United States: SEC issues - New Internet Release

The U.S. Securities and Exchange Commission's Interpretive Release on the Use of Electronic Media – its most recent Internet release – took effect on May 4, 2000. Although the Release does not break significant new ground, and in this respect was disappointing to many people involved with the securities industry, it does provide some additional guidance on the use of electronic media by operating companies, investment companies, municipal securities issuers (which is not discussed in this article) and market intermediaries.

The Release has five main components, the first three of which are discussed in this article. First, the SEC updated its previous guidance on using electronic media to deliver documents. Second, the Release addresses an issuer's liability for web site content. Third, the Release outlines selected principles that issuers and market intermediaries should consider when conducting online offerings. In addition, the Release seeks comment on a number of online issues and provides examples illustrating some of the principles discussed in the Release.

The SEC published its first Release concerning electronic delivery of information in 1995, which was followed by another Release in 1996. The 2000 Release expands upon the earlier Releases by clarifying four areas:

The three elements of satisfactory electronic delivery are notice, access and evidence of delivery. One method of satisfying the "evidence of delivery" requirement is to obtain an informed consent from an investor to receive information through a particular electronic medium. The 1996 Release indicates that informed consent should be by written or electronic means.

The 2000 Release expands upon the 1996 Release by permitting an issuer or market intermediary to obtain telephonic consent as long as a record of the consent is retained and consent is obtained in a manner that assures its authenticity. The record of the telephonic consent should contain as much detail as a written consent, including whether the consent is global (see below) and what electronic media will be used.

The 1995 Release indicated that consent to electronic delivery could relate to all documents of a single issuer and that an issuer could rely on consent obtained by a market intermediary such as a broker-dealer. The 2000 Release expands upon this, indicating that an investor can give a global consent that relates to all documents of any issuer – not just a single issuer – in which the investor buys or owns securities through a particular intermediary.

In order to be valid, the global consent must be informed; the investor should understand that he or she is providing a global consent to electronic delivery and must be apprised of the time and scope parameters of the consent. This can be achieved through an account agreement that contains a separate section with a separate electronic delivery authorization or through a separate consent. If the consent does not require a separate authorization it may not be informed. In addition, the 2000 Release indicates that a global consent would not be informed if opening the brokerage account were conditioned upon consent, unless the account is to be opened online and all transactions are to be initiated and conducted online.

The consent also must specify the types of electronic media to be used, such as a limited proprietary system or an Internet web site. Additional media can only be added with a further informed consent. The consent, however, does not need to specify the medium to be used by any particular issuer. It also does not need to identify the issuers covered by the consent, although, if it does identify the issuers, it may provide that additional issuers can be added later without further consent.

According to the 2000 Release, the consent also should advise the investor of his or her right to revoke the consent at any time and to thereafter receive paper documents. However, in order to ease its administrative burden, an intermediary may require revocation on an "all-or-none" basis if this is adequately disclosed when the consent is obtained.

The 1995 Release indicated that the use of a particular electronic medium should not be so burdensome that intended recipients cannot effectively access the information. Many issuers and intermediaries have interpreted this to preclude delivery of PDF documents that cannot be accessed without special software. The 2000 Release indicates that PDF can be used if two requirements are met. First, issuers and intermediaries must inform investors of the requirements necessary to download PDF files when obtaining consent to electronic delivery. Second, they must provide investors with any necessary software and technical assistance at no cost.

The 1995 Release contained guidance for issuers and intermediaries that electronically deliver documents when they are required to deliver multiple documents simultaneously to investors, i.e., in the same "envelope." The 2000 Release further clarifies this guidance.

The 2000 Release indicates that a hyperlink from an external document to a prospectus would result in both documents being delivered in the same envelope, but would not result in the external document being deemed to be part of the prospectus. An issuer may nevertheless be subject to liability under Section 12 of the Securities Act for the external document if it otherwise is a prospectus or part of one.

The 2000 Release also clarifies that information posted on a web site only will be part of a prospectus if the issuer or a person acting on its behalf acts to make it part of the prospectus, such as by including in the prospectus a hyperlink or an inactive URL that a software program turns in to an active hyperlink. When embedded hyperlinks are used, the hyperlinked information must be filed with the SEC as part of the prospectus and will be subject to liability under Section 11 of the Securities Act. An issuer may not use an embedded hyperlink to satisfy the line item disclosure requirements of a federal securities law filing. In addition, an embedded hyperlink alone does not satisfy the line item disclosure requirement for incorporation by reference; to incorporate a document by reference in a filing, there must be a statement to that effect in the filing listing the incorporated document.

The 2000 Release also addresses the concern raised by some securities lawyers that information on a web site that is outside of the prospectus, but in close proximity to it, would be considered "free writing" (i.e., an offer to sell the securities covered by the prospectus). The 2000 Release indicates that the focus on the location of the posted prospectus in determining whether there is free writing is misplaced; the free writing analysis is the same for both online and offline communications. Therefore, irrespective of whether or where the prospectus is posted, web site content should be reviewed in its entirety to determine whether it contains free writing.

The second topic addressed in the 2000 Release is web site content, both when issuers are in registration and at other times.

Third-party information is attributable to an issuer when it endorses or approves the information. This is known as the "adoption" theory and is especially of concern in the context of analyst reports. To the extent that an issuer is deemed to have adopted third-party information, it can be held liable for material misstatements and omissions in the information.

The 2000 Release discusses three non-exclusive factors that may be relevant in determining whether an issuer has adopted information on a third-party web site to which it has established a hyperlink:

Context of the Hyperlink. Whether an issuer is deemed to have adopted hyperlinked information may be influenced by what the issuer says about the hyperlink or the context in which it places the hyperlink. The 2000 Release indicates that, when an issuer includes a hyperlink in a document required to be filed or delivered under the federal securities laws, the issuer always should be deemed to be adopting the hyperlinked information. In addition, when the issuer is in registration, if it establishes a hyperlink from its web site to information that constitutes an offer to sell the securities being registered, a strong inference arises that the issuer has adopted the information. Therefore, when in registration, an issuer should carefully review any information on third-party web sites to which it hyperlinks.

Risk of Confusion. The use of precautions to minimize investor confusion about the source of information also is relevant in determining whether third-party information has been adopted. For example, investor confusion is less likely to result if the information is accessible only after viewing an intermediate screen that clearly and prominently indicates that the visitor is leaving the issuer's web site and that subsequently viewed information is not the issuer's. Confusion also will be reduced if third-party information is preceded or accompanied by a clear and prominent statement from the issuer disclaiming responsibility for or endorsement of the information. In contrast, the risk of confusion is higher if information on a third-party web site is framed or inlined.

Presentation of Hyperlinked Information. Efforts to direct an investor's attention to particular information by selectively providing hyperlinks also is relevant in determining whether the hyperlinked information has been adopted by the issuer. If the hyperlinked information is not representative of the available information, the creation and maintenance of the hyperlink could be deemed to be adoption of the hyperlinked information. In addition, if the issuer selectively establishes and terminates hyperlinks to third-party sites depending upon the nature of the information contained on those sites, it may be deemed to have adopted the information when the hyperlink is operative.

The layout of the screen containing the hyperlink also is relevant. The issuer may be deemed to have adopted the hyperlinked information due to the prominence, size or location of the hyperlink or other action that draws an investor's attention to the hyperlink.

The 2000 Release provides some guidance regarding the permissible content of an issuer's web site when it is in registration. Ordinary course business and financial information may continue to be posted on an issuer's web site when in registration, either directly or through a hyperlink to a third-party web site, including the web site of a broker-dealer participating in the offering. The "ordinary course" exception for online information is consistent with the SEC's position regarding ordinary course communications during a public offering generally.

Given how quickly after inception many Internet companies file to go public, the 2000 Release indicates that a first-time issuer that is contemporaneously establishing a web site may need to apply the ordinary course exception more strictly when evaluating its web site content because it may not have established a history of ordinary course business communications with the marketplace. Its web site content may be deemed to be conditioning the market for the offering since investors may be less able to distinguish offers to sell the issuer's securities from the promotion of its products or services or other business or financial information.

The 2000 Release doesn't break any new ground with respect to online public offerings. In addition to reiterating some established fundamental offering principles, it indicates that the SEC will continue to analyze the regulation of online public offerings as practice, procedures and technology evolve, with a view to possible future regulatory action. In the meantime, the SEC staff will continue to review procedures submitted to it in connection with online offerings.

The 2000 Release also addresses online offerings under Regulation D. It indicates that web sites of third-party service providers that are not broker-dealers or broker-dealer affiliates may be problematic to the extent that they invite prospective investors to qualify as accredited or sophisticated so that they can participate on an access-restricted basis in private offerings on those web sites. According to the 2000 Release, these web sites raise significant concerns as to whether the offerings that they facilitate involve general solicitations, especially when prospective investors are self-accredited (i.e., prospective investors certify themselves as accredited by checking a box, rather than completing a questionnaire that provides the web site operator with information needed to form a reasonable belief regarding their accreditation).

SEC interpretations of whether a pre-existing substantive relationship exists – which is one method of ensuring that there is no general solicitation – generally have been limited to procedures established by broker-dealers in connection with their customers. The 2000 Release indicates that the SEC staff's 1997 and 1998 responses to no-action letters submitted by Lamp Technologies – which provided information relating to hedge funds to accredited investors on a password-protected web site – have been erroneously interpreted to extend the "pre-existing substantive relationship" doctrine to solicitations by non-broker-dealers. The 2000 Release acknowledges that there may be facts and circumstances under which a non-broker-dealer could establish a pre-existing substantive relationship, although it does not elaborate on or provide examples of these facts and circumstances. In the 2000 Release, the SEC indicates that it encourages operators of private placement web sites to work with the SEC staff to resolve any securities law issues raised by their activities.

The 2000 Release also reminds web site operators that they need to separately consider whether their activities require them to register as broker-dealers. To the extent that a web site operator is acting as a broker in connection with a venture capital private placement, it will typically first need to be registered as a broker-dealer. Reflecting its concern over the activities of unregistered web site operators, the SEC requested the Division of Market Regulation staff to consider whether a web site operator providing the services described in the Lamp Technologies no-action letters needs to register as a broker-dealer (this issue was not addressed in the Lamp Technologies letters).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.