Internet offerings

Author: | Published: 3 Oct 1999
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Securities and the Internet: Sec Oversight

The offering of investment opportunities and advisory services via the internet represents a significant innovation in the financial marketplace. Individuals on every corner of the earth with access to the web can now participate in the global securities markets. However, the increasing popularity of the internet as a tool for the advertising, marketing and trading of securities has not gone unnoticed by regulators, including the US Securities and Exchange Commission (SEC). This article reviews the SEC's position on the use of the internet, particularly as it applies to non-US firms, and summarizes some of the practical steps market participants can take to ensure compliance with existing regulations.

The SEC's 1998 Interpretive Release

On March 23 1998 the SEC issued a position statement on the use of internet websites entitled "Interpretive Release Regarding Use of Internet Websites to Offer Securities, Solicit Securities Transactions, or Advertise Investment Services Offshore." The release provides issuers, investment companies, investment advisers, exchanges and broker-dealers with guidance on how internet websites may be used to solicit offshore securities business without incurring registration obligations under the US federal securities laws. The release seeks to clarify when the posting of offering or solicitation materials on internet websites would not be considered activity taking place in the US.

Avoiding SEC registration requirements in general

The release begins with an overview of the SEC's position on solicitations made through the internet and the events that may trigger registration requirements. According to the release, the application of registration obligations under the US federal securities laws depends on whether internet offers, solicitations or other communications are targeted to persons in the US. The release makes clear that the SEC will not "view an offer as targeted at the US, and thus [will not] treat it as occurring in the US for registration purposes, if the offerors implement adequate measures [reasonably designed] to prevent US persons from participating in an offshore internet offer". The SEC will judge "adequate measures" based on all the facts and circumstances of a given situation. In general, however, the SEC will not consider an offshore internet offer made by a non-US offeror as targeted at the US if the offeror undertakes the following two basic precautions:

  • placing on its website a "prominent disclaimer" notifying viewers that the offer is "directed only to countries other than the US"; and

  • maintaining procedures designed to prevent sales to US persons in any offshore offering.

With regard to prominent disclosures, the SEC has stated that a website announcement stating that the securities or services are not being offered in the US or to US persons could be characterized as not targeted towards the US, so long as the disclaimer is 'meaningful'. The following would not be meaningful:

  • a disclaimer that simply recites, "The offer is not being made in any jurisdiction in which the offer would or could be illegal;

  • a disclaimer that is not on the same screen as the offering material; or

  • a disclaimer that is not on a screen that must be viewed before a person can view the offering materials.

By contrast, a disclaimer that states, "This offering is intended only to be available to residents of countries within the EU" would constitute a meaningful disclaimer.

The SEC has also stated that procedures designed to prevent sales to US persons should include a determination of a purchaser's residence by requiring the submission of a mailing address or telephone number before entering into any sales. This recommended procedure, however, is not exclusive, nor does it create a safe harbour.

In addition to these two basic precautions, offerors may need to take other steps if they become aware or otherwise are put on notice that US persons have attempted to evade the procedures designed to prevent sales to them. The SEC suggests that an offeror is on notice if, for instance, it receives payment drawn on a US bank, correspondence containing a US taxpayer identification or social security number or other indications that a purchaser is a US resident. Confronted with this type of information, an offeror may need to request a passport, drivers licence or some other type of identification. An offeror should also continually reassess the effectiveness of its efforts to avoid sales to US persons, particularly if sales to US persons have occurred. In these situations, an offeror "may need to evaluate whether other measures may be necessary to provide reasonable assurance against future sales to US persons.

Offers to sell securities

The release also addresses issues specific to the Securities Act, particularly as the Act applies to offshore internet offerings by foreign and domestic issuers.

Regulation S

In general, a foreign issuer may make an offering through the internet without registering with the SEC so long as the issuer does not intend to sell securities in the US and otherwise complies with the basic website disclaimers and screening procedures described above. In an offering made in reliance on Regulation S an offeror must also comply with all applicable provisions of the regulation, such as the provision that all offers and sales be made in offshore transactions.

Offshore offerings concurrent with private offerings to US institutional buyers — guidance for foreign issuers

The US component of a concurrent offshore offering may be exempt from registration under Section 4(2) of the Securities Act, so long as it does not involve "any public offering". In order to conform with Regulation D's prohibition against the offer or sale of securities through a "general solicitation or general advertising", publicly accessible website postings "may not be used as a means to locate investors to participate in a pending or imminent US offering relying on those provisions". The release cautions that an issuer should adopt measures reasonably designed to prevent its offshore internet offering from being used as an indirect general solicitation for participants in their US-based exempt offerings.

The internet and the Investment Company Act

In general, an investment fund registered in a jurisdiction other than the US and offering its securities outside the US does not need to register with the SEC. When an offering is made through the internet, however, a foreign fund needs to consider special procedures to avoid SEC registration requirements. The release addresses this issue and states that the need to register with the SEC will turn on whether a fund implements measures reasonably designed to protect against sales to US persons.

Offshore offers by foreign funds

The SEC has stated that the basic disclaimers and screening procedures noted above provide a starting point for analyzing whether a foreign fund offering securities through the internet must register with the SEC. Despite following these guidelines a fund making an offer through the internet may still be viewed by the SEC as targeting US persons. The SEC could reach this conclusion if the foreign fund's actions, either as a part of or in addition to its internet offer, work to draw US persons to the internet offer. These activities could include, for example, "advertising the existence of the foreign fund's website in a US publication".

Offshore and private US offers by foreign funds

A foreign fund may decide to conduct simultaneously an offshore internet offering and a private US offering of its securities. In order to avoid SEC registration requirements, the foreign fund should adopt "measures reasonably designed to guard against public sales of its securities to US persons" and not use the internet offer to indirectly make a general solicitation for participants in the private US offer. More specifically, foreign funds making concurrent private US and public offshore offers should include a disclaimer on their internet posting that "reflects the existence of two separate offers and indicates that the internet offer is not being made in the US". Such a disclaimer, in the SEC's view, would be evidence that the fund has taken measures reasonably designed to guard against publicly selling its securities to US persons. In general, a foreign fund should not directly or indirectly provide additional information about the private US offer on its website. Exceptions may be available, however, where:

  • foreign law requires the disclosure of additional information;

  • a foreign fund provides additional information beyond that required by foreign law if the fund adopts and implements password-type procedures with respect to the additional information; and

  • an adviser to a foreign fund conducting an offshore internet offer also sponsors a US-registered investment company with the same investment objectives and policies as the foreign fund and provides information about, or directs the viewer to, the registered US fund.

Absent the aforementioned three exceptions, foreign funds generally should not provide additional information about the private US offering on their website posting. The SEC release specifies that a foreign fund should not post additional information on its website such as:

  • guidance on how US persons may obtain information on how to participate in an offer;

  • information listing the types of persons to whom offers and sales can be made pursuant to an exemption under US law; or

  • a hyperlink, or other information directing US persons to another source that provides information about the private offering.

In the SEC's view, these actions suggest that the foreign fund is using its internet offer to target US persons and would thus subject the fund to the registration requirements of the Investment Company Act.

The internet and the Advisers Act

The Advisers Act generally requires registration with the SEC of all persons who for compensation are engaged in the business of providing advice, making recommendations, issuing reports or furnishing analyses on securities. An exemption from registration is available for persons who:

  • had fewer than 15 clients during the preceding 12 months;

  • do not advise US registered investment companies; and

  • most significantly, do not hold themselves out to the US public as investment advisers.

A significant issue arises as to whether a foreign adviser who posts information on a website is holding itself out to the US public as an investment adviser. The release concludes that in general a foreign adviser posting information about itself on a website is holding itself out as an adviser to the US public. The release continues by stating, however, that based on the individual facts and circumstances an adviser could guard against holding itself out as an adviser in the US if:

  • its website contains a prominent disclaimer regarding to whom its materials are or are not directed; and

  • the adviser takes reasonable precautions to ensure that it does not direct information about its services to US persons. Requiring residency information before providing additional information could serve as a reasonable precaution.

Possible future regulatory changes

Rapid developments in the use of the internet as a medium for investing and offering securities and services, combined with its international presence, may render certain regulatory concepts obsolete. The SEC remains open to this possibility. The release notes that the SEC is contemplating, in the context of broader reform, "whether the current general solicitation and other offering communications restrictions on issuers and other offering participants should be modified to provide greater flexibility.

Use of the internet for private offerings

A further internet-related issue recently addressed by the SEC involves the use of the internet for conducting Rule 144A road shows. In a no-action letter dated January 30, 1998, the SEC permitted a company to transmit electronic road shows over its internet website, provided the company complied with a number of representations. The letter foreshadowed the SEC's March 1998 release by placing an affirmative duty on website sponsors to developing access-limiting procedures and to confirm the status and identity of end users. More specifically, the SEC permitted a company to transmit electronic road shows so long as the company would:

  • permit only qualified institutional buyers (QIBs), within the meaning of Rule 144A(a)(1), access to its website for a particular road show, and only after the seller has confirmed its reasonable belief regarding the QIB status of potential viewers; and

  • assign QIBs confidential passwords for a particular road show that would be unique to that road show and would expire no later than the date of termination of the related offering.

In making its request for no-action relief, the company expressed a number of arguments in support of using the internet for the sale of securities. These themes will likely be repeated many times over and include, specifically, that internet road shows will benefit the securities marketplace by:

  • providing wider availability of the road show and offering memorandum;

  • placing QIBs in traditionally unsolicited geographic regions on a more equal footing with other QIBs;

  • providing more timely dissemination of offering materials; and

  • providing greater convenience to QIBs who would be free to view offering materials at their own convenience.

In a no-action letter dated September 4 1998 the SEC extended this reasoning to internet road shows conducted as part of public offerings, allowing a company to transmit live or taped versions of presentations to certain potential buyers (who were not QIBs). The SEC granted the no-action letter based on the applicant's representations regarding how it would restrict the distribution of the road shows, including that:

  • access to the road shows over the internet would be limited to institutional investors of the type usually invited to live presentations;

  • access would be password-controlled; and

  • no potential investor would be given a password until the underwriters had verified that the investor had already received a copy of the applicable prospectus.

Summary of practical considerations

The internet affords securities market participants unparalleled access to the global market for securities. However, in utilizing internet websites to solicit securities transactions and reach out to a wider spectrum of potential investors, firms may subject themselves to the securities regulations of various jurisdictions worldwide. As the guidance provided by the SEC suggests, securities market participants who rely on the internet to solicit transactions and clients should carefully design their websites to reach only those persons allowable under applicable laws. The proper design should include:

  • Disclaimers.Meaningful disclaimers stating to whom information is intended and in which jurisdiction(s) sales are authorized.

  • Access limitation procedures. Procedures that limit access to a website, or to specific pages on a website and include methods such as password requirements or address and telephone number restrictions.

  • Monitoring procedures.Procedures that monitor the identity and location of persons who ultimately engage in transactions or request services to ensure that disclaimers and access-limitation procedures are effective.

    In addition, securities market participants who sponsor websites should consider the following general procedures so that they do not inadvertently violate any applicable securities regulations:

  • Limit the type of information. Do not post any information on a website that would cause a securities law violation if the information was published or otherwise provided to investors or prospective investors in hardcopy. The internet is not a safeharbor for the dissemination of false, misleading or restricted information.

  • Limit the amount of information. Do not post excessive information on a website. The probability of violating the securities laws can correspond to the amount of information posted on a website.

  • Keep materials current. Post only those materials that are current. Stale information may be false and misleading. Procedures in this area could include: i) noting the posting date on all website materials, ii) requiring periodic or event driven reviews of all website materials and iii) placing disclaimers regarding the timeliness of the information on the website.

  • Avoid information about securities offerings. Do not include statements about pending or on-going public offerings or private placements (absent compliance with regulatory guidance). Any such statements may be deemed offers to sell securities.

  • Avoid hyperlinks. A market participant who includes hyperlinks on its website may be held responsible for all information contained on the hyperlinked websites even though the market participant does not control the information on those websites.

  • Appoint a website compliance person. Designate a person to have responsibility for the market participant's website. This person should be familiar with both national and international regulation of internet websites and securities regulation in general. This person should also have sufficient authority within the organization to determine what, when and for how long information is posted on a website.

In sum, securities market participants should take a number of steps to avoid violating US securities laws when soliciting transactions or clients. To comply with applicable regulations, offerors must implement, and should continually assess the effectiveness of, their online procedures to ensure that offers of investments and services are not accessible to persons in jurisdictions where such solicitation would constitute a violation of securities regulations.

Contact Details:

Davis Polk & Wardwell

450 Lexington Avenue

New York NY10017

United States

Tel: +1 212 450 4000

Fax: +1 212 450 5536