The SEC's Coming Regulatory Retreat

As I have observed before, the SEC is a juggernaut among regulatory agencies.¹

There are several explanations for the SEC's clout. It administers statutes that are broad and open-ended. It has an aggressive enforcement program, formidable remedial powers and a talented and dedicated staff. It has a history of chairmen who are politically savvy, articulate and focused. It enjoys a favorable press. By and large, it has the Congressional oversight committees eating out of its hand.

The times, however, are changing. Two powerful forces are haunting the halls at 450 Fifth Street. We all know that technology and globalization are revolutionizing the capital-raising process. At the same time, they are undermining two essential pillars of the SEC's traditional "command-and-control" regulatory philosophy.

The first of these pillars is the SEC's strict regulation under the Securities Act of 1933 (the "1933 Act") of "offers" of securities, particularly "written" offers. Other securities lawyers and I have been contending for some years that the Internet and other technological innovations have made it untenable for the SEC to continue to attempt to regulate offers. ² The second pillar is the SEC's largely unquestioned assertion of jurisdiction over offshore securities offerings that involve incidental contacts with the United States. Again, the Internet and other technological innovations have harshly illuminated the fault lines in the SEC's approach to this area.

In 1998, the SEC tried to respond to these challenges by the publication of two important releases. The first, in March 1998 ³ , tried to make some accommodation to the use of the Internet in connection with offshore securities offerings. The second, the "aircraft carrier" release of November 1998 ⁴ , proposed (among other things) a substantial expansion of issuers' and underwriters' ability to make offers before or after the filing of a registration statement. I have no doubt that both releases reflect a good-faith attempt to come to grips with the reality of the Internet. But I also have no doubt that the SEC will have to make further and much more substantial accommodations in these areas, and within a much shorter time than it probably thinks. The fact is, I would contend, that both SEC releases are based on assumptions that may have been well-founded at some time in the past but that are now hopelessly out-of-date.

The first assumption is that it is still feasible for the SEC to prohibit or restrict truthful and non-misleading communications on the grounds that they are illegal offers under the 1933 Act. Rather, it is more likely that technology has finally caught up with the SEC in the sense that it can no longer ignore the practical -- or even the First Amendment -- implications of its traditional command-and-control regulatory approach to communications, even those communications that amount to offers.

The second assumption is that it is open to a regulator in one country to prohibit or restrict truthful and non-misleading electronic communications from outside that country, at least where they do not result in transactions by the receiving country's residents. Here, too, it is likely that technology has caught up with the SEC and other international securities regulators in the sense that they can no longer ignore the international law and comity implications of their attempts to regulate cross-border communications, even those communications that relate to securities.

I. SEC Regulation of Offers

1. Traditional Regulation

Let's look first at the 1933 Act's regulation of offers. In the absence of an exemption, Section 5(c) prohibits offers of securities prior to the filing of a registration statement. (The common term for the making of such illegal offers is "gun-jumping".) Section 5(b)(1) prohibits such offers after the filing of the registration statement, if the offers are in writing and are made by any document other than the SEC-filed prospectus.

The SEC broadly construes the term "offer" as it is defined in Section 2(3) of the 1933 Act. In effect, the SEC view is that an offer includes any communication that conditions the market for a security. ⁵ This is, of course, an intentionally broad and subjective test that effectively discourages communications that could arguably relate to a proposed securities offering. A related form of regulation of "offers" applies in the area of unregistered offerings:

• Section 4(2) of the 1933 Act exempts an issuer's transactions that do not involve a public offering. The SEC has generally construed this exemption as not being available where there is a general solicitation, i.e., where an indefinite group of investors is made aware of an offering, whether or not the investors purchase the security being offered or even have an opportunity -- within the terms of the offer -- to purchase the security. ⁶ Again, this is an intentionally broad and subjective test.
• Regulation S creates "safe harbors" from the 1933 Act's registration requirements for offers and sales of securities outside the United States. One of the conditions for the safe harbors is that there be no "directed selling efforts" in the United States in connection with an offering. "Directed selling efforts" are defined as any activity undertaken for the purpose of, or that could reasonably be expected to have the effect of, "conditioning the market" in the United States for the securities being offered in reliance on the safe harbor.

Violations of the registration provisions of the 1933 Act give rise to a "put" on the part of any purchaser of securities, i.e., the right to rescind the transaction for any reason -- or no reason at all -- for up to one year after the purchase. ⁷ This is a draconian remedy that can cost an issuer or securities firm a lot of money or even put it out of business. (As I have advised more than one of my broker-dealer clients, I do not mind it if they want to sell puts to their customers -- but they ought at least to get paid for them.)

For a long time, the mainstream securities bar had relatively few difficulties -- at least in practice -- with the SEC's tight regulation of offers in connection with public offerings, private placements or offshore offerings. "Gun-jumping" was prevented by tight controls on issuer or underwriter publicity both before and after the filing of a registration statement. Private placements were policed by severe restrictions on solicitation methods and numbers of offerees. Offshore offerings were conducted in a way that resembled semi-secrecy insofar as U.S. investors were concerned.

There were occasional complaints, to be sure, primarily in the research area. The SEC created various content-based exemptions to permit the continuation of research coverage during a company's public offering. These were eventually expanded, in part under pressure from the securities industry that expressly invoked First Amendment considerations. ⁸

Of course, an issuer or underwriter could always ask counsel for advice as to whether the content, audience and timing of a communication was such as to justify the conclusion that it did not "condition the market" for the security to be offered. This "facts and circumstances" test was and is obviously difficult and expensive to apply in practice. And given the draconian consequences of a wrong decision, the securities industry has lived for many years under a severe regime of self-censorship.

Self-censorship, it should be noted, is the most restrictive form of censorship. This means that it is also the most destructive form of censorship, since otherwise-useful information either never gets created or is never used for the benefit of investors and the market.

2. "The Age of Information"

The arrival of the Internet has changed everything. But even as the current chairman of the SEC affirms that we live in an "age of information" ⁹ , his agency's efforts continue to restrict the flow of information to investors.

For example, we now have anomalies like the following:

• a broker can telephone a customer and recommend a new offering but cannot safely send the same message in the form of an email; ¹⁰
• electronic roadshows have to be structured as if they were closed-circuit TV programs; ¹¹
• issuers about to commence a public offering are told they have to worry about what is on their Websites; ¹² and
• screen-based information relating to private placements has to be password-protected so it cannot be seen by the impressionable eyes of the non-accredited investor.¹³

In the Aircraft Carrier Release, the SEC correctly notes that "[t]echnological innovations that permit instantaneous communications are a driving force behind this decade's securities market." Moreover, it admits that the traditional "facts and circumstances" test has been difficult to apply and has led to significant restrictions on communications. It also confesses that its guidance has been "vague" and "general" and difficult to apply in practice.

We might therefore have expected from the SEC -- particularly in view of the broad exemptive authority it received in the National Securities Markets Improvement Act of 1996 -- a significant relaxation of the restrictions on communications in connection with securities offerings. In fact, the Aircraft Carrier Release does propose significant relaxations. For the most part, however, the price of reform is so high as to ensure that the proposals - if they are adopted -- will result in very little additional communication.

3. The Aircraft Carrier Release

The Aircraft Carrier Release is broad in scope and not at all limited in its significance to the problems of communications in the context of securities offerings. Nevertheless, the release proposes major innovations in this area. Specifically, it proposes no fewer than nine new or amended "safe harbor" rules for communications made in the context of a registered public offering. ¹⁴

The proposed new and amended safe harbors are the following:

--- Rule 166 exempts from the prohibitions of Section 5(c) ¹⁵ all communications during the pre-filing period by 1934 Act-reporting issuers eligible to use the proposed new Form B ¹⁶ and by certain seasoned foreign governmental issuers. Rule 166 would permit these issuers and their underwriters and dealers to make offers prior to the filing of the registration statement, but any "prospectus" (i.e., any offer that is made in writing) used during the 15 days prior to the public offering's first offer would have to be filed with the SEC (with certain exceptions, most notably certain research reports and "factual business communications" as defined in proposed Rule 169, discussed below).

--- Rule 167(c) exempts from the prohibitions of Section 5(c) all pre-filing communications by issuers not eligible for the Rule 166 safe harbor that are made more than 30 days prior to the filing of the registration statement, provided that the issuer and any participating underwriter or dealer "take all reasonable steps within their control to prevent further distribution or publication of such communication during the 30 days immediately preceding the date of filing the registration statement". For example, an issuer would have to remove information from its Website during the 30-day period, or an issuer's officer would have to obtain assurances that an interview given prior to the 30-day period would not be published during the period.

--- Rule 168 exempts from the prohibitions of Section 5(c) the dissemination by a 1934 Act-reporting issuer or any participating underwriter or dealer of any "regularly released forward-looking information" during the 30-day period immediately prior to the filing of a registration statement. Forward-looking information for this purpose includes three categories of projections or statements about future performance as well as any underlying assumptions. The safe harbor is available only if the issuer "customarily releases information of this type in the ordinary course of business on a regular basis, ... has done so in the two fiscal years (and any portion of a fiscal year) immediately prior to the communication, and the time, manner and form in which it is released is consistent with past practice". ¹⁷ The safe harbor is also available only if the forward-looking information is filed with the SEC at the time the related registration statement is filed. ¹⁸

--- Rule 169 exempts from the prohibitions of Section 5(c) any "factual business communications" made by an issuer or a participating underwriter or dealer during the 30-day period immediately prior to the filing of a registration statement. Factual business communications include six specified categories of factual information about the issuer or its business; they do not include information about the registered offering or forward-looking information.

--- Rule 165, unlike the other safe harbors, applies to the period subsequent to the filing of the registration statement. According to the Aircraft Carrier Release, the SEC now believes that the post-filing period should be a time of "open dialogue" between the issuer and potential investors, provided that the issuer is accountable for the accuracy and completeness of its communications. The proposed rule therefore exempts from the prohibitions of Section 5(b)(1) of the 1933 Act the making of offers and the dissemination of information in any form after the filing of a registration statement if (i) specified prospectus information (e.g., a term sheet for Form B issuers or certain foreign governmental issuers) is delivered to the investor prior to its having made an investment decision, (ii) the issuer files with the SEC the "free-writing prospectus" permitted by the rule and (iii) the issuer files with the SEC the information required by Section 10(a) of the 1933 Act (i.e., an "official" prospectus) prior to the making of the first sale. All free-writing materials and term sheets would have to include a prominent legend advising investors to read the other disclosure documents filed with the SEC prior to making an investment decision.

There is an additional safe harbor that is not new but that arises from the merger of two current rules, i.e., Rule 135 on giving notice of proposed public offerings and Rule 135c on giving notice of unregistered offerings. The resulting Rule 135 would not require a statement as to whether the planned offering is to be public or private, thus increasing issuer flexibility. The SEC requests comment on whether it should permit notices under the amended rule to name the proposed underwriter.

The release also proposes significant relaxations to the current Rules 137 through 139 on research material released in the context of a public offering.

4. Litigation Implications of the Aircraft Carrier Release

There is no question that the current treatment of communications under the 1933 Act is "broke". There is a serious question, however, as to whether the capital-raising process is not better off under the current restrictive regime than under that proposed by the Aircraft Carrier Release.

The fundamental focus of the release, insofar as communications with investors are concerned, appears to be an effort to increase the liabilities of participants in the capital-raising process, whether by reversing or limiting the Supreme Court's Gustafson decision ¹⁹ or the Congressional judgments contained in the Private Securities Litigation Reform Act of 1995 (the "Reform Act").

It is as if the SEC, besieged by plaintiffs' lawyers complaining that the combined effect of Gustafson and the Reform Act was making it difficult to win settlements, had consciously or unconsciously decided to redress the balance. This would be a paranoid delusion, of course, but the Aircraft Carrier Release certainly moves in this direction. Some illustrations of its effects are the following:

• It discourages private placements ²⁰ , which under Gustafson are subject only to Rule 10b-5 liability;
• It encourages Form B public offerings under circumstances that severely restrict underwriters' opportunity to perform due diligence; ²¹
• It requires the incorporation into a Form B registration statement of "offering information", thus exposing the issuer and other participants in the transaction (including the issuer's directors and signing officers) to Section 11 liability for such information; ²²
• It requires the public filing of "free-writing" material, thus increasing the odds of class action litigation under Section 12(a)(2) ²³ ; and
• It multiplies the opportunities for litigation to rescind purchases under Section 12(a)(1) by conditioning 1933 Act registration on compliance with requirements that are not easily verifiable ²⁴ and by proposing to eliminate Rule 401(g)²⁵ .

As noted above, self-censorship is the worst form of censorship. Historically, issuers and securities firms have resorted to self-censorship in an effort to mitigate the draconian liabilities associated with "gun-jumping". Many observers had hoped that the SEC, with the aid of its new exemptive authority under the 1933 Act, would take decisive action to encourage the delivery of more, rather than less, information to the marketplace. The Aircraft Carrier Release largely disappoints these hopes.

The fact is that the Aircraft Carrier Release will do nothing to promote communication. This is because it substitutes one form of liability for another. The need to gather and file the specified communications (which can emanate from many participants in an offering and which can be issued unexpectedly just prior to an offering) will lead counsel to discourage the making of such communications. And where such communications are gathered and filed, they will become subject to Section 11 or Section 12(a)(2) liability -- not only for the person who created the communication but potentially for all persons liable under Section 11 and for all persons who may be considered "sellers" under Section 12(a)(2). Such persons will have little, if any, opportunity to review such materials for the purpose of the affirmative defenses of Sections 11 or 12(a)(2). The immediate consequence will be for the issuer or managing underwriter to exclude from an offering any person, e.g., an underwriter, that has created such material. The ultimate consequence will be to discourage the creation of such material in the first place.

5. Evaluation of the Aircraft Carrier Release

There are drawbacks in other areas to the Aircraft Carrier Release's proposals. The most significant of these for the capital-raising process is the proposed requirement to deliver a prospectus (or in some cases a term sheet) to investors prior to an investment decision. This proposal has the potential to materially and adversely affect issuers' ability to take advantage of favorable market conditions to raise capital. The offsetting benefit of being able to omit the physical delivery of final prospectuses is trivial by comparison.

Are there any benefits from the Aircraft Carrier Release that would offset the increased potential for litigation and the requirement to deliver pre-decision offering documents? This appears to be very unlikely. There is probably no great constituency for instantaneous Form B offerings in view of the fact that the current system of shelf registration works reasonably well. There is only marginal utility at best in the Aircraft Carrier Release's proposed devices to mitigate underwriters' liability and to encourage more due diligence by issuers' officers and directors. The Aircraft Carrier Release's greatest potential contribution could have been in the area of communications. As flawed as the current system is, however, the innovations are not indispensable. ²⁶

6. Time to Assert the First Amendment?

Most securities lawyers (and certainly the SEC) assume that the federal securities laws are somehow not subject to the First Amendment. There have been cases, of course, where the SEC has suffered near-defeat on First Amendment grounds. For example, in Lowe v. SEC, ²⁷ it took a remarkable stretch by a bare majority of the Supreme Court to avoid the First Amendment issue by construing the Investment Advisers Act of 1940 as not being applicable to publishers of newsletters.

When one thinks in First Amendment terms about the 1933 Act's regulation of offers -- something the Internet Release describes as a "fundamental element" of U.S. securities regulation -- it is hard to avoid the conclusion that there is a substantial question as to whether this regulatory scheme is constitutional. Where else can the government exact monetary penalties, bar people from their profession or send people to jail for disseminating (truthful) offering materials or for making (truthful) general solicitations? Or, by the same token, deputize a private person to rescind a transaction based on that person's (or another person's!) being the subject of a (truthful) offer or a (truthful) general solicitation?

In response to these questions, one might expect the SEC to cite dictum in a 1978 Supreme Court case (Ohralik v. Ohio State Bar Assn. ²⁸ ) to the effect that communications in several areas of the economy may be regulated without offending the First Amendment, including those related to the exchange of information about securities (citing Texas Gulf Sulphur) or to corporate proxy statements (citing Mills v. Electric Auto-Lite). The SEC might also cite a 1988 decision of the District of Columbia Circuit to the effect that the government's power to regulate speech may be a function of its power to regulate the area of the economy in which the speech occurs. ²⁹

A short rejoinder would note that while Ohralik was decided after the Supreme Court's first recognition of constitutional protection for "commercial speech" ³⁰ , it pre-dated the Supreme Court's fundamental decision in Central Hudson. ³¹ Also, the Ohralik court's reference to "information about securities" and "proxy statements" was in the context of antifraud claims, not that of information that was presumably truthful and not misleading. A rejoinder would also note that subsequent Supreme Court decisions have substantially undercut the notion that a category of speech can be denied First Amendment protection merely because it occurs in an area subject to extensive government regulation. ³²

This is not the place for an extended discussion of the First Amendment as it might apply to the 1933 Act's regulation of offers. It is worth noting, however, that investors are not injured if they simply find themselves on the receiving end of an oral or written offer of securities. There is nothing inherently harmful in such communications; indeed, there is much worse on the Internet, including pornography and the Starr Report. Rather, investors are harmed if they buy securities on the basis of false or incomplete disclosure. Investors who purchase securities on such a basis have remedies at their disposal to recover their losses. They do not need to be protected from receiving the offer in the first place.

The 1933 Act's restrictions on communications may have been justified in an environment where the 1933 Act prospectus was the principal source of information about an issuer and where the SEC's review of the registration statement was an important aspect of investor protection. They may still be justified to some extent in the case of initial public offerings. But they are certainly not necessary for issuers whose periodic reports under the 1934 Act provide investors with continuous and current information and where the antifraud remedies are available to investors and the SEC alike. As the Supreme Court said in Central Hudson, the government cannot "completely suppress information when narrower restrictions on expression would serve its interest as well." ³³

II. Cross-Border Electronic Communications

1. Traditional Regulation

The SEC published the Aircraft Carrier Release in substantial part because of the strains that electronic communication was placing on the SEC's command-and-control approach to the regulation of domestic transactions under the 1933 Act. On the other hand, the SEC's Internet Release of March 1998 was published exclusively for the purpose of relieving uncertainty about the status of electronic communications in the international context.

In its pre-electronic form, the problem has been around for some time. Many offshore securities offerings involve the use of U.S. "jurisdictional means" such as the telephone or the mail. This is often the case not because the issuer is a U.S. corporation or because the investors include U.S. persons but rather only because of the participation of U.S. investment bankers or lawyers in the preparation of the offering documents. Notwithstanding, such offerings are literally within the scope of the registration requirements of Section 5.

As yet, no one has seriously questioned the SEC's authority in this area. For its part, the SEC relieved the pressure by a famous 1964 release ³⁴ and by the adoption in 1990 of Regulation S. As in the case of U.S. domestic public offerings, so long as the offering process depended on paper offering documents, it was not difficult to prevent an offshore deal from leaking into the U.S. market in a way that might make it difficult for U.S. lawyers to opine that SEC registration was unnecessary.

All this has changed with increasing globalization and with the use of the Internet and other electronic communications vehicles. As the SEC noted in the Internet Release in March 1998, "[t]he development of the Internet presents numerous opportunities and benefits for consumers and investors throughout the world. It also presents significant challenges for regulators charged with protecting consumers and investors." These challenges arise from the fact that securities-related information posted on the Internet "can be made readily available without regard to geographic and political boundaries." Also, the interactive nature of the Internet makes it possible for investors "to purchase electronically the securities or services offered".

Moreover, the SEC is not the only national securities regulator that has expressed concern about the implications of securities-related Internet communications. In 1996, the United Kingdom's counterpart to the SEC took the position that any investment advertising would be deemed issued in the U.K. -- and constitute a criminal violation of U.K. law -- if it were possible to view the communication on a screen in the U.K. ³⁵

In 1998, both the SEC and its current counterpart in the United Kingdom, the Financial Services Authority ("FSA"), issued important statements of their views on securities-related Internet communications that are accessible by residents of their respective countries. ³⁶ Both statements were the subject of a thorough analysis in a recent article in this publication. ³⁷ I will not attempt to duplicate that analysis, except to the extent necessary to demonstrate the important differences between the two statements. And, as noted earlier, I will suggest that neither statement goes far enough when one takes into consideration the international law and comity implications of the jurisdiction asserted by the two regulators.

2. The Internet Release

1. Opportunities and Challenges

In the Internet Release, the SEC identifies the purchase of securities by U.S. persons as its primary regulatory concern. The release nevertheless goes on to state that "[t]he regulation of offers is a fundamental element of federal and some U.S. state securities regulatory schemes". It does not analyze why this is or should be the case. It does concede, however, that the SEC's interest in regulating solicitation activity is "less compelling" absent the transaction of business in the United States.

The SEC states in the Internet Release that the posting of information on a Website "may" constitute an offer of securities or investment services for purposes of the U.S. securities laws. The release does not attempt a content-based analysis of when information on a Website may constitute such an offer. Rather, it assumes that this is the case. It then states that the pertinent legal issue for the purposes of the Internet Release is whether a Website posting should be considered to be an "offer" in the United States that can trigger U.S. registration requirements.

2. General Approach

The SEC states that it rejects a regulatory approach that would require compliance with U.S. requirements for any Internet offers of securities or investment services that U.S. residents could access. ³⁸ As a general approach, therefore, the SEC states in the Internet Release that investor protection concerns under the federal securities laws can be best addressed by the use of "precautionary measures that are reasonably designed to ensure that offshore Internet offers are not targeted to persons in the United States or to U.S. persons" (emphasis added).

As noted by others, ³⁹ the concept of "targeting" is somewhat abstract. The Internet Release goes on to state that the SEC would not view an offshore Internet offer as targeted to, and therefore as occurring in the United States for registration purposes, if the offeror implements "adequate measures to prevent U.S. persons from participating" in the offer.

This is a useful statement as far as it goes. But what measures will be deemed "adequate"? The Internet Release states that "[w]hat constitutes adequate measures [for this purpose] will depend on all the facts and circumstances of any particular situation".

Fortunately, the Internet Release does more than leave market participants in an electronic version of the "facts and circumstances" game.

3. Procedures for Non-U.S. Internet Offerors

In the case of a non-U.S. person that uses an Internet Website to offer securities or investment services, the SEC would not view the offer as "targeted" at the United States if the following procedures are followed:

• The Website includes a "prominent disclaimer making it clear that the offer is directed only to countries other than the United States". This could be accomplished by stating that the offer was not being made in the United States or to U.S. persons, or by specifying the countries (other than the United States) to which the offer was being directed. ⁴⁰
• The Website offeror would also have to implement procedures that are "reasonably designed to guard against sales to U.S. persons in the offshore offering". This could be accomplished by obtaining a person's address or telephone number before making a sale.

The above procedures are non-exclusive, i.e., other procedures that "suffice to guard against sales to U.S. persons can also be used to demonstrate that the offer is not targeted at the United States".

The Internet Release states that the use of the English language in an Internet offer would not, of itself, demonstrate that the offer is targeted at the United States. This statement is certainly correct, since English is used in much of the world to conduct securities-related business. ⁴¹

Non-U.S. Internet offerors engaged in an offshore offering in reliance on Regulation S need not be concerned that their Website in connection with the offering will constitute "directed selling efforts" so long as the issuer (and its underwriters) implement "adequate measures [as discussed above] to prevent U.S. persons from participating" in the offer. Also, the issuer's or underwriters' use of the Website will not interfere with resales into the United States by bona fide offshore purchasers who are not part of the selling group, or affiliated with the issuer or a member of the selling group, and who have no prearrangement with the issuer or the underwriters relating to the Website.

What happens if the non-U.S. issuer is making a private placement in the United States of a portion of its offering? The Internet Release notes that many offshore offerings have a U.S. component, usually in reliance on a private placement exemption such as Section 4(2) of the 1933 Act or Regulation D under the 1933 Act. (Oddly, the release does not refer in this context to Rule 144A.) The Internet Release notes that Section 4(2) and Regulation D do not permit a "public offering" or a "general solicitation". In the case of non-U.S. Internet offerors relying on a private placement exemption, the Internet Release states that such issuers could (emphasis in original) implement additional procedures "to prevent their offshore Internet offers from being used to solicit participants for their U.S.-based exempt offerings". Such procedures might include either of the following:

• The foreign issuer could exclude from the private offering all persons who "respond" to the Internet offering, i.e., persons who respond "over the Internet and all persons who otherwise indicate that they are responding to the offshore Internet offering". ⁴² Importantly, however, "any investor solicited by the issuer or underwriter prior to or independent of the Website posting could participate in the private offer, regardless of whether the investor may have viewed the posted offshore offering materials (emphasis added)."
• Alternatively, the foreign issuer could arrange (in good faith) to screen U.S. persons from viewing offering information, e.g., by conditioning access to the posted information on the furnishing of a non-U.S. address.

The Release states that the posted offering materials should relate only to the offshore offering. It goes on to say that the materials "should contain only that information (if any) concerning the private U.S. offering that is required by foreign law to be provided to investors participating in the offshore public offering". This means that the Website should not be used to "sell" the U.S. private offering (unless password procedures are implemented) but that it is permissible to mention the private offering in order to provide complete information to offshore investors.

How well does the Internet Release accomplish its purpose insofar as it relates to non-U.S. issuers? As suggested above, it does overreach in requiring that a non-U.S. Internet offeror's Website state in all cases that the subject securities are not being offered in the United States or to U.S. persons. On the other hand, the SEC has obviously made an effort to avoid a situation in which a non-U.S. issuer had to choose between using a Website abroad and making a private placement in the United States. It remains to be seen, however, how well the SEC's suggested procedures will work in practice.

4. Procedures for U.S. Internet Offerors

The guidance described so far is for the benefit of Website offerors that are non-U.S. persons. By definition, the only unregistered cross-border Internet communications by U.S. persons are likely to be in connection with offshore offerings or private placements.

In the case of U.S. issuers that rely on Regulation S, the SEC does not consider them to be in the same position as non-U.S. issuers. The Release states that additional precautions are required for Internet Websites "operated by domestic issuers" because of the substantial contacts of such issuers with the United States, the stronger likelihood of "flowback" to the United States and the "greater expectation" of investors that U.S. issuers' offerings will be subject to U.S. securities laws. As a result, the SEC "would not consider a U.S. issuer using a Web site to make an unregistered offering to have implemented reasonable measures to prevent sales to U.S. persons unless, in addition to the general precautions ... [discussed above], the U.S. issuer implemented password-type procedures that are reasonably designed to ensure that only non-U.S. persons can obtain access to the offer" (emphasis added). This means that persons seeking access to the Internet offer "would have to demonstrate to the issuer or intermediary that they are not U.S. persons before obtaining the password for the site".

The Internet Release also advises U.S. issuers engaged in an offshore offering, a part of which is to be made available to eligible U.S. investors in a private placement, that they should implement password-type procedures to ensure that U.S. investors are not able to access an Internet Website that carries offering material.

The Internet Release therefore offers substantially less relief to offshore securities offerings of U.S. issuers that it does to offerings by non-U.S. issuers. Password protection, after all, is not a minor incovenience: passwords are disliked by investors and securities firms alike. They are cumbersome, easily lost and easily compromised. The SEC's insistence on password protection is hard to understand. What is the purpose of trying to prevent a U.S. person from viewing a Website offer so long as the U.S. person cannot purchase the security?

5. Concurrent U.S. Registered Offering

If a registered offering in the United States takes place concurrently with an unregistered offshore offering, the use of an Internet Website raises "gun jumping" concerns. The Internet Release states that "premature posting of offering information must be avoided" and refers to Rule 135 for guidance on pre-filing announcements. The Internet Release does not expressly address the permissibility, after the filing of a registration statement, of posting non-prospectus information on a Website for use by offshore investors. In light of the approach taken in the Internet Release, the SEC would likely approve of such a posting only if procedures were implemented to prevent access by U.S. persons.

6. Status of Internet Release

As an interpretive statement issued by the SEC, the Internet Release is highly authoritative. It would appear that anyone relying in good faith on the release would be entitled to the protection afforded by Section 19(a) of the 1933 Act even if a court were to disagree with the SEC's interpretation.

3. Financial Services Authority ("FSA") and the Internet

In the view of the FSA and its predecessor bodies, the United Kingdom's Financial Services Act (1986) applies to an advertisement or other information issued outside the U.K. if it is directed to persons in the U.K. or is made available to them (otherwise than in a newspaper or similar publication or in a sound or TV broadcast transmitted principally for reception outside the U.K.).

The FSA's predecessor originally took the position that any investment advertising would be deemed issued in the U.K. if it were possible to view the ad on a screen in the U.K. ⁴³ In particular, it did not consider the Internet to be a sound or TV broadcast. Moreover, mere disclaimers would be insufficient to remove a communication from the reach of the Act if the communication was actually received in the U.K.

The FSA position was ironic in view of the U.K.'s readiness in the past to protest attempts by the U.S. to regulate U.K. companies without an adequate jurisdictional basis. In particular, the U.K. was reported in 1966 to have protested to the U.S. Department of State the SEC's proposal to extend certain provisions of the 1934 Act to unlisted U.K. companies. ⁴⁴

In response to a request by the Investment Company Institute, the FSA earlier this year issued additional guidance. ⁴⁵ With all respect to the views of other observers, ⁴⁶ this writer finds the new statement (like its predecessor) to be in fact a "knee-jerk exercise of jurisdiction over all Internet transactions". Apart from stating that some electronic publications could fall within the Act's definition of "periodical publication" and thus escape coverage under the Act, the new statement concedes nothing in terms of the Act's coverage of "much of the information on the Internet". It also concedes nothing in terms of the inadequacy of disclaimers to take an electronic communication outside the coverage of the Act.

Like the previous statement, the new statement is to the effect that the FSA's enforcement policy would be determined on a case by case basis, taking into account the particular circumstances (including principally whether or not U.K. investor protection issues are involved) and all relevant factors including:

• whether the site is located on a server outside the U.K. (in the writer's view, as irrelevant a factor as one can imagine and one that the FSA concedes will not be "conclusive evidence that material on that site was aimed at the UK");
• the extent to which the underlying investment or investment service was available to U.K. investors who responded to the communication (including whether the investment or investment service is available to U.K. investors "through other media");
• the effectiveness of a system ("positive steps") for limiting access to the Website and for limiting the receipt of investment services (and, presumably, investment products) to those who may lawfully receive them; and
• the extent to which any advertisement is "directed" at persons in the U.K.

As to the last factor (compare the concept of "targeting" as expressed in the SEC's Internet Release), the FSA would form a judgment on a case by case basis, but the following non-exhaustive list of factors (according to the statement's accompanying press release) "may be relevant":

• disclaimers and warnings;
• the degree to which it is clear that the communication is not aimed at U.K. investors;
• whether the communication is promoted through any search engine, listing, email, newsgroup, bulletin board or chat room; and
• whether there is any advertising in the U.K. of the site that carries the communication.

Unlike the SEC's interpretive statements in the Internet Release, the FSA guidance has no legal effect. It is simply a statement of the FSA's present policy on enforcement action. As the statement puts it, "[i]nterpretation of the Act is ultimately a matter for the Courts. This statement is an expression of the enforcement policy of the FSA, and as such, does not bind any Court or any other body with enforcement or prosecution powers under the Act."

Even on its own terms, the new FSA guidance still leaves too much room for interpretation and administrative discretion. It is no consolation to a client that maintains a Website that it is potentially committing a criminal violation of U.K. law but that the authorities are unlikely to take enforcement action. And as in the case of the SEC's Internet Release, where is the harm where U.K. investors are able to view an Internet site that contains information about securities that the U.K. investors are unable to purchase?

4. Jurisdictional Limitations

Section 2(a)(7) of the 1933 Act broadly defines the term "interstate commerce". Literally, any telephone call from abroad could violate the registration provisions of the 1933 Act. In antifraud cases, the Second Circuit has found limiting principles in terms of whether activity that takes place outside the United States can have adverse "effects" on U.S. investors or whether "conduct" in the United States causes or contributes to a loss suffered abroad. The SEC has always carefully preserved this broad antifraud (and antimanipulation) jurisdiction whenever it has created a jurisdictional exception to the registration requirements of any of the statutes that it administers.

Recently, however, the Second Circuit decided a case (Europe and Overseas Commodity Traders, S.A. v. Banque Paribas London) ⁴⁷ involving the Canadian owner -- Alan Carr -- of a Panamanian company with offices in Monaco. Carr entered into discussions in London with the London branch of a French bank about a possible investment in a Luxembourg fund managed by the bank. Carr told the bank he was leaving for Florida and would continue the discussions there. While in Florida, he engaged in several telephone conversations and ultimately made an investment on behalf of his Panamanian company in shares of the Luxembourg fund. Subsequently, he sued the bank in U.S. district court alleging violations of the registration provisions of the 1933 Act and of the Investment Company Act of 1940 and violations of the antifraud provisions of the 1933 and 1934 Acts.

The district court dismissed the complaint for lack of subject matter jurisdiction, and the SEC filed an amicus brief with the Second Circuit supporting application of the 1933 Act's and 1940 Act's registration provisions as well as the antifraud provisions.

The Second Circuit affirmed the dismissal of the complaint. Its opinion is remarkable. It is the first judicial determination that a transaction that does not qualify for any of the safe harbors of Rule 903 of Regulation S nevertheless qualifies for the general exemptive statement in Rule 901 that the 1933 Act does not apply to "offers and sales that occur outside the United States" (and notwithstanding that the purchaser was physically in the United States at the time of purchase).

In coming to its conclusion about 1933 Act registration, the court had to consider the Congressional purpose in drafting the "registration laws". It stated that the registration provisions should apply to those offers of unregistered transactions that tend to have the effect of creating a market for unregistered securities in the United States. (In this context, "creating a market" did not necessarily mean a large number of people.)

On the facts, however, the court found that there was "nearly de minimis U.S. interest" in the transactions before it. The conduct in the United States was not "such as to have the effect of creating a market for those securities in the United States".

On the question of antifraud jurisdiction, the court recognized that precedent required a looser definition of subject matter jurisdiction. Notwithstanding, the transactions did not implicate any "relevant interest of the United States".

[A] series of calls to a transient foreign national in the United States is not enough to establish jurisdiction under the conduct test without some additional factor tipping the scales in favor of our jurisdiction. Without such added weight, the exercise of prescriptive jurisdiction by Congress would be unreasonable within the meaning of the Restatement of Foreign Relations [Law] ... §§ 416(2) and 403 (1987) and is particularly so when the transaction is clearly subject to the regulatory jurisdiction of another country with a clear and strong interest in redressing any wrong. ⁴⁸

To be sure, the court's result was dictated in part by the fact that no U.S. person had been harmed. But where is the "harm" when a U.S. person is the recipient of an "offer" that the U.S. person cannot accept because of the fact that the offer is made only to non-U.S. persons? Given the court's analysis, could the SEC really proceed against a U.S. or foreign issuer or underwriter that failed to display the SEC-mandated disclaimers or to implement the other precautions specified in the Internet Release, so long as no U.S. investor actually purchased unregistered securities? And in view of the "reasonableness" requirement expressed in the Restatement (both as a matter of U.S. law and as a matter of international law), could the U.K. really bring criminal charges against a person whose Internet Website was received in the U.K. but where no unauthorized person was able to purchase the subject securities? More to the point, could the SEC - in view of its responsibilities for the U.S. capital markets - remain silent if the U.K. or another country were to attempt to do so?

III. Conclusion

I think it is inevitable that national securities regulators such as the SEC and the FSA will have to conclude -- and soon --that Internet notices do not implicate their regulatory schemes, absent actual sales to persons not eligible to make purchases. In this connection, a task force of the International Organization of Securities Commissions ("IOSCO") is currently working on the development of recommendations for IOSCO members on regulatory approaches to the Internet. ⁴⁹ The task force has the opportunity to make a valuable contribution in this area. If it does not, of course, it will be up to the SEC to resist unreasonable attempts by foreign regulators to assert jurisdiction over U.S. persons' non-harmful Internet communications. The SEC would be more convincing in this role if it would quickly move to modify the objectionable features of its own Internet Release.

To return closer to home, the SEC's insistence on regulating domestic offers under the 1933 Act will have to be the subject of further exemptive relaxation -- without the onerous conditions proposed in the Aircraft Carrier. The SEC's alternatives are to risk the possibility of modification by Congress or having its regulatory scheme held unconstitutional under the First Amendment.

If this is really the "age of information", the time has come to start acting as if we meant it.

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1. 'Ten Easy Pieces' for the SEC, 18 Rev. Secs. & Comms. Reg. 200, 201 (1985).
2. See, e.g., the letter dated December 11, 1996 of the American Bar Association's Committee on Federal Regulation of Securities (Section of Business Law) commenting on SEC Release No. 33-7314 (July 31, 1996) (S7-19-96).
3. SEC Release No. 33-7516 (March 23, 1998) (the "Internet Release").
4. SEC Release No. 33-7606 (November 3, 1998) (the "Aircraft Carrier Release").
5. See Charles J. Johnson, Jr. and Joseph McLaughlin, Corporate Finance and the Securities Laws 27-28 (2d ed. 1997).
6. Id. at 386-409.
7. Sections 12(a)(1), 13.
8. The "research rules" include Rules 137, 138 and 139. See Johnson & McLaughlin, supra note 5, at 158-63.
9. Arthur Levitt, "Corporate Finance in the Information Age" (January 23, 1997) (remarks delivered to Securities Regulation Institute, San Diego, California).
10. See Joseph McLaughlin, "Booting" the Federal Securities Laws into the 21st Century, 7 InSights 21 (1997).
11. See SEC No-action Letters, Private Financial Network (March 12, 1997), Net Roadshow, Inc. (September 8, 1997), Bloomberg L.P. (December 1, 1997).
12. Internet Release, Section VII.A.1.c.i (text following note 298).
13. SEC No-action Letters, IPONET (July 26, 1996), Lamp Technologies, Inc. (May 29, 1997), Net Roadshow, Inc. (January 30, 1998).
14. Apart from proposals that would provide greater clarity on switching from private to public offerings, and vice versa, the Aircraft Carrier Release does nothing to clarify the concept of "general solicitation" in the context of private placements.
15. The effect of exempting a communication from the prohibitions of Section 5(c) is to preserve the ability of an investor to argue that the communication amounts to a "prospectus" within the meaning of Section 2(10) and that the negligence-based Section 12(a)(2) remedy is available if a security was sold to the investor "by means of" the communication. Prior to the SEC's receipt of exemptive power in the National Securities Markets Improvement Act of 1996, the SEC's ability to exempt communications from the prohibitions of Section 5(c) was limited to defining certain communications as not constituting "offers" for purposes of Sections 2(10) or 5(c) of the Act. See, e.g., current Rule 139 relating to research reports. The effect of such a definition was arguably to remove the communication from the reach of Section 12(a)(2) and leave the investor to whatever remedy might be available under Rule 10b-5. As will be seen, the principal outcome of the Aircraft Carrier Release may well be a dramatic expansion of the negligence-based remedies provided by Sections 11 and 12(a)(2) of the 1933 Act.
16. In order to be eligible to use Form B, an issuer would have to meet specified reporting requirements, not be subject to specified disqualifications and have either (1) a public float of voting and non-voting common equity securities of $75 million or more and an average daily trading volume in U.S. markets of $1 million or more or (2) a public float of $250 million or more.
17. Although the safe harbor applies by its terms to underwriters and dealers, there is no elaboration on whether an underwriter or dealer may rely on the safe harbor to disseminate its own forward-looking information about the issuer or, if so, what "track record" will be sufficient for this purpose.
18. The information would have to be filed as part of a Form B registration statement and therefore become subject to Section 11 liabilities. It is not clear whether such information would have to be filed as part of a Form A registration statement.
19. Gustafson v. Alloyd Co., 513 U.S. 561 (1995).
20. E.g., by proposing to abolish "Exxon Capital" exchange offers and to increase the difficulty of reselling restricted securities on a registered basis. The Aircraft Carrier Release also holds out the possibility of increasing the eligibility standards for "qualified institutional buyers" under Rule 144A.
21. Due diligence would be extremely difficult if issuers could launch Form B offerings on no notice whatsoever. Indeed, the current shelf registration system works quite well for most issuers, and there would appear to be little demand for the kind of "instantaneous offering" that Form B would permit. (It is odd to see the SEC touting the absence of "market overhang" as an advantage of Form B over shelf registration, particularly since investors might be interested in being informed of the existence of "overhang".)
22. See paragraph 4(b) of proposed Form B.
23. Rule 425 would require that such material be filed with the SEC. A filing could assist the plaintiffs' bar in at least two ways: (1) it would be easier to meet the procedural requirements for a class action by making it possible to allege that a large number of investors were (or must have been) influenced by the publicly-available communication, and (2) it would be easier to allege that the person originating the filed material had Section 12(a)(2) liability to non-customers on the theory that the originator was "soliciting" such non-customers by means of the publicly-available communication and was therefore a "seller" to such non-customers within the meaning of Section 12(a)(2) as construed in Pinter v. Dahl, 486 U.S. 622, 641-47 (1988).
24. Form B will not be available if, among other things, (1) the issuer or any of its directors or executive officers or any underwriter was involved within five years before filing in specified legal proceedings or (2) an incorporated 1934 Act document is the subject of unresolved SEC staff comments. Also, it is also unclear whether the registered status of the offered securities is undermined if "free writing" or "offering" information is not filed as required by the new rules.
25. Rule 401(g) now states that a registration statement is deemed to be on the proper form unless the SEC objects prior to the effective date. The Aircraft Carrier Release proposes to eliminate this presumption for registration statements -- such as Form B -- that become effective automatically at a time designated by the issuer.
26. For example, most securities lawyers probably do not worry a great deal about problematic "offers" that take place prior to 30 days before the filing of a registration statement or the commencement of a marketing effort. As Arthur Levitt noted in early 1997, "[i]f something is said well in advance of a public offering, it's hard to argue that someone is conditioning the market." "Corporate Finance in the Information Age" (January 23, 1997) (remarks delivered to Securities Regulation Institute, San Diego, California).
27. 472 U.S. 181 (1985).
28. Ohralik v. Ohio State Bar Assn., 436 U.S. 447, 456 (1978).
29. SEC v. Wall Street Publishing Institute, Inc., 851 F.2d 365, 373 (D.C. Cir. 1988).
30. Virginia State Board of Pharmacy v. Virginia Consumer Council, 425 U.S. 748 (1976).
31. Central Hudson Gas & Elec. Corp. v. New York Pub. Serv. Comm., 447 U.S. 557 (1980).
32. See, e.g., Washington Legal Foundation v. Friedman, 13 F.Supp.2d 51, 60-62 (D.C.D.C. 1998).
33. 447 U.S. at 565.
34. Release No. 33-4708 (1964).
35. See "Investment advertising over the Internet" (available on the Financial Services Authority's Website at www.fsa.gov.uk).
36. In the case of the SEC, its Internet Release is cited at note 3 above. In the case of the FSA, its statement is titled "Treatment of material on overseas Internet World Wide Websites accessible in the UK but not intended for investors in the UK" (May 28, 1998) and is available on the FSA's Website at www.fsa.gov.uk.
37. Michael D. Mann, Donna I. Dennis and Steve T. Kang, Managing the Risk of Enforcement Action Based on Website Activity, 2 wallstreetlawyer.com (June and July 1998).
38. The SEC refers in this connection to a recommendation of the North American Securities Administrators Association ("NASAA") ("the NASAA resolution"), implemented in more than 30 states, that exempts "Internet offers" from state registration and advertising requirements when the offers provide that they are not being made in that state and where sales are made only after registration or pursuant to an exemption.
39. Mann, Dennis & Kang, supra note 37, at 5 (June 1998).
40. The release does not explain why an Internet offeror located in Iran should have to state on its Farsi-language Website that its exclusively in-country offer is not being made in the United States or to U.S. persons. But see note 41.
41. The Internet Release does not state the converse, i.e., that the use of a language other than English will suffice to show that the offer is not targeted at the United States. On the other hand, most non-English Websites would not rise to the status of an "offer" in the first place (with some conceivable exceptions such as Spanish-language Websites directed to retail markets in the United States).
42. Even if excluded from the current offering, according to the release, eligible U.S. respondents (e.g., accredited investors) could participate in future offerings.
43. See note 35.
44. See Committee on International Law, Association of the Bar of the City of New York, The 1964 Amendments to the Securities Exchange Act of 1934 and the Proposed Securities and Exchange Commission Rules -- International Law Aspects, 21 The Record 240, 252 (1966). For other illustrations of U.K. protest of allegedly "exorbitant" applications of U.S. law, see Reporters' Note 1, Restatement (Third), The Foreign Relations Law of the United States § 403 (1987).
45. See note 36
46. Mann, Dennis and Kang, supra note 37, at 3 (June 1998).
47. 147 F.3d 118 (2d Cir. 1998).
48. 147 F.3d at 129 (footnote omitted).
49. See Michael A. Geist, From Fact-finding to Rulemaking -- The IOSCO Internet Initiative Rolls On, 2 wallstreetlawyer.com 37 (1998).