Cyberspace is just like...
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Cyberspace is just like...A First Amendment exercise. There are currently many controversies brewing in the First Amendment arena regarding the online world. Discussions often center on the nature of the forum, the "participants," etc. While these are vital issues, they are beyond the scope of this e-paper.
Online securities law issues are only slowly developing. For the most part, action has revolved around online permutations of traditional securities fraud schemes. In investigating the few truly "cyber" cases for an indication of the law of electronic securities information distribution, I could only find two recent cases that might have some peripheral relation.
U.S. v. David LaMacchia, 871 F.Supp 535 (D. Mass. 1995).U.S. v. Thomas (6th Circuit, pending).
This case has generated considerable controversy in the online community. The Thomases, a Milpitas, California couple, were convicted in Tennessee for conspiring to distribute pornographic material via a computer network. The Thomases operated a computer bulletin board called "Amateur Action" which contained electronic images of many types of pornography. What made the case interesting was that they were convicted in Memphis based on the access available in Tennessee. While much has been written about the "community standards" and First Amendment precedent set by such a ruling, it seems likely that the decision will not stand long.
Though many in the cybercommunity have been up in arms over the potential application of "community standards" at a distance, the case seems to stand more for the hazards of grossly inadequate representation rather than any overarching First Amendment principles. Stanford affiliate Tom Nolan has since taken on the Thomases' appeal. Mr. Williams, the Thomases' trial lawyer, has been reproached by several judges in front of whom he has practiced, including District Judges Aguilar, Ware, and Patel, who contributed a scathing comment while referring Mr. Williams to the state bar for his ineptitude.
All of this speculation may be irrelevant, because the SEC has already successfully asserted jurisdiction over securities matters when only the most tenuous of interstate facilities are used. Where there is fraud, the SEC has very broad construction over the jurisdictional bases of its statutes: "That the jurisdictional hook need not be large to fish for securities law violations is well established."[1]. In addition to the mail and wire fraud statutes, the '33 and '34 Acts are littered with jurisdictional "hooks." Section 5 speaks of "...any means or instruments of transportation or communication in interstate commerce...," and § 17 speaks in similar terms regarding fraud in offers and sales.Direct Jurisdictional Means.
Seligman and Loss note that "it now seems fairly clear that the jurisdictional base of the section [§ 5] could be constitutionally expanded so that it would apply to all steps in the process of selling -- from offer to delivery and payment -- if the mails or interstate facilities were used in any one step."[2] The authors also note that it is well-settled that even intrastate phone calls are sufficient to invoke jurisdiction [3], and that there is "nothing in the context or background of the Act to suggest a grudging construction of the jurisdictional language."[4]
With all this as background, I can offhand envision several potential areas for interesting speculation. First, the Internet is arguably an entirely privatized body in the United States, potentially exempt from the same restrictions applicable to a regulated national phone or mail system. I doubt that this position would be availing in the end, though. Secondly, it could be argued, much like the LaMacchia case, that the current instrumentalities were unimagined when the Securities Acts were drawn up, and thus could not have been included within the ambit of construction. Again, I find this argument unpersuasive and believe that communications traveling over the Internet, relating to the offering and sale of securities in the United States, would be encompassed within the SEC's jurisdiction. Thirdly, one might speculate on the status of a foreign issuer "serving-up" documents from outside the U.S. with the recognition that U.S. citizens would purchase their securities. This scenario, while fascinating, is beyond the scope of this paper, and is at this juncture wholly speculative. Finally, on a more micro level, one might wonder whether the oral offers permitted in intrastate telephone calls during the waiting period would analogize to written or oral e-mail offers, but this issue currently remains merely a topic of speculation and lobbying. Many other related issues revolve around this introduction of new communication technology into the information distribution process, but it simply appears to be too early to predict how events will shake out.
The SEC Sidles Toward CyberspaceThe Clinton/Gore administration has clearly been able to watch its vision of an online government begin to take shape around them, though it remains debatable to what extent the administration has helped or hindered the efforts. As I note in the information distribution portion of the paper, major federal agencies are establishing online presences at a staggering rate. The SEC, however is remarkable in its absence. Even the admirable EDGAR project is being provided to the Internet from outside the agency itself. Although I understand that there are "policy groups" within the agency studying various "cyberissues," there has been precious little information leaked to the outside world about the status or direction of these projects. Thus far in the Internet era, there have been two major securities law developments.
Witbeer - The First "Internet IPO"Spring Street Brewery, a New York microbrewery, gained recognition as the first company to "go public" on the Internet. It is now possible to download a copy of their offering circular from their Web site. I spoke with the president of the company, Mr. Andrew Klein, a Harvard Law School graduate and Cravath, Swaine & Moore alumnus, and he explained that the company is making use of the Regulation A exemption to offer less than $5 million worth of securities without any prohibition on general solicitations. It would seem that one could do a Rule 504 Regulation D offering in a similar manner, but with a restriction to $1M of securities.
Mr. Klein stated that the company is promoting the offering via several channels, and is currently receiving funds at a proportion of 25% from the Internet, 50% from paid advertisement (including point-of-sale ads), and 25% from the general media. He has had over 500,000 visitors to the web site, and the offering circular has only been available since February, 1995. The offering circular was not posted to the web site prior to its qualification by the SEC.
During the comment process, the SEC seemed to concentrate on the fact that by visiting the page before downloading the prospectus, there would be additional writings communicated prior to receipt of the final offering circular. However, Mr. Klein managed to analogize the web page to a cover letter sent with a prospectus, and this satisfied the SEC's concerns. More difficult has been compliance with the multitude of state regimes. Currently, the web page lists in which of the states the offering is legal, and in which it is working to secure approval, but of course the circular may be downloaded from any state in the country. There are additional representations required of purchasers upon subscription, but it remains an open question whether the offering is violating various state laws by making an improper offering in their jurisdiction. A fair analogy is to a tombstone in the Wall Street Journal, which will appear in states where offerings are not qualified, but this does not answer the question of the circular itself appearing in states where it is not qualified. At bottom, however, although this action is potentially illegal, state regulators have better fish to fry. To date, Mr. Klein has not heard any complaints from state securities regulators on this issue.
This type of "small-fry" offering may become useful to small companies that wish to raise capital without the burden of underwriting fees. It will be interesting to note how this area develops. In an article describing the Witbeer offering, John Heine, a spokesman for the U.S. Securities and Exchange Commission, was quoted as saying that the agency hadn't issued any rules regarding electronic investment.[5] , but Mr. Klein noted that the examiners he dealt with in qualifying his offering stated that there were definitely groups within the SEC studying the issues. I attempted to pierce the veil of the SEC to locate any of these groups for comment, but was unsuccessful in my efforts.
The Brown & Wood No-Action LetterOn the other end of the size spectrum is the Brown & Wood no action letter, dealing with prospectus distribution in a more traditional broker/underwriter setting. For your reference, I provide "highlighted" versions of both the original query and the SEC's response. Although an article in the Wall Street Letter states that the letter was the result of eight months of negotiation, it is still a rather tentative step in the direction of electronic distribution.
Brown & Wood submitted the request for interpretation on behalf of clients Merrill Lynch and Goldman Sachs. Essentially, the problem sought to be solved is the pressure to deal with the T+3 settlement requirements in light of § 5(b)(2) requirement to deliver a final § 2(10) prospectus prior to delivery of other writings (so as not to render the other writings also a prospectus). In response to a detailed and well-argued no-action request by Brown & Wood, the SEC issued nine specific guidelines addressing concerns raised by electronic distribution of prospectuses. At their core, these prescriptions boil down to issues of access, insuring that investors will not receive any less information or choice than they already enjoy under a paper-based prospectus distribution regime. In an article for the Institutional Investor, Abigail Arms of the SEC was quoted as saying that any issuer or underwriter could rely on the ruling. While definitely a move in the right direction, the ruling raises more questions than it answers, and takes too small a step in sanctioning true electronic distribution.
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