEC took this position despite the fact that the issuer required various types of information from the person attempting to access the offering materials prior to displaying such offering materials.

In a July 1996 no-action letter (IPOnet, July 26, 1996), the SEC indicated its approval of an example of how to conduct a private offering over the Internet without the general solicitation problem. The IPOnet Web site is designated so that private offerings are listed on an "accredited investor" page, a page that cannot be accessed by all Internet users, only those who complete a screening process conducted by a party other than the issuer utilizing generic electronic questionnaires. Once a potential purchaser is qualified and given a password, his access is limited to those offerings made subsequent in time to his qualification as an accredited or sophisticated investor, and then only after a sufficient amount of time has elapsed between the user's acceptance as an investor and the inception of the issuer s private offering. This additional delay is intended to ensure that the qualification of a user as an accredited or sophisticated investor cannot be viewed as a general solicitation or advertisement for a particular private offering.

In other developments, California corporations (or foreign corporation subject to Section 2115 of the California Corporations Code), may solicit accredited investors residing in California (by means of a general announcement ) through the Internet without violating the state securities statute. (See Footnote 4.) At least one member of the SEC has indicated that the California standard should become a national one. However, the SEC has not yet adopted this position. (See Footnote 5.)

Forward-Looking Statements on the Company's Web Page

The Private Securities Litigation Reform Act of 1995 (the "Reform Act") established a new safe harbor under the federal securities laws for disclosure of forward-looking information. As a result, forward-looking disclosures made in registration statements filed under the Securities Act (except IPOs), periodic reports filed under the Exchange Act (e.g., Forms 8-K, 10-Q and 10-K), press releases and even oral statements may take advantage of the safe harbor if appropriate cautionary statements are made or referenced. In each of the above-referenced communications, conscientious companies generally have procedures in place for review of these documents or communications by persons familiar with securities disclosure obligations and the potential liabilities that may result from non-compliance with such requirements. However, in connection with a company's Web page, many companies often treat such disclosures with less or no concern for securities law compliance. Set forth below are points to consider regarding Web page disclosures and procedures.

• Who is responsible for compiling and updating your company's Web page? As a rule of thumb, the same group of professionals who scrutinize your company's press releases should also scrutinize the content of your Web page.

• Are the statements made on the Web page overly optimistic? Are they forward-looking? If so, consider including specific cautionary statements or references to cautionary statements or risk factors made in other published reports filed with the SEC.

• Is the Web page information dated, similar to a periodic report or a press release? A suggested practice is to date your Web page that contains forward-looking information and disclaim a duty to update.

• Does your Web site reference or link users to analyst reports? If so, consider the implications. The suggested practice is not to make specific references to, comment upon, or use a hyper-link function to allow linkage to, analyst reports.

• Remember, the safe harbor under the Reform Act only protects your company under the federal securities law. Plaintiffs can still bring causes of action under state securities laws; however, carefully drafted cautionary statements can be used to minimize the liability risk.

• Warning: In addition to the countless thousands who "hit" your Web page and become informed and excited about your company, there are droves of plaintiff lawyers looking for material to include in an upcoming class action complaint.

E-Mail Communications

Special care should be taken with electronic mail messages, with respect to content, audience and timing. The following real-life example illustrates the point. A CEO during the "quiet period" sent an intra-office e-mail message to the company's employees regarding the company's prospects. The e-mail message was leaked to the media and published. The IPO was then cancelled due to gun-jumping concerns (i.e., conditioning the public's mind or stimulating the market). (See Footnote 6.)

Conclusion

In a letter to Spring Street Brewing Company (the first company to conduct a public offering over the Internet) in March 1996, the staff of the SEC stated that "[i]nnovation and creativity are the hallmark of our nation's securities markets, contributing enormously to the most efficient capital formation system in the world. We try to encourage such modernization, but it is our job, first and foremost, to insure protections for public investors." In the current regulatory environment, a good rule of thumb is to treat public communications sent electronically in a similar manner as any other type of public communications sent by the company.

1/ Remarks of the Honorable Steven M.H. Wallman, Commissioner, U.S. Securities and Exchange Commission before the 28th Annual Institute on Securities Regulation, New York, New York (October 31 - November 2, 1996) (the 28th Annual Securities Institute). return

2/ See Securities Act Rel. No. 7233, Exchange Act Rel. No. 36345, Investment Company Act Release No. 21399 (October 6, 1995); ( Release 7233"); Securities Act. Rel. No. 7234, Exchange Act Rel. No. 36346, Investment Company Act Release No. 21400 (October 6, 1995) ( Release 7234") [Release 7233 and Release 7234 are companion releases]; Securities Act Release No. 7288, Exchange Act Rel. No. 37182, Investment Company Act Release No. 21945, Advisers Act Rel. No. 1562 (May 9, 1996). return

3/ See SEC v. Pleasure Time, Inc., Lit. Rel. No. 14440 (March 15, 1995). return

4/ Section 25102(n) of the California Corporations Code. Also see Commissioner's Opinion 96/2C, File No: OP6600, dated October 17, 1996, re: IPONET/W.J. Gallager & Company, Inc. return

5/ Remarks of the Honorable Steven M.H. Wallman, Commissioner, U.S. Securities and Exchange Commission before the 28th Annual Securities Institute. return

6/ See Deborah Lohse and Joan Indiana Rigdon, Wired Kills IPO Amid Mishap With E-Mail, Wall St. J., Oct. 25, 1996, at C1, C17. return