Avoiding E-Security Violations
Delaware Law Weekly August 6, 2001
SECTION: No. 32; Pg. p3
HEADLINE: Avoiding E-Security Violations
BYLINE: By Jonathan Bick Special to American Lawyer Media
The widespread use of the Internet by companies to raise money and to satisfy securities market reporting requirements carries with it the potential for securities law liability. However, through cursory monitoring of information posted on a company's Web site, most, if not all, such liability can be avoided or minimized.
To be specific, five simple steps should be taken. These steps are:
The adoption of a Web site policy.
The use of safe-harbor language and disclaimers.
Implementing proper site programming.
Eliminating outdated material.
(The safe harbors provided by the Private Securities Litigation Reform Act of 1995 apply only in private actions in federal court, subject to pending legislation and do not apply to disclosures in financial footnotes, initial public offerings, tender offers and certain other excluded types of filings.)
Businesses have found that a Web site can be a remarkable apparatus, not just from an e-commerce perspective, but from a fund-raising standpoint as well. Using a Web site, a company can increase the speed, accuracy and flexibility of information that it must disseminate to its shareholders, potential investors and the public.
Companies have also found that the use of a Web site can be a cost-effective method for the dissemination of information.
The Securities and Exchange Commission has recognized that the use of electronic media enhances the efficiency of the securities markets as a whole. It also suggests that the Internet may disseminate information in a more equitable manner than traditional paper-based methods. See, Securities Act Release No. 33-7233, (Oct. 6, 1995) (addressing the use of electronic media for delivery purposes.)
The SEC has considered the use of the Internet to disclose information, to satisfy reporting requirements and to offer securities. These considerations have been widely disseminated and have been coupled with warnings of potential liability. The SEC had also given meaningful guidance as to how such liability could be avoided. Such guidance can also be found in SEC rule making and litigation with respect to broadcasting and publishing, which pre-dates the Internet.
First, briefly consider the relevant liability scheme under the Securities Act of 1933 and the Securities and Exchange Act of 1934, together with their attendant rules.
The most significant liability provisions are threefold. First, there is rule 10b-5 of the Securities and Exchange Act, which prohibits untrue or misleading statements of material fact in connection with the purchase or sale of securities.
Second, there is Section 12(a)(2) of the Securities Act, 15 USC Section 771, which prohibits offering or selling a security by use of an untrue or misleading statement of material fact.
Third, there is Section 11 of the Securities Act, 15 USC Section 77k, which provides liability for making an untrue or misleading statement of material fact in a registration statement.
Forward-looking financial statements or exaggerated product information, when posted on a Web site to raise funds, causes the most legal difficulties. Forward-looking statements typically communicate corporate announcements, financial projections, management objectives and predictions of future products and services.
Companies that use the Internet for fund raising can avoid the securities liability associated with these statements simply by having a policy that prohibits their e-posting or requires the use of "safe harbor" language.
The Private Litigation Securities Reform Act of 1995, 15 USC Sections 77z-2, 78u-5, provides a safe harbor for publicized information. The PLSRA requires that such information is identified as a forward-looking statement and is accompanied by meaningful cautionary statements identifying important factors that can cause actual results to differ materially from those projected in the forward-looking statement.
Another prominent problem for companies in the process of offering securities are the Section 5 limitations of the Securities Act, which prohibit offers to buy or sell any security unless a registration statement has been filed covering that security (or unless an exemption is available). See, Securities Act Release No. 33-7233. Securities law difficulties usually arise due to the erroneous determination of an offer.
The SEC has issued four interpretive releases concerning electronic delivery, provided guidance for Internet offerings and addressed issuer liability for Web sites. Companies can simply review these releases to develop their own guidelines and practices. See, "Use of Electronic Media for Delivery Purposes" (1995); "Use of Electronic Media by Broker Dealers, Transfer Agents and Investment Advisors for Delivery of Information (1996); "Use of Internet Web Sites to Offer Securities, Solicit Securities Transitions or Advertise Investment Services Offshore" (1998); and "Use of Electronic Media" (2000).
Most companies post current information on their Web sites. This information typically includes press releases, product information, SEC filings and news articles. The company prepares some of the material, and the rest is created by third parties.
Such postings are usually found to be an efficient and an effective way to disclose information.
Normally, companies will post Internet information in one of two ways. Information may be placed in its entirety on a Web site, or an e-pathway (electronic door) to the information may be placed on the Web site by a hyperlink.
It is advisable to disseminate information by more than one means. Currently, the posting of information on a Web site is not universally accepted to constitute public dissemination for SEC purposes. It is also advisable to label all e-postings with dates and a disclaimer stating, "material is accurate as of its label date and no obligation or intention to make updates or corrections exists." Such labeling and disclaimer posting should be displayed prominently.
In addition to the use of disclaimers, business organizations should formulate and publish policies for regularly reviewing its e-security-related postings. This action, coupled with an education program directed to the technology staff, will be a good defense to a charge of intentional misrepresentation in the event that an individual fails to delete dated information that is no longer true.
Disclaimers and standard operating procedures are not cure-alls. A company in the process of registration has special concerns. Although its disclaimer may protect it from some legal difficulties by stating that the e-posting does not constitute an offer to sell or a solicitation to buy securities, it may result in an unlawful attempt to create interest in a proposed offering.
The most acceptable way to prevent this legal difficulty is to limit the security-related content of a company's Web site during the registration process. The SEC has stated that advertisements, SEC-related reports and notices and press announcements are allowed. See, "Use of Electronic Media," Securities Act Release No.33-7856, 65 Fed. Reg. 25,843 (May 24, 2000). (This release was the SEC's attempt to provide guidance on the use of the Internet by all kinds of issuers, including operating companies, investment companies and municipal securities issuers, as well as market intermediaries.)
Since employees may also become owners of the company for which they work, the SEC requires that companies be treated as potential investors. This means that any e-communication to an employee should be treated the same as external communications. Therefore, despite the fact that a Web site might be labeled confidential, securities-related information should be coupled with appropriate disclaimers.
In addition, Internet communication technologies should be deployed to limit access to e-securities-related information. As suggested above, a company should also reduce this procedure to writing and use it to educate appropriate employees. Such action will be useful as part of a defense effort in the event of legal difficulty.
Endorsed and Approved
Third-party content and hyperlinks to third-party content habitually appear on Web sites. These parts of a site may create liability because the information will be imputed to the Web site owner, according to the SEC, which suggests that a company is liable for statements made by third parties that are endorsed or approvable.
The SEC provided security issuers with guidance about responsibility for e-content under the anti-fraud provisions of the federal securities laws. A securities issuer is responsible for third-party information if it has involved itself in the preparation of the information or if it expressly or implicitly endorses or approves it.
Although it is clear that an issuer is responsible for its own actions, it is less clear what constitutes endorsement and/or approval. As a result, the SEC stated that in the case of hyperlinked information, liability would depend on certain factors related to the hyperlink.
The SEC catalogs three nonexclusive factors that can be used to determine if endorsement or approval has occurred.
First, does the context of the hyperlink demonstrate adoption?
Second, is there confusion as to the source of the information?
Third, was the hyperlinked information presented to demonstrate adoption? See, Securities Act Release No. 33 - 7856.
Most companies use the Internet to post information that is available to the public. E-posted information, more often than not, contains corporate, investor and product information. Web sites are thus useful vehicles for communicating with customers, employees and shareholders. However, they may also give rise to additional legal liability. An easy and inexpensive way to reduce or eliminate this liability is to monitor e-posting with a few questions in mind.
Is a trained person regularly reviewing the e-postings, including the hyperlinks? Has the information in the e-postings been released on the Internet alone, or has it been a part of press releases as well? Is the hyperlinked content lawful? Have all e-postings, including material prepared by third parties, been coupled with approved disclaimers prior to posting?
Without a set of operating procedures to enact the company's e-policies, the company's Web site can become a source of legal difficulties, including an invitation for securities class-action litigation.
It should also be remembered that related problems arise when employees have regular access to a company's Web site. Without consistent use of high-quality monitoring procedures, Internet postings by company insiders may result in legal difficulties.
In sum, a company should subject its Internet postings to the same analysis as a press release or an SEC filing. E-posting procedures should ensure that financial and other information placed on the company's Web site goes through meaningful internal review. Only people who are familiar with the legal risks involved in public disclosures should oversee all phases of e-posting of securities-related information. Only documents that a company has released as a press release should be posted on its investor relation's site. And all e-postings should be dated.
In addition, the Private Securities Litigation Reform Act of 1995 provides
a safe harbor for certain forward-looking statements without incurring
additional liability to investors if their expectations were not realized.
Safe-harbor language has been a successful shield in a company's arsenal
against shareholder litigation generated in part by e-postings.