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By Mark J. Astarita, Esq.
| By now most readers are aware of the initial public offering successfully
completed by Spring Street Brewing last year, where the company conducted
a self underwriting almost entirely on the Internet, and then commenced
trading of its securities at its Internet World Wide Web site.
The Securities and Exchange Commission almost immediately asked Spring Street to cease the trading activity, but then with equal speed permitted Spring Street to resume trading, with certain conditions, the most important of which being the assurance that a registered broker-dealer would handle the actual transactions.
The entire episode, the offering, and the trading, have piqued the interest of investors and entrepeneurs alike, many of whom believe they have found the holy grail of small initial public offerings. But have they?
This is not the first time that investors and small business owners have become excited at the prospect of a less expensive alternative to the traditional underwriting process. The most recent excitment was caused by the SCOR registration offering, which is addressed in another article, SCOR Offerings. The SCOR offering, while providing an effective and cost efficient method for companies to raise less than $1 million, presented a host of new problems for the entrepreneur, such as the ability to locate and attract investors.
Similiar problems are being experienced by companies who are attempting to utilize the newest method of raising capital, the so called "Internet Offering". These offerings, which have been sold through the World Wide Web, are sold pursuant to Regulation A, by the issuer itself, for less than $5 million.
In addition to Spring Street, another issuer who is attempting an "Internet Offering", Interactive Holdings Corp., is only having limited success with its offering. Since February, 1996, it has been posting a prospectus for 200,000 shares of an initial public offering.
The President of Interactive Holdings Corp. was quoted in the April 10, 1996 issue of Securities Industry Daily on the limited success of the offering as saying "It shows the need for traditional brokers...we have no experience selling securities and we're not very good at it."
While investment bankers might find other reasons for the lack of success of an Internet Offering by a startup company (or of any offering for a startup, for that matter), IHS's experience with the Internet Offering is similiar to the experience that other small companies are going to find with the Internet offering. Entreprenuers who are extremely successful at their business ventures are not necessarily able to convert their business acumen into the promotion and sale of the securities of that business. And hence, the continued need for experienced broker-dealers and registered representatives.
It is the very companies who need the benefits of Regulation A, and the SCOR offering, who are going to have the most problems with the offering. Typically, companies who raise capital by one of these smaller offerings, are smaller companies, who, aside from not being able to afford the underwriters fees associationed with a traditional offering, cannot attract an underwriter in the first instance, since the majority of investors, and hence underwriters, are looking for companies with a proven track record of sales, and hopefully profits.
If the prospective public company had a track record of sales and profits, it would not need the exemption, and would proceed with a traditional underwriting. But the same reasons that these companies cannot attract underwriters is the reason that they have trouble with the SCOR or Internet offering - they simply do not have the fundamentals that will attract investors.
Now add to that the fact that these exemptions require that the company sell the securities themselves, and you have an offering being commenced by inexperienced "brokers" in a company with no fundamentals - a double whammy.
However, for the successful company, that only needs to raise less than $5 million, these types of offerings may well be a viable conduit to financing. Provided the company complies with the state and federal securities laws, and offering conducted on the Internet has the ability to reach millions of people, and therefore exponentially increases the pool of potential investors, over traditional means of promoting an offering.
Which leads to the second major problem area. Using the World Wide Web to promote an offering, and to distribute literature regarding such offerings, such as a preliminary and final prospectus, raises new issues for the offerings, particularily in the area of compliance with the blue sky laws of the various states where the offering will be offered, or sold.
While the SEC has nearly approved the use of the Internet for prospectus delivery (see, SEC Release on Electronic Prospectus Delivery ) that "approval" is still not in the form of a regulation or an authorative interpretation, and is subject to modification and change by the commission, which has promised an interpretive release on these issues this spring.
However, assuming that the Commission continues to approve the use of the Internet for IPOs and after-market trading, a second issue looms ahead for such offerings, the Blue Sky laws of the various states.
Many states have followed the lead of the SEC and the State of Pennsylvania, and have amended their Blue Sky Laws to permit the use of an electronic prospectus. The exemption, first adopted by Pennsylvania, exempts securities offered on the Internet from registration, so long as the offers are not directed at residents of the State.
But other states are reluctant to do so. According to a report in the Compliance Reporter (April 29, 1996), the Director of the Connecticut Division of Securities, Ralph Lambiase, has criticized the SEC for its permissive stance on the use of the Internet in IPOs and after-market trading. Other states are waiting to see what the effect is of the Pennsylvania exemption, and have not yet adopted a similiar exemption in their state.
This leaves brokers with a potential problem, where securities are offered for sale over the Internet, if the broker, and his firm, and the securities themselves, are not registered in all 50 states. If that is not the case, then the posting of a preliminary prospectus, or other information regarding a offering, could be deemed a solicitation in the state. Without registration, or an exemption, the broker, the brokerage firm, and even the issuer, could find themselves the subject of a state administrative proceeding for violation of the state securities laws.
The state and federal securities law issues will ultimately be resolved, and one day the "Internet Offering" will be as common place as traditionsl tombstones, and television, radio and mail advertisements. But until that time, brokers and entreprenuers are advised to tread carefully, with the advise of experienced securities counsel, lest you become a state regulator's test case.
Originally published in 1998.
Securities Law Blog
Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article. SECLaw.com was created by and is sponsored by Mark J. Astarita, Esq., a securities attorney and partner in the law firm of Beam & Astarita, LLC, who represents financial professionals in a wide variety of matters. Mr. Astarita can be contacted by email at firstname.lastname@example.org.
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