Can Securities Registration Survive the Internet?

(November 13, 1998)  A group of lawyers and regulators held a panel discussion in Washington DC on November 12 on whether the Internet is rendering federal securities registration obsolete. The SEC's Paul Dudek was there to argue that the process will adapt and continue.  The private practitioners on the panel were not so sure.

The Securities Act of 1933 requires that before a company can make a public offering of new securities in interstate commerce it must first submit a registration statement to the U.S. Securities and Exchange Commission (SEC).  The registration statement must disclose detailed information about the nature of the business, the securities, the company management, its key shareholders, and other information.  The SEC must approve the registration statement before securities can legally be offered or sold in interstate commerce.

The panelists discussed many ways in which the Internet is making the registration laws less relevant, more difficult to interpret, and harder to enforce.  First, the statute is based on a dichotomy between written statements and oral statements.  The former are regulated.  But, web pages, email, emailed voice data, and other Internet media do not fit into the old regulatory structure.  Second, in 1933 it was easy to distinguish between interstate securities offerings, which are covered by the statute, and intrastate and foreign offerings, which are not.  The Internet confuses classification under this scheme.

Third, use of the Internet in connection with private placement offerings, which are not covered, creates further regulatory uncertainty.  Finally, the very notion of the Internet, and modern online trading, is antithetical to the principles underlying the 1933 Act.  The purpose of the Internet is to disseminate information.  The purpose of the registration provisions of the 1933 Act is to limit information.

Ed Fleischman was the moderator of the program and its first speaker.  He was a Commissioner of the SEC from 1986 to 1992.  He is currently Senior Counsel to Linklaters & Paine.  "The purpose of the 1933 Securities Act is to prevent fraud, not to clean up after the fraud," he said.  That is, the registration process is to prevent fraud before it happens. "It does that through the mandated disclosure of relevant information."

Fleischman continued:

"The whole thing summed up in the two words 'investor protection.'   Well, that was not only as it was in 33, but also the way it was in 53, and 73, perhaps even in 93.  But the world did not sit still in those sixty years, and certainly the last five years the pace of change in the media of transmitting information has been extraordinarily rapid, and that is really the provocation for our panel today.  Can this registration system as we have known it survive the Internet?   Does registration run counter ... to the Internet?  Does it elicit adaptation from the registration system, or does the registration system elicit adaptation from the Internet?  Or somehow or other do they live together in some kind of precarious harmony that is achieved in some kind of new synthesis that we have not yet reached?"

Paul Dudek, the Chief of the Office of International Corporate Finance, Securities and Exchange Commission, says that the SEC is adapting to the Internet with rule changes, interpretive releases, and no action letters.   Registration will continue to play an important role.

The SEC has been paying attention to the Internet, said Dudek:

"The SEC has been very active in the area of the Internet and electronic communication.  I think we are in charge of administering a statute that is decades old.  And I think that through our interaction with private practitioners who are, sort of, out there every day, advising clients, companies, broker dealers, and others, we see where the problems come up on a daily basis ... The SEC has been very in tune on what is going on."

Dudek stated that the SEC generally now views electronic communications the same as paper communications.

Regarding private placements -- those that are made only to well healed and knowledgeable investors, and hence are not covered by the registration requirements -- Dudek said that the Internet could be used to disseminate information, so long as it is "password protected."

Dudek conceded that a foreign securities offering, which is connected with web postings, "has raised a number of questions."  However, for offshore offerings of foreign companies, the SEC follows "a two prong approach."   The SEC approach is as follows:

"[First, the SEC is] ... making sure that there is a disclaimer of some sort, sort of making sure that information, that the offerings is not available to U.S. persons.  It is not, sort of, a check the box type of release, that the mere existence of a disclaimer will do.  If the content of the offering is clearly directed to U.S. persons, comments on the tax consequences, some sense of how you can move money from your U.S. account.  And so, there is the disclaimer, yet it does require some thinking on the part of lawyers to make sure that this is not really an offer that is directed into the United States.   And the second part is that the issuer should engage in some policing transaction, the policing of their offering, making sure that the sales are not being made into the United States.  Looking at where checks are coming from, sort of looking at where securities are being delivered to. ..."

But, Dudek is convinced that the registration process remains important, and the SEC is modernizing the way it handles the Internet.

Joseph McLaughlin, an attorney with Brown & Wood, diverged.

"The explosion of technology has put a great deal of pressure on the SEC's efforts to continue a command and control type of regulation.  Both in respect to the public offerings where the only legitimate offering material is the prospectus.  And writing, by the way, includes everything that is  reflected in electromagnetic impulses.  I had a call to one of Paul's (Dudek) colleagues once, about email, and she took the position that 'certainly, electromagnetic impulses, therefore, must be a writing.'  And I said, 'What about voice mail?'  She wasn't too sure.  So, you could have something in writing there too.  But the SEC approach in the 1933 Act has been that everything in writing is a prospectus, and unless it meets the requirements of the 1933 Act, it is an illegal prospectus. ..."

"What has technology done?"  Well, technology has lead to a great explosion of information that is available to investors around the world.  It has made it more efficient to deliver that information.  The Chairman of the SEC says we live in the age of information.  And yet, as I pointed out, the SEC's policy in this area is still based on attempts to control or restrict the flow of information.  And we have absurd results like the fact that a broker can call a customer and praise an initial public offering, and then give another customer the exact same message by email, and have committed a criminal offense, and possibly given the customer a civil remedy for one year to give the security back. ..."

"We have companies with websites that contain a great deal of useful information.   But at the outset of a public offering these days, you have to ask the company, 'What is on the website?'  And if something is on the website looks as if it is intended to promote the offering, or might be understood to promote the offering, you have to tell the company to take it down, expurgate the website.  This is not in the interest of investors."

"In the area of research, broker dealers are using the Internet to disseminate research.  Again, it is possible you might have to tell the broker dealer to take it down."

Although, from McLaughlin's perspective, the problem is not just the Internet.   The securities registration requirements were obsolete long before the Internet.

The panel was made up of the following:

• Paul Dudek, Chief of the Office of International Corporate Finance, Securities and Exchange Commission.  This office is responsible for rule-making initiatives and interpretive policies pertaining to offerings by foreign issuers in the U.S. and multinational offerings.
• Neal Sullivan, Attorney, Bingham Dana, and specialist on state securities laws.
• Joseph McLaughlin.  Attorney, Brown & Wood, and author of Corporate Finance and the Securities Laws.
• Ed Fleischman (moderator).  Attorney, Linklaters & Paines, and former Commissioner of the SEC.

The panel was part of a three day convention of the Federalist Society for Law and Public Policy Studies in Washington DC.  The Federalist Society is group of predominantly conservative or libertarian lawyers, judges, and business leaders, with about 25,000 members.  It has 60 lawyers chapters, and 140 chapters on law school campuses.