IN JULY’S COLUMN, WE ADDRESSED THE “INTERNET OFFERING,” a public securities offering on the Internet usually conducted by the issuer without using an underwriter.
Since then, broker/dealers and issuers have begun using the Internet in connection with Regulation A offerings as well as traditional IPOs. In the past few months, no less than five sites have been created on the World Wide Web to advertise offerings, and there are approximately 10 other sites created by issuers to promote the sale of their own securities. The recent Berkshire Hathaway offering was accomplished in part by distributing its offering documents through the Internet.
Brokers are learning that the Internet and its use in the offering process assists their clients, their clients’ investments and their own corporate finance activities. Internet use will continue to grow in the industry, and innovative brokers and firms will fashion creative uses to enhance client services.
However, brokers using the Internet must be cautious; it is not difficult to run afoul of existing regulations when applying new technology.
A case in point is the current attempt to expand the use of the World Wide Web to private placement offerings. The success of Spring Street generated a natural question: If Spring Street was able to conduct a public offering on the Web, why not promote private placements on the Web? A few issuers took Spring Street as a green light, and private placement notices appeared on the Web. But as quickly as the ads appeared, most of them disappeared.
The disappearing act is no accident. Although the unsuspecting issuer might believe that the Spring Street offering approval permitted all offerings to advertise on the Web, there is a major difference between a public offering, such as Spring Street or Berkshire Hathaway, and a private placement conducted under Regulation D and Rules 505 and 506. General advertising and solicitation are prohibited for Rule 505 and 506 offerings.
The prohibition of offerings conducted pursuant to Rules 505 and 506 is perfectly clear: “Neither the issuer nor any person acting on its behalf shall offer or sell the securities by any form of general solicitation or general advertising.”
The Securities and Exchange Commission (SEC) and court interpretations of the Rules have provided clear guidelines and restrictions for 505 and 506 offerings. When the issuer or a person acting on its behalf uses an advertisement, article, notice or other communication in connection with the solicitation, it must be certain that the content of the solicitation is limited and that only qualified persons are solicited.
The proscription on solicitation presents a major stumbling block for the broker/dealer who wishes to promote a private placement on the World Wide Web. The reason for using the Internet — the millions of potential investors — is the reason the Internet cannot be used for a private placement. Merely posting the offering memorandum is a general solicitation or general advertising, as the document is being made available to millions of people whose qualifications as investors are unknown.
A broker/dealer could direct appropriate advertisements to preexisting clients, but then the advantage of the Web and its huge potential for distribution of information is lost. This issue and others have kept private placements off the World Wide Web. However, this may soon change.
In trying to avoid general Web solicitation, brokers and their counsel have been attempting to create a mechanism whereby information about a private placement could be delivered online to potential sophisticated investors without constituting a general solicitation. One suggestion was to “pre-qualify” visitors to a firm’s Web site for their financial sophistication, and thereafter direct a limited solicitation to those investors for a later offering. However, past interpretations of the general solicitation rule always focus on a “preexisting relationship” with the solicited investor. In the pre-qualification scenario, the solicitations are directed to sophisticated individuals, but not to those who had necessarily done business with the broker/dealer before.
However, in July 1996, the SEC issued a No Action letter to the sponsor of a World Wide Web corporate finance site that removed most of those concerns. While No Action letters are not SEC rulings and are strictly limited to the facts that are presented, they provide insight into the SEC staff’s thinking on a particular issue, and guidance for others considering a similar course of action.
The SEC, which has been the most progressive regulator regarding the use of the Internet, once again showed its progressive nature and informed the Web site sponsor that it would not take any action against it for violation of the general solicitation rule because of its proposed pre-qualification mechanism. The letter assumes that the content of the solicitation to those investors is appropriately limited.
Basically, as detailed in the No Action letter, the Web site sponsor proposes to ask potential investors to complete a questionnaire to determine if the investor is accredited or sophisticated. Information about private offerings would then be available in a password-protected section of the Web site, accessible only to those investors who had previously qualified as accredited investors through the questionnaires.
The SEC stated that such a process would not be a general solicitation, but specifically noted that the qualification decision would be made by a broker/dealer affiliated with the site sponsor; that the invitation to complete the questionnaire itself would be generic in nature and would not reference any specific transaction posted or to be posted at the site; and that potential investors could purchase securities posted in the password-protected area only after their qualifications are submitted and approved.
The SEC’s views don’t completely put the matter to bed. There are an additional 53 regulators that an issuer or broker/dealer may have to satisfy. For now, though, it appears that the general solicitation issues in 505 and 506 offerings may be settled at the federal level. An increasing number of states have adopted the view that an Internet post is not in and of itself an offering of securities. This new interpretation by the SEC takes another step toward the full use of the Internet to disseminate corporate finance information.
There are other issues that must be resolved before a private placement can be conducted on the Internet, but the recent action by the SEC provides hope that those issues will be resolved in a cooperative effort between the industry and the regulators. In the meantime, brokers, their firms, and issuers are cautioned to tread lightly in this area and to seek the advice of securities and legal professionals when conducting offerings, whether private or public. While the SEC has been extremely progressive in its views on the use of new technologies, this area of law is still evolving and is by no means settled.
This article originally appeared in the November 1996 edition of Research Magazine.
Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.
He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.