SECURITIES LAWS IN CYBERSPACE
By James Verdonik

Internet securities rules will be in a state of transition over the coming years as the Securities & Exchange Commission weighs the benefits and detriments of the Internet.

Although the SEC has made some initial pronouncements about the Internet, the commission does not have a unified voice about how the Internet may be used to conduct all securities transactions. Insights into the SEC's hopes and concerns about the Internet are useful to predict how entrepreneurs can maximize the utility of the Internet in securities transactions while minimizing liability risks.

SEC Love/Hate Relationship with Internet.
For securities law purposes, the Internet is merely a means of communication like the telephone, radio, newspapers and mail.

The SEC likes the unique attributes of the Internet that afford ordinary investors greater access to information about investments. But the SEC dislikes the Internet because it can be a powerful tool for unscrupulous promoters to disseminate false and misleading investment information.

Consequently, the SEC has and will continue to examine how traditional securities laws should apply to Internet communications with a view towards balancing the usefulness of the Internet as a tool for investors against the need to regulate Internet usage by issuers and others to protect investors.

SEC Web Site
The SEC's web site (www.sec.gov) is one of the most heavily trafficked places in cyberspace.

The SEC sees concrete benefits to itself, investors and issuers from its own use of the Internet. Of particular usefulness are the disclosure documents filed with the SEC by all public companies, which can be reviewed and downloaded from the web site.

Although each individual company has its own unique disclosure issues, entrepreneurs can make a good beginning in drafting disclosure documents by downloading prospectuses, Form 10-Ks and other documents filed with the SEC by public companies in the same industry.

Entrepreneurs can also learn about industry trends by researching the securities filings of companies in their industries.

SEC Internet Patrols
As entrepreneurs utilize the Internet to communicate with investors, the SEC has begun to devote substantial resources to ferreting out fraudulent Internet investment schemes.

Investigators in the SEC's Enforcement Division and other SEC employees also intermittently review Internet investment related activity. Accordingly, entrepreneurs should assume Big Brother at the SEC will review their communications with investors conducted via the Internet.

Indeed, the SEC is more likely to take action against Internet fraud than fraud conducted by other means because of the high profile nature of the Internet at this time.

Private Placements
As its name suggests, a private placement of securities is a transaction that is supposed to be PRIVATE.

An offer of securities that is available to anyone to read on a web site is not private. Instead, web site offerings of securities constitute a "general solicitation" that would cause the issuer to be deemed to be making a public offering, which is required to be registered with the SEC.

The solicitation of an offer is the same as an offer. Consequently, until the SEC indicates otherwise, statements on a web site that the issuer will send investment information to investors who contact the issuer should be viewed as constituting a public offering of securities.

Nevertheless, entrepreneurs can use their web sites as a means of DELIVERY of investment documents to investors in a private placement.

For example, if a private placement memorandum is accessible only by a code given to investors prescreened by the issuer, the use of a web site to deliver the private placement memorandum to investors would not by itself constitute a general solicitation.

In short, use of the Internet is permitted in a private placement if the use replaces permissible use of the mail, fax or telephone to communicate with a select group of investors who have had prior contacts with the issuer. Where, however, the Internet is a substitute for radio, television or newspaper advertisements or a substitute for mass mailings, used to expand the number of investors who know about the securities offering, use of the Internet will constitute a public offering.

Internet Road Shows in Public Offerings
The SEC is willing to "bend" traditional rules regarding road shows in public offerings, where issuers of securities typically make in person presentations to groups of institutional investors in major financial centers around the country.

These traditional rules prohibit broadcasting the road show to investors in remote locations via closed circuit radio or television. A recent SEC release, however, allows investors to attend road show presentations over the Internet, provided that the investors are limited to the same type of very sophisticated institutional investors who have traditionally attended road shows in person.

Also, in keeping with SEC rules that information in a prospectus is the only written information that can be distributed prior to a registration statement becoming effective, precautions should be taken to prevent investors from downloading the road show presentation to their own computers.

Such downloading would constitute the distribution of written information. By treating the Internet differently than the SEC has traditionally treated television and radio, the SEC is promoting the goal of making information more widely available among institutional investors, thereby creating a more level investment playing field.

Internet Public Offerings
Some companies are utilizing the Internet in public offerings for more than their road shows.

If the offering is registered with the SEC and state securities filings are made or exemptions are available, offers can be made via the Internet to any potential investor in the U.S.

This means that a prospectus can be posted on a web site and delivered to potential U.S. investors via the Internet after a registration statement is filed with the SEC. This can increase the number of investors who are aware of the offering, either assisting the underwriters in their sales effort or, in some cases, allowing the issuer to sell securities without an underwriter.

Another advantage of Internet prospectuses for issuers is that printing costs (which usually cost $100,000 to $200,000 for a public offering) can be substantially reduced.

Issuers conducting public offerings via the Internet should refrain from distributing written information outside the prospectus and should use electronic means to verify that the prospectus has in fact been delivered to all purchasers of securities. Public offerings without underwriters are often very small (less than $1 million) and in some ways resemble private placements that are registered to allow general solicitation.

Secondary Trading Markets
The Internet is being used as an alternative to the stock exchanges and NASDAQ as a place for investors to trade securities, blurring the lines between public and private companies.

In some cases, the issuer of the securities "sponsors" the trading site. In other cases, a broker-dealer is the "sponsor."

This secondary market activity provides investors with increased liquidity in securities that are too thinly traded to justify listing expenses or whose issuers do not meet the listing standards of stock exchanges or NASDAQ.

As Internet trading could circumvent stock exchange rules, issuers should expect the SEC to closely scrutinize how such trading is conducted and to take enforcement action where it perceives abuses.

Providing investors with even modest amounts of liquidity, however, is motivating some issuers to attempt to manage such risks. Many of the issuers whose securities are traded over the Internet have conducted very small public offerings with or without an underwriter.

Other issuers have never conducted a public offering, but have hundreds of shareholders from multiple private placements of securities or acquisitions of other companies.

Web Site Securities Compliance

Issuers of securities should review the content of their web sites to ensure the contents do not contain false or misleading statements or omissions.

Cleaning up a web site to ensure securities compliance becomes especially important if the issuer refers to the web site directly or indirectly in its securities disclosure documents. Securities compliance for web sites can be challenging because web sites often serve many corporate purposes, including recruiting employees and soliciting customers, that require upbeat language about the issuer that could create securities disclosure problems.
Web site compliance measures that reduce securities liability risks include:

• frequent review and editing of web site information to ensure it is current, complete and accurate;
  
• placing on the web site warnings to investors about risks and forward looking information disclaimers;
  
• requiring investors to click on an icon to acknowledge they have read and understood the risks and disclaimers before they can access other information;
  
• establishing a separate web site for investors to avoid the puffery that is on many web sites;
  
• avoiding referring to web sites in securities disclosure documents or referring only to web sites specifically established for investors;
  
• and carefully scrutinizing other web sites the issuer hyperlinks to its own web site to ensure there are no false or misleading statements related to the issuer or its business on the linked web site as an issuer may be liable for false or misleading information on a web site the issuer links to its web site.

Investor Chat Rooms
Many investors utilize the Internet to exchange information about public companies.

These discussions often contain erroneous information. In some cases, erroneous information is intentionally spread by a competitor, a disgruntled former employee or investors who are shorting the stock.
In other cases, the misinformation is unintentional. Issuers should resist the temptation to engage investors in a debate or to respond to erroneous information on line. Knowledge of what information is circulating over the Internet can be used to shape the issuer's overall public relations and disclosures policies in press releases, analyst conference calls and documents filed with the SEC.
Consequently, issuers have good reason to monitor Internet communications by investors.

In summary, the Internet is a new world to which old laws are being applied. Maximizing the utility of the Internet for securities transactions while minimizing liability risks will require more than knowing securities laws.
Instead, to predict how securities laws will be applied to Internet transactions one must understand the PURPOSES of securities laws and the unique attributes of the Internet to determine how such purposes will or will not be furthered in different Internet securities transactions.
See you in cyberspace.