The Internet Newsletter October 2001 volume 6, Number 7 American Lawyer Media

Securities Law

Avoiding the Violations Risked by Companies

That Use the Web to Disseminate Information

By Jonathan Bick

(Jonathan Bick is an adjunct professor of law at Rutgers Law School and Pace Law School. He is the author of 101 Things You Need To Know About Internet Law (Random House 12/00)).

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.

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.

The Securities and Exchange Commission has recognized that the use of electronic media enhances the efficiency of the securities markets and even has suggested 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 also has warned, however, of the potential liability that goes along with using the Internet to disclose information, satisfy reporting requirements and offer securities

The most significant liability provisions under the Securities Act of 1933 and the Securities and Exchange Act of 1934 are the following: (1) 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; (2) Sec. 12(a)(2) of the Securities Act, 15 USC § 771, which prohibits offering or selling a security by use of an untrue or misleading statement of material fact; (3) Sec. 11 of the Securities Act, 15 U.S.C. § 77k, which provides liability for making an untrue or misleading statement of material fact in a registration statement. Luckily, the SEC has given meaningful guidance on how to avoid liability for violating those provisions. Such guidance also can be found in SEC rule making and litigation with respect to broadcasting and publishing, which pre-dates the Internet.

To be specific, companies that use the Internet in the above-described ways should do the following: (1) Adopt web site policies, (2) Use safe-harbor language and disclaimers, (3) Review postings, (4) Implement proper site programming and (5) Eliminate outdated material.

Adopt Policies

Posting forward-looking financial statements or exaggerated product information 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 about 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 those statements from being posted on the Internet or requires those statements to include "safe harbor" language, which I will explain shortly.

Another prominent use of the Internet that requires companies to develop their own guidelines and practices is the use of the Web to offer securities. Sec. 5 of the Securities Act prohibits offers to buy or sell securities unless a registration statement has been filed covering those securities or an exemption applies. See, Securities Act Release No. 33-7233.

The SEC has issued four interpretive releases concerning electronic delivery, provided guidance for Internet offerings and addressed issuer liability for web sites: 1995—Use of Electronic Media for Delivery Purposes; 1996—Use of Electronic Media by Broker Dealers, Transfer Agents and Investment Advisors for Delivery of Information; 1998—Use of Internet Web Sites to Offer Securities, Solicit Securities Transitions or Advertise Investment Services Offshore; and 2000—Use of Electronic Media. Companies can help their chances of avoiding securities law liability by developing their own guidelines and practices based on their review of these releases.

Use Safe Harbor Language and Disclaimers

The Private Litigation Securities Reform Act of 1995, 15 USC §§ 77z-2, 78u-5, provides a safe harbor for publicized information. Subject to pending legislation, those safe harbors apply only in private actions in federal court, and do not apply to disclosures in financial footnotes, initial public offerings, tender offers or certain other excluded types of filings.

To qualify for the PLSRA’s safe harbors, companies must identify publicized information as a forward-looking statement and make sure that such information is accompanied by meaningful cautionary statements identifying important factors that can cause actual results to differ materially from those that the information projects.

To avoid violating SEC laws, companies also should be aware that posting either “forward-looking” statements or other information on a web site—either directly or via hyperlink—is not universally accepted as constituting public dissemination for SEC purposes. If a company nevertheless opts to use the web for information disclosure purposes, it should disseminate the posted information by at least one other means. The company also should 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.” Companies should make sure that such labeling and disclaimer are displayed prominently.

Since employees also may 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, even if a web site is labeled confidential, the company should couple securities-related information with appropriate disclaimers.

In addition, the company should deploy Internet communication technologies to limit access to e-securities-related information and 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.

Publish Review Policies

In addition to using disclaimers, business organizations should formulate and publish policies for regularly reviewing their e-security-related postings. If an individual fails to remove dated, inaccurate information, publishing a posting review policy, as well as conducting an education program with the technology staff, will be good defenses to a charge of intentional misrepresentation.

Limit Postings During the Registration Process

Disclaimers and standard operating procedures are not cure-alls, however. A company in the process of registration has special concerns. Although a disclaimer denying an e-posting’s qualification as an offer to sell or buy securities may protect the company from certain legal difficulties, it will not insulate a company from claims that the e-posting constitutes 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 companies may post the following on their web sites: advertisements, SEC-related reports and notices and press announcements. 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.)

Be Wary of Hyperlinking Information

Third-party content and hyperlinks to third-party content often appear on companies’ web sites. According to the SEC, under the anti-fraud provisions of the federal securities laws, security issuers will be responsible for third-party information on their web sites if they have participated in the information’s preparation or expressly or implicitly endorsed or approved the information.

The SEC catalogs three nonexclusive factors that can be used to determine whether a company has endorsed or approved the information on its site: (1) whether the context of the hyperlink demonstrates adoption; (2) whether parties have been confused about the information’s source; (3) whether the presentation of the hyperlinked information demonstrates adoption. See, Securities Act Release No. 33 - 7856.

Put It All Together

Monitor e-postings 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?

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 the e-posting of securities-related information. Only documents that a company has released as a press release should be posted on its investor relations site. And all e-postings should be dated.