May 1, 2000
Legally In Line, Online
US laws on offering securities over the Internet remain incomplete. But banks and issuers promoting products electronically should understand existing SEC policies to protect themselves and investors. Significant regulatory hurdles remain in the development of the Internet as a distribution channel for securities. In the United States, the Securities and Exchange Commission continues to struggle to reconcile this new medium of communication with traditional concerns over investor protection. The SEC has issued several clarifications and statements on existing policies for electronic media. But further clarification and guidance is needed. In the meantime, issuers and underwriters are groping for a way to make the most of the Internet amid an almost 70- year-old scheme of securities regulation. The offering and sale of securities outside the US are exempt from the registration requirement of the 1933 Securities Act, provided certain conditions are met. Issuers must consider how to meet those conditions when websites are accessible from anywhere in the world: securities offered through the Internet outside the US may be purchased by US investors, no matter what market is targeted by such offerings. The SEC commented on the use of Internet websites for offshore offerings in March 1998, saying the key question is "whether measures reasonably designed to guard against sales to US persons have been implemented." For example, an offshore Internet offer made by a non-US issuer will not be considered to be targeting the US if the website includes a prominent disclaimer clarifying that the offer is directed only to other countries and if it uses procedures that are reasonably designed to guard against sales to US citizens in the offshore offering, such as obtaining addresses or telephone numbers. Additional precautions are necessary if US issuers make an offshore Internet offer. They must implement password-type procedures that can reasonably ensure that only non-US citizens can access the offer. Delivering Materials The Internet is used in large scale, conventional public offerings with Wall Street underwriters as well as for the delivery of a prospectus and for roadshows. A prospectus must meet certain requirements under Section 10 of the Securities Act and be delivered to the purchasers of the securities. Any written communication that offers securities for sale is legally considered a prospectus and must meet the prospectus requirement. The Internet is a form of written communication and traditional concepts continue to apply. So how can an electronic version of a prospectus satisfy the delivery requirement and how can Internet roadshows avoid being treated as an unlawful prospectus? The SEC commented in October 1995 and in April 2000 on the use of electronic media for delivering documents including prospectuses to investors. Fundamentally, a method of electronic delivery must provide assurance comparable to paper delivery that the required information will be delivered in order to satisfy prospectus delivery obligations. The SEC addressed three aspects of the delivery requirement: notice, access and evidence to show delivery. Investors should be provided with timely and adequate notice that information is available for them. Providing the prospectus by e-mail will satisfy the notice element, but merely posting the prospectus on an Internet website is insufficient unless investors receive separate notice. Recipients of electronic delivery must have access comparable to that given by regular mail. A recipient must be given the opportunity to retain the information by downloading a copy, and if the prospectus is posted on the web site, it should be accessible as long as the delivery requirement applies. Issuers also should be able to make paper versions available upon request. Furthermore, issuers must have reasonable cause to believe the delivery requirement is satisfied. For example, the requirement will be satisfied if the issuer obtains an informed consent from an investor to receive the information through a particular electronic medium or if issuers obtain evidence of the receipt by investors, such as electronic mail return receipt. Until the registration statement is effective, any written communication that offers any security for sale is prohibited unless it satisfies the prospectus requirement under Section 10 of the Securities Act. On the other hand, oral communications after the filing of a registration and circulation of a "red herring" are permitted. On the Road Rules Is an Internet roadshow a permitted oral communication? The SEC has issued several no-action letters, or clarifications, about whether an Internet roadshow might be regarded as an unlawful prospectus. The SEC commented that to comply with Section 10, viewers were limited to the type of investors and investment advisors that underwriters would customarily invite to a roadshow. Second, the filed prospectus must be made available to the viewers of the roadshow and they were urged to read it. Third, viewers had to agree not to copy, distribute or retransmit the roadshow. Fourth, issuers or underwriters were required to assure that the roadshow was consistent with the prospectus or the live roadshow. Fifth, the roadshow could not be transmitted before the registration statement was filed with the SEC. Live roadshows have also been customary for offerings to qualified institutional buyers under Rule 144A offerings. The use of written material is not prohibited for a Rule 144A roadshow, but general solicitation and general advertisement are banned. Consequently, measures similar to those discussed above need to be taken. Especially, viewers must be restricted to sophisticated investors. Even if issuers do not actively use the Internet for securities offerings, they must use their corporate website cautiously. Posting information on a website is generally deemed a written communication. Before filing a registration statement, written or oral communications to offer securities are prohibited. After the filing but before the registration statement becomes effective, written communication is prohibited unless it meets the prospectus requirement. During both periods, information published on a website may be regarded as a prohibited communication. In addition, making any material change on the website during those periods may be regarded as an illegal attempt to condition the market. A hyperlink may also cause trouble. A third party's misleading statement (such as investment analysis) may be treated as an issuer's own misleading statement. After the registration statement becomes effective, the prohibition on written communication is lifted. But issuers must be careful not to be accused of using their website to undercut the primacy of the prospectus. Issuers should avoid launching a new Web site or altering materially an existing website until the offering is complete. A related issue is hyperlinks contained in documents filed with the SEC. According to the SEC rule for the EDGAR System released on April 24, 2000, hyperlinks to external websites are forbidden in the EDGAR System, and material linked impermissibly will not become part of the official filing for the purpose of determining whether the disclosure requirements have been satisfied. However, the rule also provides that the linked material will be subject to civil liability and antifraud provisions of federal securities laws. Issuers should not use hyperlinks in a filing unless they are prepared to take responsibility for the linked material. Where the US withholding tax regime is implicated (for example over payments of US source interest or dividends), rules generally require beneficial owners to certify -- under penalties of perjury - that they are entitled to exemptions from withholding taxes. While proposed regulations would permit those certifications to be made electronically if certain conditions were met, there currently is no provision in the US tax rules for electronic certification by beneficial owners. As a result, a purchaser of securities over the Internet may have to submit a paper certificate to escape the withholding tax. Similar to US securities requirements under Regulation S, US tax rules generally restrict offers or sales of bearer debt instruments to most persons within the United States. There is no guidance on how offers and sales of bearer debt instruments may be made on the Internet without violating those restrictions. Issuers and underwriters obviously have to comply with basic securities regulations in their Internet offerings just as they do in conventional non-Internet offerings. There are no "Internet exemptions". Perhaps the greatest merit of the Internet is that it enables anyone to access vast amounts of information. But issuers cannot take full advantage of this feature. They are allowed to provide investors with only limited information because of the prospectus requirement. Despite unchanged securities regulation, issuers and underwriters, however, already seem to be enjoying another feature of the Internet: easy, fast and inexpensive access to information. By posting prospectuses on a Web site and transmitting roadshows through the Internet, issuers and investors can potentially reach small investors. Many of the investors who bought World Bank bonds in January 2000 through the Internet are reported to have been retail investors or small institutional investors who were new purchasers of World Bank bonds. Though a more progressive approach by the SEC is desirable to allow issuers and underwriters to take full advantage of the Internet, the Internet is already a powerful tool to attract small investors even under current regulations.
Whitney Debevoise, a senior partner at Arnold & Porter, specializes in international finance.
Whitney Debevoise, a senior partner at Arnold & Porter, specializes in international finance.