Brave new world?: The impact(s) of the Internet on modern securities regulation

Business Lawyer

Volumn 52, Issue 4, 1997, Pages 1195-1233

  Coffee Jr , John C ^a  

^a Law School ^*

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EID: 21944448702     PISSN: 00076899     EISSN: None     Source Type: Journal    
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References (199)

1. WILLIAM SHAKESPEARE, The Tempest, act 5, sc. 1.
2. See Andrew Kantor & Michael Neubarth, Off the Charts, Internet World, Dec. 1996, at 45, 46-47. For a forty million estimate
3. See Greg Allio & Gary Lloyd, WebStock: The Latest Internet Love-In Will Be the Direct Selling of Shares, Recorder, July 1, 1996, at 6, available in LEXIS, News Library, Recrdr File.
4. See Allio & Lloyd, supra note 2;
5. See also Greg Miller & Tom Petruno, For Investors, the Internet Has Promises, Perils, L. A. Times, June 3, 1996, at Al, available in 1996 WL 10574186 (estimating that 1.3 million such accounts will be opened by 1998).
6. Indeed, it is a story others have perceptively examined at periodic intervals. See, e.g., Donald C. Langevoort, Information Technology and the Structure of Securities Regulation, 98 HARV. L. Rev. 747 (1985);
7. Office of Tech. Assessment, U. S. Congress, Electronic Bulls and Bears: U. S. Securities Markets and Information Technology (U. S. Gov't. Printing Office, Sept. 1990).
8. The impact of the telegraph on the securities markets provides a fascinating example of how the gains from technological innovations can be appropriated by a limited number of traders. Prior to the telegraph's invention, news reached the securities markets primarily by mail, but reached traders in the market at more or less the same time. The invention of the telegraph introduced significant informational asymmetries, in part because use of the telegraph was costly in comparison to the mail. Those who could afford to use the telegraph got news ahead of those that could not-and traded ahead of them. The easiest way for the informed trader to profit was by arbitraging the price differences between securities traded in two different markets. As a result, the differences between the prices of securities traded in both London and Glasgow narrowed significantly between 1846 and 1860 as telegraph technology was introduced and made reliable.
9. See R. C. MICHIE, THE LONDON AND New York Stock Exchanges, 1850-1914, 7-10 (1981). A similar narrowing of price differentials occurred between stock prices in New York and London once the trans-Atlantic cable was laid in 1866. Id. at 47-48.
10. In contrast, the Internet (in part because of its broad accessibility and low cost) offers the prospect of a market that comes closer to approaching the ideal of a market of homogeneously informed traders. For a fuller treatment of these issues and a more skeptical view that such a homogeneously informed market is unlikely, see Paul Mahoney, Technology, Property Rights in Information, and Securities Regulation, 73 WASH. U. L. REV. (forthcoming in symposium issue in 1997).
11. This is not to suggest that all informational advantages will be eliminated by the Internet. The information in the Securities and Exchange Commission's EDGAR database is often stale, and access to it will not equalize informational advantages. But the Internet does much more than simply make the information filed pursuant to the SEC's mandatory disclosure system available to investors. Other sources of information, particularly those reaching online services, are very current, although not always reliable. To the extent that market prices are moved by rumors and possibilities of future contingent events, online services provide the individual investor with substantially greater access to such "noisy" information. This is both a virtue and a vice, as discussed later.
12. SEC, EDGAR Database (last modified May 5, 1997)
13. For the first suggestion of this possibility, see John C. Wilcox, Electronic Communication and Proxy Voting: The Governance Implications of Shareholders in Cyberspace, INSIGHTS, Mar. 1997, at 8, available in LEXIS, News Library, Insite File.
14. I do not mean to imply that the pass through of voting rights would be a sensible change from a public policy standpoint. If large institutions holding portfolios with several thousand stocks are today often overloaded, individual pensioners would be both swamped and rationally indifferent to the outcome of most proxy contests (given their small stakes). Still, a continuum of possibilities exists: beneficial owners could opt out and cast their own votes, or could engage in referenda that would inform, or even formally instruct, the fiduciaries holding the actual voting power.
15. See Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549 (1984).
16. Generally, the "fraud on the market" doctrine applies only to companies traded in an efficient market. See, e.g., Jonathan B. Lurvey, Who Is Bespeaking to Whom? Plaintiff Sophistication, Market Information, and Forward-Looking Statements, 45 DUKE L. J. 579, 593-94 (1995).
17. See SEC, Report of the Advisory Committee on the Capital Formation and Regulatory Processes (last modified Oct. 25, 1996) [hereinafter Report of the Advisory Committee];
18. See also Securities Act Concepts and their Effect on Capital Formation, Exchange Act Release No. 34-37480, 62 S. E. C. Docket (CCH) 1046 (July 25, 1996).
19. Of course, it has long been clear, if it was not in 1934, that some very close questions could arise on the boundary.
20. See, e.g., Board of Trade v. SEC, 923 F.2d 1270 (7th Cir. 1991).
21. See Regulation of Exchanges, Exchange Act Release No. 34-38672, 64 S. E. C. Docket (CCH) 1631 (May 23, 1997) [hereinafter Regulation of Exchanges].
22. Id. at 1635.
23. For reasons both of space economy and the author's limited knowledge, this Article does not undertake to describe the internal structure, organization, or operation of the Internet. But for a very accessible description in an important judicial opinion, see ACLU v. Reno, 929 F. Supp. 824, 830-44 (E. D. Pa. 1996)
24. Aff'd, 117 S. Ct. 2329 (1997).
25. 15 U. S. G. § 77b (10) (1994). The "oral" versus "written" distinction is basically made by section 2 (10) of the 1933 Act which defines the term prospectus to mean "any prospectus, notice, circular, advertisement, letter or communication, written or by radio or television, which offers any security for sale." Thus, oral statements do not amount to a prospectus and hence can be communicated during the "waiting period" prior to effectiveness without violating section 5 (b) of the 1933 Act. Id. § 77e (b). But is an interactive Internet communication shown on a computer monitor oral or written or something else?
26. See infra text accompanying notes 43-47.
27. See ACLU v. Reno, 929 F. Supp. at 844.
28. The difficulty in any such proposal is not technological but legal. Today, silence is not actionable, absent a duty to disclose. See Basic, Inc. v. Levinson, 485 U. S. 224, 231 (1988). Such an obligation can arise because of a reporting requirement under the 1934 Act. Thus, a consequence of a constant obligation to report material developments on a timely basis is vastly to increase the risk of liability.
29. See John C. Coffee, Jr., Re-Engineering Corporate Disclosure: The Coming Debate over Company Registration, 52 Wash. & Lee L. Rev. 1143, 1153-54 & n. 34 (1995).
30. Among academics, the leading prophet of the "virtual exchange" without intermediaries is probably Professor Junius Peake, a finance professor at the University of Northern Colorado and a former vice chairman of the National Association of Securities Dealers (NASD).
31. See also Melissa Bane, The Virtual Exchange: Who Needs Wall Street?, COMPUTER- WORLD, June 17, 1996, at 125A, available in 1996 WL 2372613.
32. See Michael Meyer, Deep- Sixing Doubloons, NEWSWEEK, June 16, 1997, at 72. Professor Donald Langevoort probably published the first prophecy that new information technology would lead to the partial replacement of underwriters by electronic substitutes that would permit direct sale of equity by issuers.
33. See Langevoort, supra note 4, at 765-78. That prophecy now appears to have been at least thirteen years premature (although it could still prove accurate and perceptive).
34. For an overview of the recent upsurge in Internet fraud, see Joseph J. Cella III & John Reed Stark, SEC Enforcement and the Internet: Meeting the Challenge of the Next Millennium, 52 Bus. Law. 815 (1997).
35. For a brief description of the Internet, see A. Jared Silverman, Cyberspace Offerings Raise Complex Compliance Issues, N. J. L. J., Dec. 25, 1995, at 10, available in LEXIS, Legnew Library, Njlawj File.
36. The term "gatekeeper" has a special meaning within the field of law and economics: namely, a third party typically having reputational capital whom a firm enlists to gain legitimacy, expertise, or satisfy a legal requirement (for example, an accountant). See Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J. L. ECON. & ORG. 53 (1986).
37. For representative accounts, see Gerard R. Boyce, Offering and Trading Securities on the Internet, N. Y. L. J., May 9, 1996, at 5, available in LEXIS, Legnew Library, Nylawj File;
38. Cheryl Currid, Microbrewery's Web IPO: A Taste of Things to Come?, HOUSTON Chron., June 1, 1997, at 7, available in LEXIS, News Library, Hchrn File;
39. Stephanie Gruner, When Mom and Pop Go Public, INC., Dec. 1996, at 66, available in LEXIS, Busfin Library, Inc File;
40. Mark Kollar, Do- It-Yourself Public Offerings: The Internet Brings a New Dimension to an Old Financing Vehicle, INVESTMENT DEALERS' DIG., Mar. 24, 1997, at 14, available in LEXIS, News Library, Idd File;
41. A. Jared Silverman, Securities Regulation on the Internet: Make Me an Offer Online, LEGAL TIMES, July 8, 1996, at 20, available in LEXIS, Legnew Library, Lgltme File.
42. See Kollar, supra note 25.
43. See Gilson & Kraakman, supra note 10, at 613-21.
44. See Regulation A-Conditional Small Issues Exemption, 17 C. F. R. §§ 230.251-.263 (1997).
45. See id. § 230.251 (a) (2).
46. See id. §230.251 (b).
47. Rule 254 permits the use of a "solicitation of interest" document prior to filing an offering statement.
48. See id. § 230.254.
49. See Internet Offerings: On-Line Capitalism, ECONOMIST, Nov. 23, 1996, at 92, available in LEXIS, News Library, Econ File (estimating that 30 companies were then embarked on similar initial offerings patterned after Spring Street). It is not clear that all these issuers are relying on Regulation A; some may be attempting fully registered IPOs.
50. Of course, underwriters might (or might not) be used on a standby basis and receive a commitment fee for this service. Although subscription offerings have not been popular in the United States, they are the dominant distribution technique in Great Britain. One reason for their unpopularity in the United States is the delay associated with their use. Typically, investors are given a 30-day period to exercise the subscription warrants that were earlier distributed to them as a dividend. This time period might easily be telescoped in a world of electronic communications.
51. Such conditioning is known as "gun jumping" and violates section 5 (c) of the 1933 Act. 15 U. S. C. § 77e (c) (1994).
52. See Eric A. Chiappinelli, Gun Jumping: The Problem of Extraneous Offers of Securities, 50 U. Pitt. L. REV. 457 (1989);
53. Joseph P. Richardson & Joseph E. Reece, Gun Jumping, 26 REV. SEC. & COMMODITIES REG. 1 (1993).
54. See section 5 (b) of the Securities Act of 1933, 15 U. S. C. § 77e (b).
55. See 17 C. F. R. § 230.134. The traditional "tombstone ads," which appear in financial newspapers, such as the Wall Street Journal, and list the participating underwriters, are expressly permitted by Rule 134. Id. § 230.134 (a) (7).
56. For example, in 1996, Berkshire Hathaway placed its prospectus on its underwriter's (Solomon Brothers) Web page so that it could be downloaded by investors. General Motors provided probably the best illustration of the utility of the Internet to the larger industrial issuer. Its affiliate, General Motors Acceptance Corp., marketed S500 million in bonds by placing its prospectus on a Web-based bulletin board, which both allowed investors to download it and also supplied them with an interactive bond yield calculator with which to determine their overall return.
57. See Linda Himelstein, The Net Hits the Big Time, Bus. Wk., Oct. 28, 1996, at 142, available in LEXIS, News Library, Buswk File.
58. See Securities Act Release No. 33-7188, 59 S. E. C. Docket (CCH) 1634 (June 27, 1995) (proposing Rule 135d). I should note that I have been elsewhere critical of this proposal.
59. See John C. Coffee Jr., SEC Deregulation: Sense and Nonsense, N. Y. L. J., Sept. 28, 1995, at 5, available in LEXIS, Legnew Library, Nylawj File.
60. One justification that has been raised for Rule 135d is that few problems have been experienced with Rule 254 under Regulation A, which permits a "testing the waters" solicitation document. Two short answers to this justification should suffice: (i) given the S5 million ceiling on Regulation A, there has been relatively little interest in exploiting its permissiveness; and (ii) Regulation A offerings were not intermediary-less until the Spring Street Brewery offering in 1996. Thus, the experience under Regulation A for both these reasons is not likely to provide a realistic proxy for what might happen in the case of registered IPOs.
61. See 17 C. F. R. § 230.434 (1997).
62. This follows section 2 (10) of the 1933 Act, which defines "prospectus" to include any notice, circular, advertisement, letter, or communication... which offers any security for sale... except that (a) a communication sent or given after the effective date of the registration statement... shall not be deemed a prospectus if it is proved that prior to or at the same time with such communication a written prospectus meeting the requirements of subsection (a) of section 77j of this tide at the time of such communication was sent or given to the person to whom the communication was made....
63. U. S. C. § 77b (10) (1994).
64. Precisely this proposal that an up-to-200 word electronic statement be exempted from the definition of free writing has been made by another commentator. See Joseph Mc- Laughlin, 'Booting' the Federal Securities Laws into the 21st Century, INSIGHTS, July 1997, at 21, 22.
65. During 1994 and 1995, the average waiting time at the SEC for registration materials of Form S-2 registrants was 15.6 days. See Report of the Advisory Committee, supra note 12, at appendix A, table 2.
66. 15 U. S. C. § 77b (10). In Securities Act Release No. 33-7288, the Commission indicated last year that the legal status of a communication under the 1933 Act could depend in part on whether it "replace[s] or substitute[s] for telephone conversations."
67. See Use of Electronic Media by Broker-Dealers, Transfer Agents, and Investment Advisers for Delivery of Information, Securities Act Release No. 33-7288, 61 S. E. C. Docket (CCH) 2167 (May 9, 1996), available in 1996 SEC LEXIS 1299, at *7.
68. Both the New York Stock Exchange (NYSE) and the NASD have submitted rule change proposals to the SEC that would end the current requirement of prior approval by the firm of all written correspondence with the client. In lieu thereof, sampling techniques would be used, involving random spot checks and e-mail logs.
69. See Notice of Filing of Proposed Rule Change by the NASD, Inc. Relating to Supervision and Record Retention Rules, Exchange Act Release No. 34-38548, 64 S. E. C. Docket (CCH) 1159 (Apr. 25, 1997) (discussing the earlier NYSE proposal as well).
70. See Private Financial Network, SEC No-Action Letter, 1997 WL 107175 (Mar. 12, 1997). The no-action letter was premised on the concern that the video transmission could be deemed a prospectus given the express reference in section 2 (10) of the 1933 Act to communication by television. The staff agreed, however, that video transmission to a limited audience does not amount to "television" as that term is used in section 2 (10).
71. See 15 U. S. C. § 77b (10).
72. See supra note 45.
73. For example, obvious distinction can be drawn between one-to-one e-mail and "listserv" communication to a broad audience.
74. This point is not as definitional as it sounds. If on the announcement of a direct issuer offering by a mature company its stock price fell, and by an amount greater than the underwriter's typical discount, the actual cost of capital to the issuer would be greater in such a direct offering.
75. One study has found that the average operating company's IPO return is 10-15% on its first day of trading-strong evidence of underpricing. See Roger G. Ibbotson et al., The Market's Problems with the Pricing of Initial Public Offerings, J. APPLIED Corp. Fin., Spring 1994, at 66.
76. See Langevoort, supra note 4, at 777 (arguing that other "specialists" who assisted in "securities marketing" would likely be deemed "underwriters" under the broad definition in section 2 (11) of the 1933 Act).
77. PSLRA substantially heightened the requirements for pleading fraud under the 1934 Act, but not the 1933 Act. New section 21D (b) (2) of the 1934 Act requires a plaintiff who seeks to plead a cause of action under that Act (including Rule 10b-5) to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." The parallel provision of the 1933 Act (new section 27 (b)), however, contains no corresponding pleading requirement (although it does provide for a similar stay of discovery pending a motion to dismiss). Thus, except with regard to the special area of "forwardlooking statements" (see section 27A of the 1933 Act), the PSLRA does relatively little of significance to change the balance of advantage between plaintiff and defendant under the 1933 Act.
78. Indeed, recent cases may have increased the underwriters' exposure under section 11. See Shaw v. Digital Equipment Corp., 82 F.3d 1194 (1st Cir. 1996).
79. See 17 C. F. R. § 230.415 (a) (4) (1997).
80. See Stephen J. Choi, Company Registration: Toward A Status Based Antifraud Regime, 64 U. Chi. L. Rev. 567 (1997).
81. Professor James Cox proposes the novel ideal that periodically (he suggests every three years) the issuer's Form 10-K would be subject to section 11 liability. See James Cox, The Fundamentals of an Electronically-Based Federal Securities Act (forthcoming). His goal is to escape section I 1's current transactional focus, but the resulting liability risk seems enormous. Moreover, it is not clear who would have standing to assert this proposed remedy. If all persons who acquire the equity securities in the open market over the year following the Form 10- K's release could sue (a significantly larger population than under section 11 today), the result would often be that a majority of the shareholders would be suing the issuer (and indirectly the remaining minority).
82. See James Bohn & Stephen Choi, Fraud in the New Issues Market: Empirical Evidence on Securities Class Actions, 144 U. Pa. L. Rev. 903, 936 (1996) (Table 2.5 shows that offerings below S6.71 million accounted for only 14 out of 122 liability suits in the sample, or roughly 11 %);
83. See also Janet Cooper Alexander, Do the Merits Mailer? A Study of Settlements in Securities Class Actions, 43 Stan. L. Rev. 497, 513 (1991) (Table 3 shows that, of the 12 worst-performing computer-related IPOs in 1983, the six companies with the smaller offerings were not sued, while those with the larger were).
84. The assumption here is that the offerings will be sufficiently separated in time that they cannot be combined into a single class. Generally, the definition of the class in a federal securities class action includes those who purchased or sold over a relatively brief time period.
85. Commentators differ as to whether they regard the SEC as a valuable gatekeeper. This author does. For a similar view, see Abba David Poliakoff, SEC Review: Comfort or Illusion?, 17 U. Balt. L. Rev. 40 (1987).
86. According to the SEC, alternative trading systems now account for almost 20% of over-the-counter stock volume and nearly 4% of the NYSE's volume. See Regulation of Exchanges, supra note 14, at 1635.
87. SEC Rule 15c2-l 1 precludes a broker-dealer from entering bid or asked quotations in a security (i.e., making a market) unless it has specified information in its possession. 17 G. F. R. §240.15c2-11 (1997).
88. For a fuller description, see Boyce, supra note 25.
89. See Spring Street Brewing Co., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 435 (Apr. 17, 1996).
90. See Jed Horowitz, Wit Capital Puts Together More Pieces of Its Strategy, INVESTMENT DEAL- ERS' DIG., Mar. 10, 1997, at 19, available in LEXIS, Busfin Library, Idd File.
91. See Real Goods Trading Corp., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 566 (June 24, 1996).
92. See Gerard R. Boyce, Internet Stock Trading and the SEC, N. Y. L. J., July 11, 1996, at 5, available in LEXIS, Legnew Library, Nylawj File.
93. See also Recent Agency Action, 110 HARV. L. Rev. 959 (1997).
94. See Real Goods Trading Corp., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 566, at* 17.
95. See Flamemaster Corp., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 972 (Oct. 29, 1996);
96. PerfectData Corp., SEC No-Action Letter, 1996 SEC No-Act. LEXIS 700 (Aug. 5, 1996).
97. In a recent Concept Release, the SEC estimates that broker-dealer firms have placed over 140 alternative trading systems in operation (although some are only for internal use by traders within a single firm). See Regulation of Exchanges, supra note 14, at 1639 n. 14.
98. See Kimberly Weisul, Leveling the Trading Field; Unlike Institutions, Retail Investors Haze Largely Been Unable to Cross Their Trades... Until Now, INVESTMENT Dealers' Dig., Aug. 26, 1996, at 14.
99. See Gracian Mack, Retailers Efforts to Remove Traders Hasn't Worked, TRADERS, Feb. 1997, at 48, available in LEXIS, Market Library, Iacx File.
100. Even in the case of Instinet, the largest and best known trading system, match rates usually fall below 30%, meaning that the customer's trade is usually not executed. See Leslie Eaton, Wall Street Without Walls-A Special Report; Slow Transition for Investing; Stock Market Meets Internet, N. Y. TIMES, Nov. 11, 1996, at A1. This is a less serious problem for the institutional trader, which is regularly executing portfolio trading strategies and has a lesser need for immediacy. In this light, to attract retail customers, execution must either be guaranteed (which is unlikely) or crossing systems must provide for an automated fallbàck referral to the market if a match cannot quickly be found.
101. See Order Execution Obligations, Exchange Act Release No. 34-37619A, 63 S. E. C. Docket (CCH) 2083 (Sept. 6, 1996).
102. The Island System is operated by Datek Securities Corp., a registered broker-dealer and long a "SOES activist." Island System has accepted the designation of an EGN. See Regulation of Exchanges, supra note 14, at 1646 n. 59. Not all EGNs display to the public the best prices of all orders entered into their systems, but at least two ECNs now do. Id. at 1645 n. 58. Doing so clearly shows that the ECN is attempting to facilitate competition to narrow the bid/asked spread.
103. See id. at 1635.
104. Id. at 1646.
105. Id. at 1645.
106. See Proprietary Trading Systems, Exchange Act Release No. 34-26708, 43 S. E. C. Docket (CCH) 979 (Apr. 11, 1989).
107. See Regulation of Exchanges, supra note 14, at 1657-58.
108. Section 4 (2) of the 1933 Act exempts from registration "transactions by an issuer not involving any public offering." 15 U. S. C. § 77d (2) (1994).
109. See SEC v. Ralston Purina Co., 346 U. S. 119 (1953).
110. See 17 C. F. R. § 230.502 (c) (1997).
111. Section 5 (c) says that "[i]t shall be unlawful for any person, directly or indirectly, to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to offer to sell or offer to buy... any security, unless a registration statement has been filed." 15 U. S. C. § 77e (c).
112. See Use of Electronic Media for Delivery Purposes, Securities Act Release No. 33-7233, 60 S. E. C. Docket 1091, ex. 20 (Oct. 6, 1995).
113. Id.
114. See IPOnet, SEC No-Action Utter, 1996 SEC No-Act. LEXIS 642 (July 26, 1996).
115. The SEC no-action letter noted that in reaching its conclusion, the SEC relied on the fact that "a potential investor could purchase securities only in transactions that are posted on the password-protected page of IPOnet after that investor's qualification with IPOnet." Id. at *2. The staff appears to have been concerned that, if the investor could participate in already commenced offerings, the qualification procedure might become simply a pretext with the real focus on identifying offerees for the current offering.
116. See Angel Capital Electronic Network, SEC No-Action Letter, 1996 SEC No-Act. LEXIS 812 (Oct. 25, 1996).
117. See Stephanie N. Mehta, Angel Investors to Get On-line Service, WALL St. J., Oct. 28, 1996, at B2.
118. Angel Capital Electronic Network, SEC No Action Letter, 1996 SEC No-Act. LEXIS 12, at * 2 (emphasis added). This exception suggests that the Angel Network could establish a matching system among accredited investors for resale of privately placed securities. This would be a significandy more difficult doctrinal barrier for the SEC to relax (except possibly pursuant to Rule 144A, or sales pursuant to Rule 144, after the requisite waiting period).
119. Lamp Technologies, Inc., SEC No-Action Letter, 1997 SEC No-Act. LEXIS 638 (May 29, 1997).
120. The private funds claimed to be exempt from regulation as investment companies pursuant to section 3 (c) (1) or (7) of the Investment Company Act of 1940, which, respectively, exempt funds held by not more than 100 persons or held by "qualified purchasers." 15 U. S. G. A. § 80a-3 (c) (l), (c) (7) (1994 & West Supp. 1997).
121. The SEC staff noted, however, a special characteristic of private investment funds in accepting this substitution: the private funds involved were only available to take subscriptions on a quarterly or annual basis (and thus would not be in a state of constant solicitation).
122. Lamp Technologies, Inc., SEC No Action Letter, 1997 SEC No-Act. LEXIS 638, at * 5. Based on this factor, the staff was satisfied that investors would not be subscribing to the service "to invest in any particular fund." Id.
123. The SEC's staff has granted an important no-action letter to Niphix Investments Inc., a registered broker-dealer, for an alternative trading system that would specialize in trading exempt securities issued under Regulation A and securities of businesses that qualified as "small business issuers" under Rule 405.
124. See Niphix Investments, Inc., SEC No-Action Letter, 1997 SEC No-Act. LEXIS 566 (Apr. 18, 1997). All trading participants were to be accredited investors. The interesting question this no-action letter raises is whether the SEC may eventually approve a similar system for private resales that were exempt from registration under the 1933 Act pursuant to Rule 144, or pursuant to the so-called "section 4 (1 1/2) exemption" (for transactions between accredited investors), or, in some cases, pursuant to Rule 144A.
125. The PORTAL market is an electronic market for the resale of securities issued without registration pursuant to Rule 144A. The early experience with PORTAL has been disappointing because of low volume and limited liquidity. See Franklin J. Chu, The U. S. Private Market for Foreign Securities, Bankers Mag., Jan. /Feb. 1991, at 55;
126. Stephen Davis, The Wiring of 144A, Institutional Investor, July 1990, at 219, available in LEXIS, Busfin Library, Abi File. More recently, PORTAL appears to have had increased activity.
127. Cf. PORTAL Pilot Planned for '96, PRIVATE PLACEMENT REP., Oct. 2, 1995, at 1, available in LEXIS, News Library, Abbb File.
128. See Cella & Stark, supra note 22, at 835-37.
129. For representative recent stories about the problem of anonymity on the Internet, see Deborah Lohse, Stock Regulators Are Worried Dangers Lurk for Investors in On-Line Chat Sites, WALL ST. J., Sept. 12, 1996, at C1;
130. Gregory Spears, The Wild, Wild Web, KIPLINGER'S PERS. FIN. MAG., Nov. 1996, at 59, available in LEXIS, News Library, Kippf File.
131. For present purposes, it is not necessary to distinguish here between "private" chat rooms (for which a subscription fee may be charged) and public newsgroups.
132. For representative stories, see Miller & Petruno, supra note 3 (detailing actual rumors entered into newsgroups about Comparator);
133. Therese Poletti, Internet Stock Tips Pose Free Speech Dilemma, REUTERS BUS. REP., June 11, 1996, available in LEXIS, News Library, Reubus File.
134. See Poletti, supra note 98 (quoting Marc Beauchamp of the NASD).
135. See, e.g., McIntyre v. Ohio Elections Comm'n, 514 U. S. 334 (1995);
136. Talley v. California, 362 U. S. 60 (1960).
137. McIntyre, 514 U. S. at 347.
138. Id. at 343-44, 348-51.
139. See, e.g., A. Michael Froomkin, Anonymity and Its Enmities, 1995 J. ONLINE L. art. 4;
140. David G. Post, Pooling Intellectual Capital: Thoughts on Anonymity, Pseudonymity, and Limited Liability in Cyberspace, 1996 U. Chi. Legal F. 139;
141. Lee Tien, Innovation and the Information Environment: Who's Afraid of Anonymous Speech?, 75 Or. L. REV. 117, 120 (1996).
142. Techniques vary from simple remailing that deletes the message heading to more sophisticated forms of encryption. See Froomkin, supra note 103, para. 20-25;
143. Tien, supra note 103, at 120 n. 5.
144. New section 20 (f) of the 1934 Act provides that "any person that knowingly provides substantial assistance to another person in violation of a provision of this chapter... shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."
145. See 15 U. S. C. § 78t (f) (Supp. I 1995).
146. Id.
147. Cyber Patrol, first introduced in 1995, now serves both direct Internet access providers (e.g., Netcom, Uunet, etc.), and commercial online service providers (e.g., America Online, CompuServe, Prodigy, etc.), is compatible with all Web browsers (e.g., Netscape, Netcruiser, Mosaic, etc.), and seeks to detect and delete inappropriate materials.
148. See ACLU v. Reno, 929 F. Supp. 824, 840 (E. D. Pa. 1996)
149. Aff'd, 117 S. Ct. 2329 (1997). Technologically, it or similar software could seemingly also detect non-traceable sources and deny them access, delete their comments, or at least specially label their comments.
150. Pub. L. 104-104, 1996 U. S. C. C. A. N. (110 Stat.) 133-39
151. Struck down in part by, Reno, 117 S. Ct. 2329 (1997).
152. 47 U. S. C. A. § 230 (c) (1) (West Supp. 1997). This statute was intended to reverse a specific unreported case
153. Strattom Oakmont, Inc. v. Prodigy Services Co., No. 31063/94, 1995 WL 323710 (N. Y. Sup. Ct. May 24, 1995).
154. See R. Hayes Johnson, Jr., Note, Defamation in Cyberspace: A Court Takes a Wrong Turn on the Information Superhighway in Stratton Oakmont, Inc. v. Prodigy Services Co., 49 Ark. L. Rev. 589, 593-95 (1996).
155. See supra note 105.
156. Charles Schwab & Co., Inc., SEC No-Action Letter, 1996 SEC No-Act LEXIS 976, at* 5 n. 1 (Nov. 27, 1996).
157. See NASD Regulatory & Compliance Alert, Ask the Analysts About Electronic Communications (Apr. 1996).
158. Paradoxically, there is also the countervailing danger that any such list might be perceived as a list of "hot" Web sites, thereby increasing the investor attention paid to them.
159. See 15 U. S. C. § 78o (a) (1) (1994).
160. See 17 C. F. R. § 240.15a-6 (1997).
161. See Registration Requirements for Foreign Broker-Dealers, Exchange Act Release No. 34-27017, 43 S. E. C. Docket (CCH) 2079, 2084 n. 41 (July 11, 1989).
162. Id. at 2086 & n. 52. Suffice it to say that this is a more controversial assertion of SEC jurisdiction, which no court has yet upheld.
163. See Itoba Ltd. v. Lep Group PLC, 54 F.3d 118 (2d Cir. 1995);
164. Zoelsch v. Arthur Anderson & Co., 824 F.2d 27 (D. C. Cir. 1987);
165. Leasco Data Processing Equip. Corp. v. Maxwell, 468 F.2d 1326 (2d Cir. 1972).
166. The Internet is a "giant network which interconnects innumerable smaller groups of linked computer networks." ACLU v. Reno, 929 F. Supp. 824, 830 (E. D. Pa. 1996)
167. Aff'd, 117 S. Ct. 2329 (1997). This point may have considerable jurisdictional significance because the information content provider does not voluntarily penetrate the space of a jurisdiction in the same way that it does by mailing a letter or sending a wire. Rather, the audience finds the content provider by using browsing strategies and search engines. This distinction may prove important under the standard "minimum contacts" test used by federal courts to determine the outer constitutional boundaries on personal jurisdiction.
168. See Helicopteros Nationals de Columbia v. Hall, 466 U. S. 408, 414 (1984) (a foreign defendant must have minimum level of contact with jurisdiction that allows exercise of jurisdiction to be reasonable);
169. International Shoe Co. v. Washington, 326 U. S. 310 (1945). The case law on when an Internet user can be sued in a foreign jurisdiction is scarce. For an important decision in which a service provider (CompuServe, Inc.) was able to establish personal jurisdiction over a foreign defendant
170. See CompuServe, Inc. v. Patterson, 89 F.3d 1257 (6th Cir. 1996).
171. See also Zippo Mfg. Co. v. Zippo Dot Com, Inc., 952 F. Supp. 1119 (W. D. Pa. 1997). Still, the minimum contacts between the defendants in these cases and the forum state seem substantially greater than those of the market maker with the United States in the hypothetical in the text. For a decision finding insufficient minimum contacts based on use of the Internet to establish personal jurisdiction
172. See Pres-Kap, Inc. v. System One, Direct Access, Inc., 636 So. 2d 1351 (Fla. Dist. Ct. App. 1994). Obviously, different interests, and a different statute, apply in the SEC's case, but even in the most expansive decisions upholding personal jurisdiction in cases brought by the SEC against a foreign defendant, the defendant had typically engaged in a securities transaction in a U. S. securities market or had opened a U. S. brokerage account.
173. See, e.g., SEC v. Knowles, 87 F.3d 413 (10th Cir. 1996);
174. SEC v. Unifund SAL, 910 F.2d 1028 (2d Cir. 1990).
175. This would not affect the SEC's suit, but might preclude private litigation depending on a legal standard that currendy differs from circuit to circuit. See, e.g., Scherk v. Alberto- Culver Co., 417 U. S. 506 (1974);
176. The Bremen v. Zapata Off-Shore Co., 407 U. S. 1, 15 (1972);
177. Bonny v. Society of Lloyd's, 3 F.3d 156 (7th Cir. 1993);
178. Roby v. Corporation of Lloyd's, 996 F.2d 1353 (2d Cir. 1993).
179. See Regulation of Exchanges, supra note 14, at 1695-1704.
180. See id. at 1695.
181. Id.
182. Id. The term "securities information processor" is defined in section 3a (22) (A) of the 1934 Act.
183. See 15 U. S. C. § 78c (a) (22) (A) (1994). Such persons are required to register with the SEC and to comply with SEC rules by section 11A of the 1934 Act.
184. See 15 U. S. C. § 78k- 1 (b).
185. Regulation of Exchanges, supra note 14, at 1695.
186. Id. (emphasis added).
187. Memoranda of understanding are deemed not to be treaties and thus not to require Senate ratification. At least, that is the theory.
188. See 17 C. F. R. § 230.902 (b) (1997).
189. See In re Orders Effected Through Internet that Do Not Result in Sales in Pennsylvania, Order of the Pennsylvania Securities Commission, available in 1995 WL 574678 (Pa. Sec. Com.) (Aug. 31, 1995).
190. See also Pennsylvania Securities Act of 1972, Pa. Stat. Ann. tit. 70, §§ 1-101 to 1-704 (West 1994 & Supp. 1997).
191. See generally K. Robert Bertraum, Offers and Sales of Securities on the Internet, PRAG. Law., Oct. 1996, at 23;
192. Ronald Loeb & David Richter, Electronic Offerings: Securities Law in the Age of the Internet (PLI Corp. Law and Practice Handbook Series No. B4-7142, 1996).
193. See Bertraum, supra note 129, at 26.
194. Some 20 NASDAA jurisdictions have apparently provided transactional relief for Internet offerings, either by order, regulation, or no-action position. Other states face statutory problems, however, that make it impossible for them to grant exemptive relief without new legislation. Id. at 27-28.
195. Id. at 27.
196. Id.
197. Indeed, at least if the offering material is in English, the same rules will probably apply as govern non-password-protected Web pages in private placements. See supra notes 80-94 and accompanying text.
198. For the standard definition of "gatekeeper" in a strategy of third-party liability as requiring such a relationship, see Reinier H. Kraakman, Corporate Liability Strategies and the Cost of Legal Controls, 93 Yale L. J. 857, 891 (1984).
199. See also Kraakman, supra note 24.