Federal Securities Law and the Internet

by Boris Feldman and David Priebe (1)
© 1996

With the growth of the Internet, some entrepreneurs are considering going on line to raise capital. One company, Spring Street Brewing, recently conducted its initial public offering ("IPO") on the Net.(2) Many other companies are considering Internet IPO's.(3) Companies already public have used World Wide Web pages to communicate with investors.(4)

Businesses interested in using the Internet to trade securities or contact investors may not be aware of all the legal issues raised by such activities. After a quick sketch of the statutory and legal framework, this article addresses the Top Ten questions asked by businesspeople about securities law and the Net.

Statutory Framework

The two principal federal securities laws are the Securities Act of 1933 (commonly known as the "'33 Act") and the Securities Exchange Act of 1934 (commonly known as the "'34 Act").

The '33 Act sets forth basic rules governing registration and issuance of securities. These rules apply to a company's IPO, as well as to any follow-on offerings. With few exceptions, the '33 Act requires a company to register stock with the SEC before selling it in a public offering.(5) The registration process begins when a company files a registration statement, containing a preliminary draft of the prospectus, with the SEC.(6) That usually occurs about 45 days prior to the date the company intends to begin selling stock (the "effective date" of the offering). Upon filing, all written offers to potential investors may be made only by the preliminary prospectus.(7) The SEC provides legal and accounting comments to the company. The SEC and the Company engage in an interactive process that usually results in changes to the preliminary prospectus.(8) The registration statement becomes effective only when approved by the SEC. The public offering may then take place.

Sections 3 and 4 of the '33 Act exempt a narrow set of securities and transactions from the registration requirements. One of the more important exemptions for a business is the private placement exemption contained in Section 4(2). 15 U.S.C. § 77d(2). Another exemption, Regulation A, enables a company to sell up to $5 million in securities in a public offering without the detailed disclosures required under the registration statement process. The potential use of those exemptions in the Internet context is discussed in Question 1.

The '34 Act sets forth basic rules governing a public company's non-offering communications with investors. The '34 Act requires public companies to file periodic reports with the SEC. Section 10(b) of the '34 Act, as interpreted by the SEC in SEC Rule 10b5, imposes civil liability for materially false or misleading statements that are made with intent to deceive investors or with reckless disregard of the truth. Those rules are discussed in the Internet context in Questions 4 and 5.

SEC Interpretations

As part of its ongoing interpretation of the '33 and '34 Acts, the SEC has recently issued guidelines with respect to investor communications on the Internet. In October 1995, the SEC published an interim interpretation on use of electronic media, including the Internet, to communicate information required by the '33 and '34 Acts.(9) In that release, the SEC recognized — and welcomed — the growing significance of the Internet: "given the numerous benefits of electronic distribution of information and the fact that in many respects it may be more useful to investors than paper, its use should not be disfavored." 1995 WL 588462 at *1. The SEC considered electronic communication valuable because it "permits small investors to communicate quickly and efficiently with companies as well as with each other." Moreover, electronic communication "enhances the efficiency of the securities markets by allowing for the rapid dissemination of information to investors and financial markets in a more cost-efficient, widespread, and equitable manner than traditional paper-based methods." Id.

The SEC's October 1995 Interpretation concluded that "information that can be delivered in paper under the federal securities laws may be delivered in electronic format." Id. at *3. "The federal securities laws do not preclude the delivery of a document through different media." Id. at *13. The interpretation then analyzed hypothetical examples of electronic communications with investors in light of various SEC regulations.

On May 9, 1996, the SEC announced technical amendments to various rules and forms governing distribution of electronic documents. The SEC also issued an update of the October 1995 Interpretation, with additional examples.(10) These releases again reflected the SEC's favorable view of the Internet as an investor communications medium. The SEC stated that "[q]uick and broad access to material information was one of the fundamental premises upon which the federal securities laws were adopted, and electronic distribution will no doubt benefit issuers and investors through cheaper and faster means of communication."

Top Ten Questions

1. Can my company sell stock to the public over the Internet without going through the public offering process using underwriters?

The public offering process usually involves investment banking firms acting as underwriters. The underwriters solicit potential investors and determine the price at which shares can be sold. On the effective date, the underwriters commit to buy the shares from the company at the offering price (minus an underwriters' discount). The underwriters then sell the stock to investors they solicited. The underwriters participate in drafting the prospectus to ensure that investment risks are adequately disclosed. Section 11 of the '33 Act imposes monetary liability if a prospectus contains an untrue statement or an omission of a material fact.(11)

As noted above, private placements are exempt from SEC registration requirements under Section 4(2). The October 1995 Interpretation states that a public company may not include on its Web site offering materials for a private placement, where the investors have not already been located without a general solicitation. The SEC reasoned that such publication would be inconsistent with the rule against general solicitation or advertising in a private placement. 1995 WL 588462 at *11. Thus, a common type of stock offering that companies may conduct without registering the stock with the SEC may not be done over the Internet.

The Spring Street Brewing IPO made clear, however, that a company may conduct a public stock offering on the Internet, rather than through an underwriter. Spring Street Brewing also illustrated the use of Regulation A to streamline the public offering process.(12) The October 1995 Interpretation explicitly states that an issuer may structure its offering "as one that will be made only through electronic documents." 1995 WL 588462 at *5 n. 27. Nevertheless, a company should consider whether the assistance of an underwriter is desirable — for example, to help raise the desired amount of capital, to validate the company as one taken public by an investment banking firm experienced in the particular industry, and to help price the stock.

A company considering selling shares directly to the public over the Internet should be aware of potential liability from a statute that may not apply to the Company in an underwritten offering: Section 12(2) of the '33 Act. Section 11 liability is restricted to prospectuses. Section 12(2) liability is not so restricted; it prohibits any materially false or misleading oral or written statement in connection with a solicitation to sell stock.(13) In a typical "firm commitment" underwriting, investors purchase their shares from the underwriter, not the company. Several courts have ruled that lack of privity between the company and the investor precludes a claim that statements in the prospectus constitute a "solicitation" for Section 12(2) purposes.(14) Such privity would exist, however, if a company sold its shares directly to the public on the Internet. Thus, if a company conducts an Internet public offering through a prospectus posted on a Web page, and the Web page contains direct links to other information about the company, a disgruntled shareholder may attempt to hold the company liable under Section 12(2) for material errors in that information.

2. Could our Web page be construed as "gun jumping" at the time of a public offering?

The SEC imposes restrictions on publicity about a company during various stages of the public offering process. Prior to filing the registration statement, a company cannot offer to sell securities at all, absent an applicable exemption to the registration requirement. If a company makes public statements that condition the public to expect an offering or that arouse investor interest in the company, the SEC may construe the activity as "gun jumping" and delay the effectiveness of the registration statement. Once the registration statement (containing the preliminary prospectus) is filed, written offers to sell must be made using the prospectus; a company may not disseminate any other written information that could be construed as offering material. This is designed to ensure that investors make decisions based on the full disclosure of risks in a prospectus. After the offering has become effective, the sale of the security must be accompanied or preceded by a prospectus. For simplicity's sake, we will refer to these various types of prohibited offering-related publicity as "gun-jumping."

There is a danger that a company will be found to have engaged in gun-jumping because of information accessible on its Web page. The SEC's October 1995 Interpretation presented a hypothetical in which a company places on its Web page a copy of its preliminary prospectus, as well as a link to a research report on the Company located on a brokerage firm's Web site. 1995 WL 588462 at *10. The SEC concluded that such linkage would not be permissible: the link would violate the rule against gun-jumping by "provid[ing] the ability to access information located on another Web site almost instantaneously."

In another hypothetical, a company places its final prospectus and "supplemental sales literature" on its Web site; "both could be accessed from the same menu, are clearly identified on, and appear in close proximity to each other." 1995 WL 588462 at *9. The SEC said that the sales literature must be preceded or accompanied by the final prospectus, as would be required in the case of a paper prospectus. The SEC said that this hypothetical would satisfy that requirement, so long as the prospectus and the literature were in "close proximity to each other on the menu": "[f]or example, the sales literature should not be presented on the first page of a menu while the final prospectus is buried within the menu." This requirement would also be satisfied if the sales literature containing a link providing "direct access" to the final prospectus, enabling the latter "to be viewed directly as if they were packaged in the same envelope as the sales literature."

Based on those examples, other information on a Web page to which investors have "direct access" might be said to constitute a communication to investors during the quiet period, in violation of the rule on gun-jumping. The concern over gun-jumping should not be taken to extremes. Some companies use their Web sites for customer inquiries and service calls. Such companies should not be required to turn off those portions of their Web sites during a quiet period, any more than they would be required to ignore paper documents sent for the same purposes.

3. Can our company's stock trade on the Internet alone, instead of on an exchange?

For most people, public stock trading means trading through an exchange, such as the New York Stock Exchange or NASDAQ. In order to trade on an exchange, a company must meet minimum capitalization and other requirements, and agree to various corporate governance provisions.

Some companies may wish to avoid the costs of trading on an exchange by trading directly on the Internet. Even before the Internet, the SEC did not require companies to trade on exchanges. More recently, the SEC has given qualified approval to Spring Street Brewing to operate an Internet trading mechanism called "Wit-Trade." Wit-Trade is the only system on which Spring Street Brewing shares will be traded in the secondary market. According to a recent press release, Wit-Trade expects the system to be given final approval upon implementation of four steps suggested by the SEC to potential investors: the company will use an independent agent to receive checks from purchasers of the securities; the company will publish certain warnings on its Web materials; the company will disclose through Wit-Trade "a complete transaction history showing the price and number of shares for each recent transaction"; and the company will subject financial information provided through Wit-Trade "to certain SEC oversight."(15)

Companies should be aware that there may be significant costs associated with trading outside the existing exchanges. The exchanges attempt to promote orderly trading of a company's shares. They also attempt to provide investors with a fair price for shares in listed stocks. Online trading may be unable to provide those benefits. The exchanges also receive wide dissemination of stock prices in daily newspapers, which may be of value to investors not comfortable with the Net.(16)

Deciding not to trade on an exchange may require registering with numerous state securities commissions. Most states have their own securities regulations, commonly known as "Blue Sky laws." Those laws typically require companies to register their stock in order to offer or sell shares in that state. Most states have an exemption from this requirement if a company's stock is traded on a national exchange or is listed on the NASDAQ National Market System. If a company decides to trade on the Net, it may not be able to trade in a particular state unless it registers its shares there.(17)

4. Do I need to file with the SEC information placed on our Web page?

The answer to this question is "no," unless the information on the Web page is also the type of information that must be filed with the SEC.

Public companies are required to file certain reports, such as quarterly reports on Form 10Q, with the SEC. There is no general requirement that a company submit all of its investor communication materials to the SEC. For example, companies do not typically submit press releases to the SEC. SEC Regulation 8K requires companies to file interim reports upon the occurrence of extraordinary events. Companies may benefit from filing such interim reports, because they provide constructive notice to investors of the information disclosed in them.

Even though companies need not file press releases or other non-mandated investor communications with the SEC, this does not mean that the SEC —; or private litigants — will ignore those materials. The SEC has brought several enforcement actions against individuals alleged to have committed securities fraud by posting false or misleading investment information on the Internet.(18)

5. Is marketing material that I post on our Web page subject to the same standards as investor relations material?

Investor communications are governed by the antifraud provisions of Section 10(b) of the '34 Act and SEC Rule 10b5.(19) Rule 10b5 imposes liability for materially false or misleading statements made with intent to deceive investors or with reckless disregard of the truth. Most shareholder lawsuits are brought under Rule 10b5. The plaintiff asserts that the company and its officers issued false statements in order to entice investors to purchase the company's stock at an artificially inflated price. If the plaintiff can prove those allegations (and satisfy various other requirements), shareholders can recover the difference between the price they paid for the stock and what they would have paid had the truth been disclosed to the market. In many cases, the damage claims amount to hundreds of millions of dollars.

The fact that a company posts a statement on a Web page, rather than issuing it in a press release, does not insulate the statement from securities liability. In the October 1995 Interpretation, the SEC stated that: "[t]he liability provisions of the federal securities laws apply equally to electronic and paper-based media. For instance, the antifraud provisions of the federal securities laws as set forth in Section 10(b) . . . and Rule 10b5 . . . thereunder would apply to any information delivered electronically, as it does to information delivered in paper." 1995 WL 588462, at *3 n.11. The SEC Interpretation appears to apply the same legal standards to Web pages as it does to other corporate communications:

Electronically delivered documents must be prepared, updated, and delivered consistent with the provisions of the federal securities laws in the same manner as paper documents. Regardless of whether information is delivered through paper or electronic means, it should, of course, convey all material and required information.

Id. at *3 n.20.

6. Does posting information to our Web page satisfy our disclosure obligations?

The SEC has taken the position that posting information to a Web page does not satisfy a company's disclosure obligations, in those circumstances where a company is required to deliver information to prospective investors or shareholders.

In the October 1995 Interpretation, the SEC stated that "delivery of information through an electronic medium generally could satisfy delivery or transmission obligations under the federal securities laws." 1995 WL 588462 at *3. But where the '33 Act or '34 Act require delivery of a particular document to investors, the SEC has stated that a company does not satisfy its delivery obligation simply by posting the document on its Web site, because it is not proper to presume that everyone has access to the Internet. Id. at **6, 11. The SEC's test is whether "such distribution results in the delivery to the intended recipients of substantially equivalent information" to investors as they "would have had if the information were delivered to them in paper form." Id. at *4. The SEC looks to three factors. The first factor is notice: "the extent to which the electronic communication provides timely and adequate notice to investors that information for them is available." The SEC explained that, if necessary, a company should "consider supplementing the electronic communication with another communication that would provide the notice similar to that provided by delivery by paper." Thus, if an investor document "is provided on an Internet Web site, . . . separate notice would be necessary to satisfy the delivery requirements unless the issuer can otherwise evidence that delivery to the investor has been satisfied or the document is not required to be delivered under the federal securities laws."

The second factor is access. The SEC stated that "the use of a particular medium" to deliver an investor communication "should not be so burdensome that intended recipients cannot effectively access the information provided." The investor "should have the opportunity to retain the information or have ongoing access equivalent to personal retention." The SEC stated that if a disclosure is made available by posting on the Internet or online services, "the document should be accessible for as long as the delivery requirement applies." The SEC also noted that investors should be able to make paper versions of electronically delivered documents.

The third factor is proof of delivery. The SEC stated that companies delivering information electronically should "have reason to believe that any electronic means so selected will result in the satisfaction of the delivery requirements." The SEC suggested several means by which this proof requirement could be satisfied: obtaining prior informed consent to deliver a communication electronically; obtaining evidence of actual receipt by the investor; disseminating information through a facsimile; hyperlinking; and providing proof that an investor had used forms or other material available only if the investor had received the electronically transmitted information.

The October 1995 Interpretation presented several scenarios in which posting information on a Web page would not satisfy those requirements for mandated investor communications. Several principles can be inferred from those examples. First, "if consent [to electronic dissemination of information to a particular investor] is to be relied upon, the consent should indicate the specific electronic medium or media that may be used for delivery." Second, if an investor requests delivery by a particular form of electronic transmission, delivery by that form is effective. Third, any notice of an investor communication must, among things, make investors "aware of the availability and location of the electronic document." 1995 WL 588462 at **8, 11. If a company decides to use an underwriter to conduct a public offering, the October 1995 Interpretation states that the underwriter may rely on a consent to electronic delivery of information supplied to the company by an investor. Id. at *7.(20)

For required post-offering disclosures, such as quarterly reports, the SEC has promoted electronic filing. Companies may now file documents with the SEC via an electronic database called EDGAR. The SEC has not, however, allowed companies to file required reports solely through posting on Web sites. Moreover, as of May 1996, EDGAR does not allow filing of audio, video, or graphic presentations.(21) To ensure that the EDGAR version of a disclosure document does not vary from versions disseminated by other electronic means, the May 1996 Rules provide that where "documents delivered to investors or others" contain material that cannot be reproduced in an EDGAR filing, "the EDGAR filing must include a fair and accurate narrative description, tabular presentation or transcript of the omitted material."(22)

7. Does posting material information on our Web page constitute selective disclosure?

When a company issues material information about its business, it must disclose that information to the market as a whole, not just selectively to favored investors. Tipping off some persons but not others about a major corporate developments invites an SEC prosecution for insider trading, if it can be proven that the person doing the "tipping" had reason to believe that the person receiving the tip would use it to buy or sell the company's stock.(23)

Although there is not yet any case law on the issue, we believe that disclosure via a company's Web site should not be regarded as selective disclosure. The SEC has spoken favorably of the Internet's potential to facilitate investor communications.(24) Indeed, the SEC has recognized that Internet-based communication "enhances the efficiency of the securities markets by allowing for the rapid dissemination of information to investors and financial markets in a more cost-efficient, widespread, and equitable manner than traditional paper-based methods." October 1995 Interpretation, 1995 WL 588462 at *2.

The SEC's use of the phrase "enhances the efficiency of the securities markets" invokes a central doctrine of securities law: the efficient market hypothesis. Under this principle, all publicly available information about a company is absorbed by the market and reflected in the company's stock price.(25) In deciding whether a company adequately disclosed particular information, the test is whether the disclosure occurred by means that ensured that the information "credibly entered the market."(26) If the statement "received only brief mention in a few poorly-circulated or lightly-regarded publications," this requirement might not be met.

Given the SEC's position that the Internet is so widely used that it "enhances the efficiency of the securities markets" — indeed, that it offers a more equitable means of dissemination of information than "traditional paper-based methods" — a disclosure on the Web should satisfy the standard of the efficient market hypothesis and hence be regarded as disclosure to the market as a whole. This issue certainly will be tested in future lawsuits, as plaintiffs claim that information posted on a particular Web location was not disclosed to a place with sufficient circulation to ensure that it "credibly entered the market." Until the issue is resolved definitively, a prudent company should avoid posting material information only to its Web site without also issuing it in a press release or SEC filing.

8. Do I have any duty to update information on our Web page?

Few securities law issues are as controversial as the duty to update. Many shareholder lawsuits are filed when a company's stock price drops following the disclosure of disappointing financial results. In such cases, plaintiffs allege that the company should have updated its prior forecasts publicly as soon as it knew that they would not be achieved. While this position has often been accepted by courts, it is not conclusively settled. The alternative view is that if a company chooses to issue a public forecast of expected financial results, the forecast speaks only as of the date it was issued. Under this view, there is no duty to issue a new forecast, based on new information, when the circumstances of the old forecast have changed.

The duty to update is particularly important in the Web context. The Web allows a company to post a great deal of information about the company and its products. If all that information must be constantly updated, companies will have to spend a great deal of time and effort policing their Web sites.

The SEC appears to have taken the position that the duty to update applies to information posted on the Net. The October 1995 Interpretation states that "[e]lectronically delivered documents must be prepared, updated, and delivered consistent with the provisions of the federal securities laws in the same manner as paper documents." 1995 WL 588462, at *3 n.20 (emphasis added). The SEC further noted that "[i]f an issuer posts electronically a preliminary prospectus on its Web site, the prospectus should be updated to the same degree as paper. . . ." Id. at *5 n. 26.

These statements should not be read too broadly. They do not affirmatively create a duty to update; rather, they state that any such duty, where it exists, also applies to Web-posted documents. Moreover, the comments occurred in the context of discussing a document that requires updating in the normal course: a preliminary prospectus. The SEC's view, however, is likely to be given some weight by courts. To the extent that case law presently imposes a duty to update, a company should assume that the duty applies to information posted on the Web, until a substantial body of law develops to the contrary. A company may attempt to disclaim any duty to update information posted on its Web page; to date, the effectiveness of such a disclaimer has not been tested in court.

9. Do I incur any liability by providing links to other Web pages?

Generally, persons can be liable under the securities laws only for statements that they make. In limited circumstances, a company may be liable for statements that appear under the name of others. This arises most often in the context of analyst reports. In many shareholder lawsuits, the only persons who had issued public forecasts about a company's expected earnings were securities analysts. To establish that a company owed a duty to disclose the earnings shortfall prior to its actual disclosure, plaintiffs typically allege that the company should be held responsible for forecasts in analyst reports. Plaintiffs attempt to prove that the company adopted or endorsed the analysts reports.

The October 1995 Interpretation takes the position that a link allowing "direct access" from one Web site to another Web site, "provid[ing] the ability to access information located on another Web site almost instantaneously," associates the two Web pages as one electronic document.(27) In determining whether a company can be liable for providing link to any particular piece of information on another Web site, the threshold issue is whether the manner in which the information from one Web site to another is linked provides "direct access."

One rule suggested by the October 1995 Interpretation is that direct access exists if the two pieces of information are accessible from the same menu or from an uncomplicated menu structure. In discussing access, the SEC noted that "if an investor must proceed through a confusing series of ever-changing menus to access a required document so that it is not reasonable to expect that access would generally occur, this procedure would likely be viewed as unduly burdensome." 1995 WL 588462 at *5 n.24. In a contrasting hypothetical, in which links to a prospectus and to supplemental sales literature were "accessible on the same menu," the SEC noted that "the existence of the prospectus and its location [were] readily ascertainable by the investor viewing the sales literature." Id. at *9 n.36.

Two other hypotheticals suggest that the existence of direct access depends on the burdensomeness of accessing linked information. One hypothetical involved a mutual fund posting on the Internet supplemental sales literature and a prospectus. In that situation, the SEC stated that delivery of the prospectus could be inferred where an investor "would not need any additional software or need to take burdensome steps to access the prospectus and thus has reasonable comparable access to both documents." 1995 WL 588462 at *14. In a contrasting hypothetical, the SEC said that delivery could not be inferred where "[l]ogistically it is significantly more burdensome to access" a document, "e.g., the investor needs to download special software before accessing the prospectus." Id. at *15.(28)

Thus, one might read the SEC's position as holding that a company can be liable for providing links to information available on another Web site. This is an important factor that companies should consider in structuring their Web sites — especially if a duty to update exists, which would be hard to discharge for information on another person's Web site.

10. How can I use our Web page to protect against a shareholder suit if our stock price drops?

Instead of just worrying about incurring liability through a Web page, a company may use the Web proactively to protect against a shareholder suit if its stock price falls. First and foremost, a company should post its cautionary disclosures (whether made in SEC filings, press releases, or letters to shareholders) on its Web page. Shareholder lawsuits, after all, are about concealing adverse information. If a company has fully laid out on the Internet the risks and challenges facing its business, a claim of concealment will ring hollow.

Second, if a company decides to disclose forward-looking information — i.e., statements or forecasts about its future prospects — it should structure its Web site to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 (the "Reform Act").(29) According to the legislative history of the statute, Congress created a statutory safe harbor "to provide certainty that forward-looking statements will not be actionable . . . if they are accompanied by a meaningful cautionary statement."(30) If a company accompanies its forward-looking statement with a list of the risk factors that could cause actual results to vary, a plaintiff challenging the forward-looking statement "must plead with particularity all facts giving rise to a strong inference of a material misstatement in the cautionary statement to survive a motion to dismiss." The plaintiff also must the plead facts giving rise to a strong inference that the speaker of the statement had "actual knowledge . . . that the statement was false or misleading."(31)

In the months since the Reform Act took effect, companies have experimented with a variety of ways to accompany forward-looking information with cautionary disclosures.(32) The October 1995 Interpretation suggests that companies can use Web links to achieve this end, provided that the links provide direct access from the forward-looking statement to the cautionary disclosures, along with notice of the location of those disclosures. In explaining the requirement that notice of the Web location of a final prospectus must be prominent in any accompanying sales literature, the SEC said that such notice "should be in the forepart of the literature and clearly highlighted to make investors aware of the availability and location of the final prospectus." 1995 WL 588462 at *10. Based on this principle, a company should consider placing a notice of the availability and location of a link to cautionary disclosures in the forepart of any portion of the Web site containing forward-looking information.

An alternative approach is to place the cautionary language about investment risks in the forepart of the menu structure of the Web site itself. Spring Street Brewing has partially implemented this approach. The main menu for its Web site contains a table of contents posting links to topics about the company and its products. To enter the Wit-Trade mechanism on which the company's stock is traded, a user clicks on a page that bears the following disclaimers:

Investing in Spring Street Brewing Company's common stock is speculative, involves substantial risks and should be considered only by persons able to bear the economic risk of the investment for an indefinite period of time.

Spring Street Brewing Company developed and operates this stock market mechanism for the benefit of its shareholders. The Company's role in this mechanism is limited to facilitating transactions between parties that have agreed through direct correspondence to enter into a trade. The company does not trade directly or indirectly in its common stock and nothing herein should be construed to mean that the Company offers to buy or sell, or guarantees any purchase or sale, of common stock.

This approach is consistent with the SEC's admonition that, where a prospectus must accompany supplemental sales material sent to an investor through the Internet, "the sales literature should not be presented on the first page of a menu while the final prospectus is buried within the menu." October 1995 Interpretation, 1995 WL 588462 at *9.

Third, a company should use multiple links to invoke the protection of the "bespeaks caution" doctrine. Under this doctrine, if a document contains sufficiently specific disclosures of investment risks to "warn[] potential investors [of the risks] in a meaningful way," a securities fraud claim cannot be based on the assertion that other positive statements made by the company ultimately proved to be inaccurate.(33) A few courts have erroneously assumed that the bespeaks caution doctrine applies only to statements contained in a single document. Under that view, even if a company disclosed its risks in a recent prospectus or quarterly report, it would not be able to invoke those risks if a plaintiff challenged forward-looking statements made in a subsequent press release. The SEC's endorsement of links provides a powerful mechanism by which a company can use forward-looking statements posted on its Web site to accompany all of the risk disclosures accessible on the Web site. This would increase the probability that a court would find that a company's disclosures sufficiently apprised investors of those risks.

Finally, as a precautionary measure, a company should avoid linking its Web site to information from stock market analysts. If a company decides to issue forward-looking statements, such as earnings projections, it should do so in its own name and follow the guidelines of the Reform Act's safe harbor. If a company decides that it does not want to provide such information, it should avoid the potential liability that may result from linking to the same type of information from stock market analysts.

* * *

The question is not whether the Internet will become an integral part of the American securities landscape, but only how quickly. The issues sketched out in this article will be vigorously debated (and litigated). As in other areas of securities law, definitive answers to these questions may not emerge for years. As companies start down the Internet path, a prudent approach would be to err on the side of over-disclosure (e.g, paper and electronic) and, whenever possible, to seek prior SEC approval before conducting any experiments.


(1) The authors are lawyers with Wilson Sonsini Goodrich & Rosati, P.C., in Palo Alto. This article presents their own thoughts and does not necessarily reflect the views of others at their firm.

(2) According to the company, it raised $1.6 million in its IPO. 3500 investors paid $1.85 per share for Spring Street Brewing stock. See World's First Digital IPO (Feb. 26, 1996) (available on Wit Capital World Wide Web site).

(3) See Tapping the Web for Cash, The Recorder, Apr. 30, 1996, at 1.

(4) See Boris Feldman, Investor Relations on the Internet: A Securities Disclosure Perspective, 2 Off-Line (Winter 1996)

(5) '33 Act § 5(a), 15 U.S.C. § 77e(a).

(6) '33 Act § 6(a), 15 U.S.C. § 77f(a).

(7) '33 Act § 5(c), 15 U.S.C. § 77e(c).

(8) See 1 Louis Loss and Joel Seligman, Securities Regulation 52427 (3d ed. 1989).

(9) Use of Electronic Media for Delivery Purposes, 6 S.E.C. Docket 1091, Securities Act Release No. 33-7233 (Oct. 6, 1995). This article refers to this release as the "October 1995 Interpretation," with page references to the copy published on the WESTLAW legal database, starting at 1995 WL 588462.

(10) Use Of Electronic Media For Delivery Purposes, Securities Act Release No. 33-7289 (May 9, 1996) (the "May 1996 Rules"); Use of Electronic Media By Broker-Dealers, Transfer Agents, and Investment Advisers For Delivery Of Information, Securities Act Release No. 33-7288 (May 9, 1996) (the "May 1996 Interpretation").

(11) 15 U.S.C. § 77k(a).

(12) See World's First Digital IPO (Feb. 26, 1996), supra n. 2.

(13) 15 U.S.C. § 77l(2). Section 12(2), but not Section 11, applies to offerings conducted under Regulation A.

(14) See, e.g., Pinter v. Dahl, 486 U.S. 622 (1988); Shapiro v. UJB Fin. Corp., 964 F.2d 272, 286 (3d Cir.), cert. denied, 113 S. Ct. 365 (1992); Endo v. Albertine, 812 F. Supp. 1479, 1494 (N.D. Ill. 1993).

(15) See SEC Gives Green Light To Digital Stock Trading (Mar. 25, 1996) (available on Wit Capital World Wide Web site).

(16) The SEC expressed some of those concerns in its no-action letter regarding Wit-Trade. It stated that the purpose of the warnings to be included on the system was to ensure that investors understood the risks inherent in investing in illiquid securities. See Spring Street Brewing Co., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 435, *1 (Mar. 22, 1996). The SEC also was concerned "that buyers are aware of last sale prices" for stocks traded on WitTrade. Id.

(17) According to Spring Street Brewing, the company registered its stock in 22 states by the date of completion of its IPO. This is an evolving area of the law. See Order of the Pennsylvania Securities Commission In Re Offers Effected Through Internet that do not Result in Sales in Pennsylvania (Aug. 31, 1995) (exempting registration where securities not offered to persons in Pennsylvania); October 1995 Interpretation, 1995 WL 588462 at *3 n.11 (discussing state law developments).

(18) See, e.g., Securities & Exchange Comm'n v. Spencer, Litigation Release No. 14856, 1996 WL 145918 (S.E.C.) (Mar. 29, 1996) (alleging that defendants used the Internet and other means to disseminate false and misleading statements seeking investors to finance construction of ethanol plant in Dominican Republic); Permanent Injunction and Asset Freeze Issued Against Scott Frye to Halt Securities Fraud on the Internet, SEC News Digest 95-221-2, 1995 WL 679305 (S.E.C.) (Nov. 16, 1995) (announcing injunction against solicitation on Internet seeking investors in Costa Rican enterprises); Court Enters Permanent Injunction Against Individual Engaged in Fraudulent Prime Bank Scheme on the Internet, SEC News Digest 95-181-1, 1995 WL 551302 (S.E.C.) (Sept. 19, 1995) (announcing injunction against solicitation on the Internet for "Prime Bank Guarantees"); Permanent Injunction Entered Against Individual Offering Fraudulent Investment Scheme on the Internet, SEC News Digest 95-165-4, 1995 WL 503868 (S.E.C.) (Aug. 25, 1995) (announcing injunction against false and misleading solicitation on Internet for $500,000 bond sale); Securities & Exchange Comm'n v. Pleasure Time, Inc., 58 S.E.C. Docket 2659, Litigation Release No. 1440, 1995 WL 108994 (S.E.C.) (Mar. 15, 1995) (alleging that defendants used Internet and other means to sell $3 million in unregistered securities).

(19) 15 U.S.C. § 78j(b); 17 C.F.R. 240.10b-5.

(20) The May 1996 Rules also allow companies to place in a prospectus a statement that the SEC maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the SEC. May 1996 Rules at 10.

(21) The October 1995 Interpretation described a hypothetical scenario in which a company would have to file with the SEC information accompanying a prospectus delivered in CD-ROM format. 1995 WL 588462 at *8. In this scenario, a company desires to include with the prospectus a movie illustrating the company's operations. The SEC stated that while the company could do this, it would need to file with the SEC, as an appendix to the prospectus, "the script of the movie and a fair and accurate narrative description of the graphic or image material," just as other supplementary information is filed with the SEC.

(22) May 1996 Rules at 7. At the same time, the SEC decided not to require a complete identity between paper and electronic versions of a document sent directly to investors. The SEC declined to adopt a regulation providing "that if material graphic, image and audio information is included in one version of a disclosure document, but not in other versions, the issuer must include in the other versions a fair and accurate description or transcript of the omitted information." Instead, the SEC said that "[w]here more than one version of of a document is delivered to investors, each version must contain all information required by, and otherwise comply with, the requirements of the applicable form and other provisions of the federal securities laws." May 1996 Rules at 6. This is illustrated in a hypothetical from the May 1996 Interpretation. In this example, a mutual fund presents prospectuses with format differences: "[f]or example, text that appears as a block in the margin of a page in the paper prospectus appears in a box in the flow of the text in the electronic version." The SEC held that "[t]he mere difference in format without any difference in text would not qualify the electronic version of the document as a different >form of prospectus' for which filing [of the latter under Securities Act Rule 497] is required." May 1996 Interpretation at 27.

(23) See, e.g., United States v. Chestman, 947 F.2d 551, 566-67 (2d Cir. 1991) (en banc).

(24) SEC officials have echoed these comments in public speeches. See Chairman Arthur Levitt, The SEC Today: An Accent On Individual Investors, Remarks Before The Public Pension Investment Policy Conference, 1996 WL 124205 (S.E.C.), *5 (Mar. 20, 1996); Commissioner Steven Wallman, Regulating In A World Of Technological And Global Change, Remarks Before the Institute of International Bankers, 1996 WL 102708 (S.E.C.), *2 & n.2 (Mar. 4, 1996).

(25) Basic v. Levinson, 485 U.S. 224, 248-49 (1988).

(26) In re Apple Computer Sec. Litig., 886 F.2d 1109, 1116 (9th Cir. 1989), cert. denied, 496 U.S. 943 (1990).

(27) The May 1996 Interpretation appears to be in accord. It presented a hypothetical involving a company with a "Dividend Reinvestment Program." A company need not register such a program if its involvement with the program is limited to administrative or ministerial functions. The SEC stated that the company could have a link on its Web site to the home page of the independent agent responsible for the Dividend Reinvestment Program. The Company could not, however, link its Web site "directly to the Dividend Reinvestment Program materials." May 1996 Interpretation at 2425.

(28) A hypothetical from the May 1996 Interpretation provides a further illustration of this principle. In this example, a mutual fund places its supplemental sales literature and its prospectus on a commercial online service. While users could view the supplemental sales literature on line, and click on a box to have the prospectus downloaded or to request that it be mailed, they could not view the prospectus on line. The SEC opined that this would constitute gun-jumping "because there would not be sufficient access to the prospectus." The SEC also stated that this system did not provide "reasonably comparable access to the prospectus and the sales literature," unlike the acceptable examples of prospectus delivery in the October 1995 Interpretation. May 1996 Interpretation at 2526.

(29) Pub. L. No. 104-67.

(30) H.R. Conf. Rep. No. 104-369, 104th Cong., 1st Sess. 32, 44 (1995).

(31) See Boris Feldman, Informing the Investor, Stifling the Shareholder Suit, The Recorder, Jan. 3, 1996 .

(32) See, e.g., Litigation Law Creates Work For Disclaimer Writers, New York Times, Apr. 14, 1996, at C3.

(33) Romani v. Shearson Lehman Hutton, 929 F.2d 875, 879 (1st Cir. 1991). The bespeaks caution doctrine had been adopted by most of the Courts of Appeals. See I. Meyer Pincus & Assoc., P.C. v. Oppenheimer & Co., 936 F.2d 759, 763 (2d Cir. 1991); In re Donald J. Trump Casino Sec. Litig., 7 F.3d 357 (3d Cir. 1993); Sinay v. Lamson & Sessions Co., 948 F.2d 1037, 1040 (6th Cir. 1991); Moorhead v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 949 F.2d 243, 245-46 (8th Cir. 1991); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407 (9th Cir. 1994); Salzberg v. TM/Sterling Austin Assocs., Ltd., 45 F.3d 399 (11th Cir. Feb. 16, 1995) (per curiam).