Interpretative Release III on use of electronic media — Web site content and free writing

On April 28, 2000, the Commission issued an Interpretative Release[1] dealing, among other things, with one aspect of issues raised by restrictions on free writing while in registration[2] — information on or linked to the issuer’s web site. That this continues the piecemeal and less than definitive approach to the free writing issues is evidenced by the pointing with pride to the liberalization of communications in connection with “business combinations and similar transactions,” but noting as follows: “Thus far, we have not extended the same flexible treatment to securities offerings aimed at raising capital. For these offerings, we are considering separately the liberalization of communications by issuers and other market participants.”[3] A footnote to this statement adds: “We also are considering separately the use of road shows in the capital-raising context.”[4] In fact, as of this date (August 23, 2004), none of the liberalization had been forthcoming, but apparently it is once again on the Commission’s radar screen. See BELOW.

This section focuses on those aspects of Interpretative Release III relating to information appearing on the website of registrants and/or participants in the offering during the pre-effective and waiting periods. We have not included Interpretative Release III but provide a LINK to it on the Commission’s website. Interpretative Release III is a continuation of two earlier Interpretative Releases relating to the use of electronic media.[5] See BELOW. Interpretative Release III should end once and for all any question whether information that appears on a registrant’s web site while in registration may constitute a prospectus within the Section 2(a)(10) definition of a prospectus as a “communication, written or by radio or television, which offers any security for sale.”[6] The staff had previously noted that the Commission has under consideration “issues arising from the use of electronic communications media” and stressed that one of those issues relates to “the question of whether Internet-based or other electronic communications should be treated as written or oral in character.”[7] Interpretative Release III in large part is all about when information on a web site constitutes impermissible free writing and explicitly states: “[T]he web site content must be reviewed in its entirety to determine whether it contains impermissible free writing. The Commission staff will continue to raise questions about information on an issuer’s web site that . . . would constitute an “offer to sell,” “offer for sale” or “offer” under Section 2(a)(3) of the Securities Act.”[8] If the information on the web site is an offer to sell, then obviously it is subject to the anti-fraud and civil liability provisions of the Securities Act as well.[9]

There never should have been much question that information that can be read from a screen, that can be printed, downloaded, and copied, clearly is a “written communication.” The principal reason why there should be any doubt in this regard is that when television came upon the scene the Commission in 1954 took the precaution of having Congress amend the definition of a prospectus to eliminate any question that it covered televised communications by adding “or by radio or television” to “written” communications.[10] One could argue, but not very persuasively, that the fact it was deemed necessary to specifically include the then new medium of television suggests that similarly it is necessary to amend the definition to include the Internet, which the framers of the Securities Act never thought of in their wildest dreams of the future. The 1954 amendments were part of more fundamental amendments that redefined the term “sale” in Section 2(a)(3) so as to distinguish between “offers” and “sales.” Separating the definition of sale and offer in this manner was an essential aspect of changing the gun-jumping scheme of things so that under Section 5(c) any offer or sale before the filing of a registration statement is precluded, oral offers are permitted after the filing of a registration statement, and under Section 5(b)(1) written offers by a prospectus other than a Section 10 prospectus are not permitted before the registration statement becomes effective. Taking a convenient occasion to amend the definition of a prospectus was out of an abundance of caution.

One of the objectives of Interpretative Release III is to clarify “general legal principles that govern permissible web site communications by issuers when in registration.”[11] The basis for this interpretation is a number of guidance-type releases as to what does and does not constitute free writing while in registration, the most recent of which (Release 5180) dates back to 1971,[12] and we discussed it in connection with the pre-filing and waiting period generally. Interpretative Release III revisits Release 5180 in the context of the electronic media. See NEW OLD GUIDANCE..

Applying the guidance to IPOs

Interpretative Release III attempts to clarify the “old” guidance as it relates to IPOs. The Release 5180 guidance contemplated a reporting company, as evidenced by the reference to Exchange Act reports and proxy statements. The new guidance does make clear what has been widely assumed that it also may be applicable to information appearing on the web site of a non-reporting company going public. The acknowledgement that such may be the case, however, is subject to a number of qualifications that leave the area murky at best. The Release in this regard states as follows:[13]

A non-reporting issuer that has established a history of ordinary course business communications through its web site should be able to continue to provide business and financial information on its site consistent with our original guidance. A non-reporting issuer preparing for its first registered public offering that contemporaneously establishes a web site, however, may need to apply this guidance more strictly when evaluating its web site content because it may not have established a history of ordinary-course business communications with the marketplace. Thus, its web site content may condition the market for the offering and, due to the unfamiliarity of the marketplace with the issuer or its business, investors may be unable to view the issuer’s communications in an appropriate context while the issuer is in registration. In other words, investors may be less able to distinguish offers to sell an issuer’s securities in a registered offering from product or service promotional activities or other business or financial information.

There are several problems with the foregoing. Release 5180 is premised on allowing factual communications while in registration “as a matter of policy.”[14] Such communications may very well condition the market in the sense of stimulating interest in the offering, but this was not the test Release 5180 applied. The IPO market of the mid and late 1990s and today continues to be characterized by companies that from their inception plan to go public. Whether the company has a web site for a year or a month does not lessen the need to build its profile as a company with a business model, service, or product that will attract the clientele needed to succeed in the world of e-commerce. Viewing “communications in an appropriate context,” distinguishing “offers to sell an issuer’s securities” from “product or service promotional activities” do not depend upon whether the company has had a web site for a month or a year. The net result under these criteria is not dependent upon reasonably objective criteria, but upon whether the issuer seeks advice from conservative disclosure counsel or one willing to push the envelope. Such criteria are in the same category as attempting to separate out and banning “hype,” something the Commission in the Fair Disclosure Release expressed concern about in determining when proposed Rule 181 should allow written communications while in registration in order to avoid selective disclosures made in the course of road shows.[15]

Information on Website Constituting a  Section 2(a)(10) Prospectus

Interpretative Release III observes perceptively that where such communication appears on the issuer’s web site is not the focus of the free writing inquiry. Rather “the web site content must be reviewed in its entirety to determine whether it contains impermissible free writing. The Commission staff will continue to raise questions about information on an issuer’s web site that is either inconsistent with the issuer’s Section 10 prospectus or that would constitute an ‘offer to sell,’ ‘offer for sale’ or ‘offer under Section 2(a)(3) of the Securities Act.”[16] The fact that information on a web site can constitute a Section 2(a)(10) prospectus and as such may constitute gun-jumping and/or free writing while the registrant is in registration and may be subject to the anti-fraud provisions whether or not in registration, appears, at least from the Commission’s point of view, to be beyond peradventure. The focus is also appropriate, but for reasons noted the guidance provided is old guidance, ambiguous, inadequate, and fails to take into account the difficulty in the Internet age of distinguishing between what promotes the company’s ordinary business and what is an impermissible conditioning of the market for an offering.

Until the Commission deals with the free writing issue directly and through the exercise of its rule-making power, subject to the caveat noted below, not much is likely to change as to what appears on company’s web site while in registration. The statement in the Release that the “staff will continue to raise questions about information on the issuer’s web site,” however, apparently was intended as a warning that the staff has commenced to scrutinize the web sites of companies filing ’33 Act registration statements. In particular, the author understands that the staff is aggressively questioning companies going public and asking them to justify old and new press releases on their web sites about their activities as being within the guidelines. If the staff views information on the web site as constituting impermissible free writing, it may, among other things, deny acceleration and force a delay of the offering.[17] All companies while in registration should carefully review the content of their web site with a view to cleansing it of releases and other information that might be deemed outside of the guidelines. Although it should not be necessary to go that far, a company to assure it has no problem in this regard may even consider removing all archived press releases on its web site and refrain from including any new ones.[18] This does not encourage the kind of dialogue that the Aircraft Carrier Release suggested would be desirable:[19] “We believe that the waiting period should be a time of open dialogue between the registrant and its potential investors, provided that the registrant is accountable for the accuracy and completeness of its communications. The medium in which disclosure is made should not be dictated by the regulatory structure but, rather, by the needs of investors.”
 

Online offerings

Interpretative Release III also promises to “[f]acilitate online offerings by clarifying general legal principles that broker-dealers should consider when developing and implementing procedures for online public offerings.”[20] The principal guidance is based on the Wit Capital no-action letter. See LINK. That letter reflects the staff’s long-standing preference for soliciting oral indications of interest rather than written conditional offers during the waiting period. This notwithstanding that the legal principles Interpretative Release III refers to as governing public offerings specifically provide that conditional offers can be solicited provided (1) the offer can be revoked before acceptance, (2) the offer cannot be accepted and no cash payment is permitted until the registration statement is effective. Wit Capital’s procedures made the matter of revoking a conditional offer as simple as placing an x in a cancel box on the list of conditional offers reflected in the customer’s electronic account available on-line at any time during any day. Wit Capital, nonetheless, presumably to obtain the no-action letter, imposed upon itself a commitment before confirming any transaction to require a reconfirmation of all conditional offers at a point of time in the process related to the effective date.[21] Wit Capital appeared to have some difficulty in figuring out how to do this in the fluid circumstances that surround pricing and when a registration statement may go effective.[22]

Wit Capital also established and described at length in its request for a no-action letter what it referred to as a cul de sac approach designed to limit access by customers submitting a conditional offer to a Rule 134 communication and the preliminary prospectus. Wit Capital in announcing the availability of a new offering sent those with an account an email that does not go beyond a Rule 134 statement. The email included a live URL, which when clicked on took the prospective investor to the cul de sac. The only access to information on the cul de sac wasto a preliminary prospectus and the means for the account holder to submit a conditional offer. In theory, the prospective investor could not access any other material on the Wit Capital web site. This is theory only, however, as account holders were well aware of the availability of other information on the web site and how to access it. The no-action letter specifically stated: “You have not asked, and we do not address, Wit Capital’s responsibilities under the federal securities laws to cleanse (or otherwise modify) its general web site of any information that could be deemed illegally to condition the market for a particular IPO security. These and other issues arising from the use of electronic communications media in the context of registered and exempt securities offerings (including, but not limited to, those identified in the preceding paragraph) are under consideration, or will be considered, by the Commission. . . . Accordingly, nothing in our response should be viewed as taking a substantive position on any of these issues.” The staff also cautioned, “because regulatory responses to legal issues raised by rapid developments in information technology necessarily must evolve, you should be aware that this no-action position may be re-evaluated by the Division and is subject to change by the Commission.”[23]

Interpretative Release III, although referring to the Wit Capital no-action letter, says nothing about the cul de sac and its discussion about information included on a web site relates almost exclusively to registrants. The Interpretative Release does address the question of information on a web site as constituting impermissible free writing in the context of the registrant and also the registrant’s responsibility for hyperlinks that include information on third-party web sites. See BELOW. The Commission, as discussed BELOW, has issued Interpretative Releases that permit the delivery of a preliminary and final prospectus and of confirmations electronically, including via the Internet, provided appropriate consents are obtained. The two interpretative releases provided the basic impetus for making a public offering, and, in particular, an initial public offering, on the Internet. The leader in making use of an Internet site for making or participating in an initial public offering of securities was not any of the major investment banking firms, but Wit Capital (www.witcapital.com). E*TRADE Securities (www.etrade. com) in conjunction with E*OFFERING (www.eoffering.com) followed the Wit Capital lead. Wit Capital no longer exists and E*Trade no longer features electronic offerings as to which it acts as an underwriter or member of the underwriting group. There were several others engaged to varying degrees in using the Internet as IPO sites. These included IPONet, WebIPO, DirectIPO, and the Direct Stock Market. All are gone. Searching for them on the Internet, will bring you to sites you do not care to visit.

Donaldson, Lufkin & Jenrette (SEC Chairman Donaldson’s old firm) through DLJdirect (www.dljdirect.com) at its Internet site took indications of interest in IPOs over the Internet as an adjunct to the traditional syndication method of distribution, but limited this feature to accounts with a balance of $100,000 or more. Going to the www.dljdirect.com URL will redirect you to Harrisdirect (http://www.harrisdirect.com/) an online broker that among other things takes indications of interest on line as a distributor (i.e. member of the selling group) as appears as close to the Wit Capital format as any. The major investment banks for the most part are content to syndicate their underwritings in the traditional fashion, secure in their belief that the institutional investors who are the primary purchasers of public offerings can be and prefer to be reached through personal contact and via road shows. That does mean they don’t have information available on their website relating to IPOs. Goggle in effect was an electronic offering and force many investment banks to participate in an electronic offering although some are reputed to have dropped out because of that aspect of the offering (and, perhaps, the low commission). WR Hambrecht initiated what it refers to as the OpenIPO, a form of dutch option and was a co-manager of the Google offering (probably because of its know-how), but doesn’t have too many deals of late. Below we provide a walk-through of the Harrisdirect approach and also the IPO center of CreditSuisse First Boston.
Harrisdirect to the extent it participates as a member of the selling group provides an online approach to offering IPOs to its customers, adapting the procedures used byWit Capital. Of course, it may not get a large allocation, is dependent on the managing underwriter for participation, and it determines how it will allocate its participation to customers whereas Wit Capital did it in effect on a lottery basis. Hence, there is no assurance of participating in the IPO and/or the quality of the IPO as to which participations are available at Harrisdirect. CSFB makes available on its website a listing of its current offerings that can be accessed by anyone willing to register, and which includes the preliminary prospectus, but participation depends upon contacting an account representative. Use the bookmarks to follow IPO online information/procedures as appropriate.

Harrisdirect IPO Center.

CreditSuisse First Boston (CSFB)

Google in many respects also illustrates how an offering can be done electronically. Google did not obtain a no-action letter, but undoubtedly the company and counsel had one or more conferences with the staff. Although it built on what had gone before, there were some unique features, including a page on its website devoted to giving the notices required in order to keep prospective bidders advised of where they were in the process, what to expect next and the like.

Click here to view all of the filings listed in EDGAR made from the initial S-1 through amendment No. 9, on which the company went effective and the Rule 424(b) final prospectus.

Click here to view how participating underwriters (here WR Hambrecht) instructed customers about the bidding process and made preliminary prospectus available.

Click here for notice that registration statement is effective and availability of final prospectus.

Click here for 424(b)(4) Final Prospectus with Pricing Information
 

The Internet age — Legal concepts vs. common sense

The Commission in the Securities Act Reform Proposal part of the Aircraft Carrier Release said some very sensible things about road shows and the distinction between written and oral offers during the waiting period that suggest some very common sense but anti-conceptual answers.[24] First, the distinction between written (prohibited) and oral (permitted) offers during the waiting period “appears to do little to enhance investor protection or facilitate the capital formation process.”[25] Second, the distinction provides “an incentive for issuers and underwriters” to provide information in a manner (orally) “that is not readily available to investors for later reference.” Third, it permits participants in the distribution process to “provide some information . . . only orally” and to limit the audience to keep it from “being considered broadcasted.”[26] Fourth, “[w]e believe that the waiting period should be a time of open dialogue between the registrant and its potential investors, provided that the registrant is accountable for the accuracy and completeness of its communications. The medium in which disclosure is made should not be dictated by the regulatory structure but, rather, by the needs of investors.”[27] Fifth, the traditional road show that plays such a prominent role in the distribution process is a good example of what is wrong with the process. Restricting road shows and limiting the materials to those presented orally raise “selective disclosure” concerns and whether this is an opportune way to inform investors.[28] Sixth, “[r]estricting communications to one document may in fact serve to impede, rather than promote, informed investing and voting decisions.”[29] Nothing has been done, however, to significantly liberalize communications while in registration except in connection with business combinations.

Despite some false starts, once again it appears that the SEC may be thinking about doing something about free writing during the waiting period and maybe even in advance. Alan Beller, Director of SEC Division of Corporation Finance on July 14, 2004 buried in a speech on SEC UPDATE included as an Item on the SEC’s current agenda the following: “We are looking at the liberalization of communications, especially written communications beyond the statutory prospectus, in registered offerings. We are considering liberalization in the context of both routine communications and communications that are offers. We are also looking at these questions as they relate to filing requirements and liability issues.” SEC Chairman Donaldson in the aftermath of some of the Google missteps is quoted by Reuters on August 18, 2004, "We have had under review the whole issue of the quiet period, and we will continue to have it under review," Donaldson told reporters after a public meeting. Referring to technological changes that have dated the "quiet period" rule, he said, "We're aware of the origins of the rule, we're aware of the changing circumstances over decades and I think we need to take a good, hard look at it." The Commission probably will but need look no further with some adaptation than what it did in the context of business combinations and exchange offers.

Business Combinations and Communicating with Shareholders of the Acquired Company

The Aircraft Carrier proposal had two parts. Part 1, on which most of the emphasis was placed, involved what the Commission now refers to as the Securities Act Reform proposal. Part 2 involved business combinations, exchange offers, and tender offers. The latter by and large escaped the criticism many commenters directed at Part 1 and, with some modification, the Commission adopted Part 2 of the Aircraft Carrier Proposal. In doing so, however, the Commission had to take into account that Part 1 contemplated new Forms C and SB-3 for business combinations and exchange offers. The Commission did so by the simple expedient of disregarding that part of Part 1 and by making some modest changes to Form S-4 (the form for registering securities offered in a business combination) and Form SB-3. The reason Part 2 found such favor is that it gave a lot in the way of freedom to communicate with shareholders before and after filing the appropriate documents, without demanding much in return that was not already required. Part 1 also expanded freedom to communicate outside of the filed documents, but imposed a high threshold for receiving this entitlement and otherwise demanded what was perceived as too much in return. Aside from the details, perhaps, the most significant aspect of the new framework applicable to business combinations, exchange offers, and tender offers is the Commission’s recognition of the following: “We recognize that restricting communications to one document may actually impede, rather than promote, informed investing and voting decisions.”[30] The draftspersons of the Securities Acts had good reason to focus on the primary disclosure document and to restrict, in the case of Securities Act, written disclosure to a narrow framework. The revolution in information technology, the changing nature of capital markets, the widespread publication of and access to financial information, and the keen interest of the marketplace, including individual investors, in that information makes those restrictions outmoded. Our focus is primarily on the securities act aspects of a merger.

In a statutory merger, the acquiring company issuing its securities will have to file a registration statement on Form S-4 covering the shares to be issued in the merger. Shareholders of the acquired company, assuming a statutory merger, will have to approve the merger by the vote required under the applicable statute. The merger is likely to be structured so that under the applicable statute approval of its shareholders of the acquiring company is not required, although, if the acquiring company is listed on a stock exchange, the rules of the exchange may require approval of its shareholders as well. Thus, at least one meeting of shareholders will be involved and, assuming the company to be acquired is a public company with shares registered under the Exchange Act, solicitation of proxies will be subject to the proxy rules. The typical statutory merger, therefore, involves both the sale of securities registered under the Securities Act and a solicitation of proxies subject to the Exchange Act proxy rules. In the case of a merger, under the prior regime no information relating to the merger could be distributed prior to the filing of a registration statement if it could be deemed either an offer of the securities or a proxy solicitation. The former was precluded by Section 5(c) of the Securities Act and the latter by the proxy rules.[31] If the registration statement is filed before the definitive proxy statement has been distributed, even the limited communications permitted under the Securities Act might be deemed a proxy solicitation. This meant in theory something of a blackout of information (other than a bare bones Rule 135 announcement) prior to the distribution of the proxy statement/prospectus, notwithstanding if either party was to deny merger negotiations when queried by the press, it would violate Rule 10b-5.[32]

The Commission adopted a very simple solution. The only restrictions on free writing in connection with the business combination is (1) to require all writings to be filed; (2) conceptually all are part of the prospectus for purposes of the civil liability provisions of Section 12(a)(2), and (3) all are subject to the anti-fraud provisions of the Securities Acts. See ATTACHED.