Introduction

Three Score and six years ago,[1] Congress brought forth on this nation the Securities Act of 1933 (Securities Act), conceived in fairness, and dedicated to the proposition that full public disclosure, mandated by the federal government, is needed to protect investors “on the special occasion of a public offering.” [2] - [3]

 

The Securities Act has been the cornerstone of securities regulation in the United States.[4]  However, unlike Abraham Lincoln’s Gettysburg Address, the Securities Act is not carved in stone.[5]  It is my position that the Securities Act has become obsolete and should be repealed. 

 

This paper examines the impact of modern information technology (MIT), especially the Internet, on the structure of federal securities regulations.[6]  First, I review the historic background of securities regulations.  Next, I examine the two key statutes in the structure of federal securities regulation in the United States.  After that, I examine the impact of Modern Information Technology, in general, on securities regulation.[7]  Then, I assess the impact of the Internet, specifically, on SEC policies.  Finally I conclude that the Securities Act is outmoded.

 

The History of Securities Regulation in America

Raising capital through the sale of shares is as old as commercial activity in America; the Mayflower expedition was even supported by a group of investors.[8]  Early on, neither state nor federal government regulated the sale of securities in America.[9]  Investors had to protect themselves from unscrupulous issuers, brokers and dealers; caveat emptor was the motto of the day.[10]  Hard economic times and the “New Deal” changed that.

 

First, this section will review the first disclosure law, the English Companies Act of 1900 (amended in 1929).  Next, I review state regulations, or “Blue-sky” laws.  Finally, I review Franklin Delano Roosevelt’s campaign and victory for President of the United States of America and his “New Deal” securities policies.

 

The Companies Act of 1900

In the nineteenth-century, stock offerings were almost exclusively promotional ventures.[11]  An entrepreneur, or a professional promoter (underwriter), would enlist potential investors to subscribe to an offering, either orally or in writing.[12]  “The formation of a company and its initial offering of stock to the public normally went handin-hand (sic).”[13] 

 

Nineteenth century Anglo-American courts faced two common problems connected to stock offerings, “loading” the purchase prices and hidden promotional fees.[14]  I will review each problem separately.

 

First, the practice of  “loading” the purchase prices.  Courts saw entrepreneurs load the purchase price "over and over again."[15]  Loading the purchase price was accomplished when an entrepreneur would purchase property for one price, yet represent to investors that a much higher price had been paid.[16]  “Secretly, and therefore dishonestly, they put into their own pockets the difference between the real and the pretended price.”[17]  Investors were misled about the actual cost of the company’s assets, therefore the value of their investment. 

 

The second problem involved hidden promotional or underwriter’s fees.[18]  The English version of the scheme saw the entrepreneur and the promoter enter into a “side” agreement for the sale of the stock to the public.[19]  The promoter would receive a fee as detailed in the side agreement.[20]  The issuer’s profits from the sale were used to pay the promoter’s fee.[21]  With the fee disguised as a private contract, the prospectus could truthfully state that the “company” was not paying a promotional fee.[22]

 

The American version of the scheme involved an investment bank underwriting a stock sale.[23]  The underwriter would pay a discounted price for the stock, then sell the stock at to the public without disclosing the extent of the underwriter’s commission.[24]  The investor, therefore, paid an exaggerated price in relation to the value of the issuing companies assets.[25]   

 

Both practices (loading and hidden promoter’s fees) were deceptive, though not technically fraudulent.[26]  Without government securities regulations, courts relied on disclosure rules that “closely tracked, the disclosure obligations traditionally owed by an agent when dealing adversely with his principal.”[27]   Some courts deemed the promoter, or the entrepreneur, a fiduciary of the corporation “and therefore [they] had a duty to disclose an interest adverse to that of the corporation” to potential investors.[28] 

 

Agency solutions were not adequate to solve the disclosure problems for several reasons.[29]  First, agency principles called for disclosure, but did not mandate a disclosure procedure to potential investors.[30]  Second, most of the time the scheme was not uncovered.  Finally, even if the scheme were uncovered, there were many ways for the promoter or entrepreneur to avoid liability under agency principles.[31]

 

Responding to what Parliament saw as inadequacies of agency remedies for stock offerings, England enacted the Companies Act of 1900 (Companies Act), the first Anglo-American mandatory disclosure law.[32]  In broad terms, the Companies Act required promoters and entrepreneurs to disclose any financial dealing they may have had with the company within a three-year period before selling an offering to the public.[33]  The Companies Act, as amended in 1929, served as a model when America enacted its first federal disclosure law in 1933.[34]

 

Blue-Sky Laws

Shortly after England enacted the Companies Act, individual states in America began enacting securities regulations, or “blue-sky” laws.  It is not clear why state securities laws are referred to as “blue-sky” laws.  Some claim that it is because promoters were selling “everything in [the] state but the blue sky.”[35]  Others claim Kansas legislators enacted securities regulations to "protect the Kansas farmers against the industrialists' selling them a piece of the blue sky."[36] 

 

Another claim, also credited to Kansas’s legislators, is that regulations were meant to “check stock swindlers so barefaced they would sell building lots in the blue sky.’"[37]  Yet others credit a judge of the era with “coining the phrase” when he concluded that the speculative schemes of many promoters had “no more substance than so many feet of blue sky.”[38]  Whatever the origin, “blue-sky laws” now refer to state securities regulations.

 

In 1911, Kansas adopted the first blue-sky law.[39]  Additional states followed with securities regulations of their own.[40]  By 1933 nearly every state had enacted one of two versions of a securities regulation, either a licensing law or an anti-fraud law.[41]

 

Kansas enacted a typical licensing statute.[42]  The statute “required both full disclosure by issuers and qualification based on ‘merit,’ or the quality of the investment.”[43]  In order to sell a stock offering in Kansas, an issuer had to gain approval of the offering by state regulators.[44]  The regulators reviewed the disclosure documents and made a finding based on the quality of the offering.[45]  If the regulators withheld approval of the offering, the stock could not be sold in the state.[46]

 

A typical anti-fraud statute did not require disclosures by an issuer in order to sell an offering in the state.[47]  The statute set up a coordinated effort to investigate allegations of fraud.[48]  If evidence of fraud was discovered, the state could enjoin the offering from being sold within that state.[49]

 

Because of the varying rules, blue-sky laws proved an ineffective protection of investors.[50]  State regulations were easy to circumvent.  “Sellers took great care to avoid the jurisdiction of states that had effective statutes.”[51]  Promoters would set up in states with the least restrictions, then sell securities to citizens in every state.[52]  “Since a sale consists of an offer and acceptance, until the buyer accept[ed] an offer there [was] no sale.  Under the law of contracts, the sale [was] legally made at the place where the acceptance [was] given.”[53] 

 

With contract law in mind, promoters required buyers to mail their acceptance to the seller’s state.[54]  Therefore, the “acceptance” was made in the state in which the seller received it.[55]  Because the sale technically occurred in the state with limited restrictions, the buyer’s home state could not exercise jurisdiction over the sale.[56] 

 

In order to close the blue-sky loop holes, between 1922 and 1933 the National Conference of Commissioners on Uniform State Laws drafted a uniform blue-sky law (Uniform Act).[57]  However, not a single state ever enacted the proposed Uniform Act.[58] 

 

States were reluctant to pass the Uniform Act because they feared that enacting the Uniform Act before other states would force businesses to set-up or move operations to states with fewer restrictions.[59]  In addition, the fear of lost business caused many states to be lax in enforcing the existing state regulations.[60]

 

Congress also tried to close the blue-sky loopholes.[61]  In 1922 Representative Edward Dennison of Illinois introduced a bill that would have made it illegal to sell securities by mail “or any facilities of interstate commerce” unless the offerings complied with the state's blue-sky laws.[62]  The bill passed by a wide margin in the House, but never made it out of committee in the Senate.[63]

 

Blue-sky laws are still in effect.[64]  Many issuers must register their offering with each state in which the securities are marketed and with the SEC.[65]

 

Roosevelt’s New Deal

The economy of the early 1920’s was strong, and stock sales were booming.[66]  The problem was, many of the stock offerings were highly risky or downright fraudulent.[67]  When the stock market crashed in 1929 the economy went into a tailspin, leading to the Great Depression.[68] 

 

Not surprisingly, the presidential campaign of 1932 focused on the economy in general and stock sales in particular.[69]  Blaming the depression on fraudulent stocks was the easy answer to a complicated problem.  Then President Hoover believed that federal securities regulations were unnecessary.[70]  Since corporations were state chartered, regulating stock sales ought to remain with the states; he had doubts about the constitutionality of federal regulation of the sale of state chartered corporate stocks.[71]

 

The democratic candidate for president in 1932 was Franklin Delano Roosevelt.[72]  His position, as spelled out in the democratic platform, called for “[p]rotection of the investing public by requiring to be filed with the Government and carried in advertisements of all offerings of foreign and domestic stocks and bonds true information as to bonuses, commissions, principal invested and interests of sellers.”[73]

 

After Roosevelt became president, he immediately implemented a national scheme to regulate securities.[74]  During his inaugural address he said,  “there must be a strict supervision of all banking and credits and investments.”[75]  Also, in an address to Congress soon after he took office President Roosevelt said:   “[T]here is . . . an obligation upon us to insist that every issue of new securities to be sold in interstate commerce shall be accompanied by full publicity and information, and that no essentially important element attending the issue shall be concealed from the buying public.”[76]

 

President Roosevelt directed Felix Frankfurter, the President’s top aide, to appoint a three-man committee to write federal securities legislation.  James Landis, a Harvard Law Professor; Benjamin Cohen, a former student of Frankfurter’s while he was a professor at Harvard; and, Thomas Corcoran, also a former Frankfurter student, were selected to make up the committee.[77]

 

During President Roosevelt’s first two terms, Congress “complete[d] an integral regulatory scheme designed to provide investors with certain minimal protections.”[78]  This regulatory scheme includes six legislative actions and makes up today’s federal securities regulations.[79]  The two most influential statutes are the Securities Act of 1933 and the Securities Exchange Act of 1934 (Exchange Act).

 

The Securities Act & The Exchange Act

The Securities Act and the Exchange Act created a dual disclosure system: one based on the transaction of a public offering (Securities Act), the other based on the company’s business (Exchange Act).[80]  Because both Acts required disclosure of similar information, “[t]he result was often duplicative disclosure.”[81]

 

The Securities Act

The 73^rd Congress enacted the Securities Act of 1933, the first federal securities statute.[82]  “[T]his first statute was essentially a narrowly focused but high‑powered effort to assure full and fair disclosure on the special occasion of a public offering.”[83]  The provisions focused on this single transaction.[84]  The commission, recruited to draft the Securities Act, patterned the Act after England’s Companies Act.[85]

 

The core provisions of the Securities Act require an issuer to file a registration statement with the SEC before each public offering, get the registration approved before the company sells any stock, deliver a prospectus to all potential investors, and restrict public communications about the offering.[86]  I will address each provision separately.

 

a)  Registration Statement

Any security may be registered with the Commission  .  .  . by filing a registration statement in triplicate, at least one of which shall be signed by each issuer, its principal executive officer or officers, its principal financial officer, its comptroller or principal accounting officer, and the majority of its board of directors or persons performing similar functions .  .  .[87]

A two-part registration statement is required.[88] The first part of the registration process is the prospectus.[89]  The prospectus is the selling document and must be available to all potential investors.[90]  The second part of the registration process is the reporting statement.[91]  The reporting statement contains additional information not included in the prospectus.[92]  Each part must be submitted to the SEC;[93] I will review each separately.

 

I              Prospectus

The first half of the registration statement is a prospectus.[94]  Section 5 (c) of the Securities Act requires that a prospectus is delivered to potential investors, and a final prospectus is delivered to any investor before cash is exchanged for stocks.[95]  The prospectus must include nearly all of the information filed with the SEC about the offering company, including:

·        its business;

·        its properties;

·        its competition;

·        the identity of its officers and directors and their compensation;

·        material transactions between the company and its officers and directors;

·        material legal proceedings involving the company or its officers and directors;

·        the plan for distributing the securities; and

·        the intended use of the proceeds of the offering.[96]

 

II          Reporting Statement

The second part of the registration process is accomplished with a reporting statement.[97]  There is a variety of reporting statements an issuer can use to register with the SEC.[98]  The reporting statement an issuer uses may depend on the size of the offering, the size of the company, the number of shares already publicly traded, the number of shareholders holding existing stock, or the length of time the company has been making continuous disclosures under the Exchange Act.[99] 

 

The reporting statements include the information provided in the prospectus, plus additional information.[100]  There are 35 different pieces of information required for the registration form; each listed in Schedule A of the Securities Act.[101]

 

1.    Basic Registration Forms

Basic registration is accomplished with Form S-1, S-2, or S-3.  Form S-1 is the standard form for an initial public offering, although all issuers making an offering can use form S-1. 

 

Forms S-2 and S-3 are shortened registration forms.  Although they contain the same information found in Form S-1, they incorporate information from other SEC filings (discussed in a later section).  Form S-2 is available to issuing companies that have filed Exchange Act disclosures for at least 3 consecutive years “and have timely filed all required reports during the 12 calendar months and any portion of the month immediately preceding the filing of the registration.”[102] 

 

Issuing companies may use Form S-3 if they meet all of the requirements for Form S-2.[103]  In addition, the issuing company must have at least $100 million in stock held by non-affiliates and an annual trading volume of at least three million shares, or have $150 million in stock held by non-affiliates.[104]

 

2.    Alternative Registration Form

There is an alternative to basic registration for small business issuers.[105]  A small business issuer under the Securities Act is an issuer:

·        that had less than $25 million in revenues in its last fiscal year, and

·        whose outstanding publicly-held stock is worth no more than $25 million.[106]

 

Form SB-1 allows a company to raise up to $10 million in any twelve-month period.[107]  The registration form is in a question and answer format.[108]  There are fifty questions designed to elicit “prospectus” type information from the issuer.[109]  In addition, the issuer must provide audited financial statements to the SEC.[110]

 

A small business issuer may also use Form SB-2.[111]  Form SB-2 has a number of advantages over other registration forms.[112]  First, unlike Form SB-2, there is not a limit to the amount of money an issuer may raise.[113]  Next, using Form SB-3, an issuing company is required to provide audited financial statements for the previous two years using generally accepted accounting principles.[114]  In contrast, basic registration requires audited financial statements for the previous three years “prepared according to more detailed SEC regulations.”[115]

 

3.    Limited Registration Form

Regulation A offerings are exempt from full registration, but still require a limited registration statement with the SEC for review.[116]  The SEC created Regulation A under authority of Section 3(b) of the Securities Act.[117]  The registration statement consists “of a notification, offering circular, and exhibits.” [118]  In addition, the public offering must not exceed “$5 million in any 12 month period.” [119]

 

Other differences between a Regulation A offering and an offering under a basic registration is that the financial statements need not meet the strict SEC requirements.[120]  Rather, generally accepted accounting principles apply.[121]  Also, the financial statements do not have to be reviewed by an independent auditor.[122]

 

4.    Other Registration Forms

There are a host of lesser-used registration forms.  For example:

·        “Form S-4 is used for registration of securities obtained by a company's shareholders in mergers, consolidations, and asset transfers;”

·        Forms F-1, F-2, F-3 and F-4 are used to register securities issued by foreign companies;

·        Securities issued as part of an employees benefit plan are registered with Form S-8; and,

·        “Insiders” use form S-18. [123]

 

 

5.    Full Exemptions

There are a variety of exemptions from filing a registration statement with the SEC.[124]  An exemption is available when the SEC determines that the targeted investors are not in need of the protection offered by the Securities Act.[125] 

 

There are exemptions for small offerings under Regulation D Rule 504,[126] Accredited Investors under Regulation D Rule 505,[127] informed Investors under Reg. D rule 506,[128] Institutional Investors under Rule 144a,[129] intrastate offerings under Section 3(a)(11),[130] and municipal securities exemption under Section 3(a)(2).[131]   

 

b)  Registration Review

 

The SEC must approve an offering before an issuer may sell an offering to the public.[132]  However, unlike the blue-sky “merit” approval system, the SEC only reviews the offering to assure the documents are “adequate and accurate disclosure of the material facts concerning the issuer's business, finances, securities, proposed offering, and risks.”[133]  The SEC does not attest to the “quality” of the offering.[134]  A registration may be “in registration” between forty-five and ninety days before an offering becomes “effective.”[135]

 

c)   Communications

 

The Securities Act strictly prohibits issuers from “conditioning the market” in any way.  Therefore, a company contemplating an offering can not “test the waters.”[136]  Companies making a regulation A offerings may “test the waters” before formally making an offering.  The SEC has proposed Rule 135d.  If approved, amended rule 135d would allow all issuers to “test the waters.”  However, at the time of this writing rule 135d has not been approved.

 

The restrictions were included in the Securities Act because “Congress feared that if glossy, promotional materials could be distributed to investors before the prospectus, investors might pay little attention to the gray, dull, legalistic document prepared in accordance with elaborate governmental instructions.”[137]

 

The Exchange Act

The year after the Securities Act, Congress enacted the Securities Exchange Act of 1934.[138]  The Exchange Act focused on company specific information, rather than information about a specific transaction.[139]  Immediately after the Exchange Act was enacted only a limited number of companies fell under its requirement.[140]  The Exchange Act was greatly expanded through the Securities Acts Amendments of 1964.[141]  Thereafter, many more companies fell within the Exchange Act requirements.[142] 

 

The Exchange Act requires publicly held companies to make continuous periodic disclosures about:[143]

 

·        its operations;

·        its officers, directors, and certain shareholders (including salary, various fringe benefits, and transactions between the company and management);

·        the financial condition of the business (including financial statements audited by an independent certified public accountant); and

·        its competitive position and material terms of contracts or lease agreements.

 

In addition, all companies that register under the Securities Act (even companies that qualify for an exemption) must also file under the Exchange Act “at least through the end of the fiscal year in which your registration statement becomes effective.”[144]  They must register initially, whether or not they must also file continuously under the Exchange Act.[145]

 

Companies that must register continuously file an annual report (Form 10-K), a quarterly report (10-Q), and an occasional report (Form 8-K).[146]

 

Modern Information Technology

Milton H. Cohen, former Chairman of the SEC, wrote an influential article in 1966 calling for an overhaul of the structure of securities regulations in the United States.[147]  Chairman Cohen recognized that “we [cannot] assume that methods which were entirely proper, even praiseworthy, at an earlier time are necessarily beneficial in a changed environment.”[148] 

 

The “changed environment” that Chairman Cohen referred was the growing impact of MIT on the securities markets.  In 1966 MIT was just beginning to revolutionize the securities markets by making them more efficient.[149]  MIT made it possible for investors to quickly assimilate available information about a widely traded company into the market price of that security.[150]   The United States Supreme Court has since recognized the Efficient Capital Market Theory (ECMT).[151]

 

This section examines the method that Chairman Cohen advocated.  Then I examine how the SEC has altered the two major provisions of the Securities Act, registration and prospectus delivery, in order to implement that method.

 

Company Registration

Chairman Cohen suggested that the focus of our public offering registration system should be altered from the transaction, to the company.[152]  The integrated method of registration Chairman Cohen advocated has been dubbed “Company Registration.”[153]

 

The American Law Institute (ALI) advanced Chairman Cohen’s proposal.[154]  After ten years in the works, the ALI approved an integrated securities regulation plan in 1978, the Federal Securities Code (ALI Code).[155]  The ALI Code was “an ambitious attempt to recodify all six federal securities statutes into one seamless code.”[156]  After modifications, the SEC endorsed the ALI Code in 1980.[157]  However, Congress never implemented the ALI Code.[158]

 

Even though Congress never revamped the securities laws, the statutes in place have allowed the SEC wide latitude to redo the structure through administrative action, or non-action.[159]  The SEC has used administrative policy to dismantle the Securities Act and implement the Company Registration method.[160] 

 

In 1982, relying on the ECMT, the SEC began dismantling the Securities Act by adopting the "Integrated Disclosure System” (IDS).[161]  The IDS replaced the Securities Act’s traditional “Transactional Registration” method with an integrated “Company Registration” method for widely traded companies.[162]

 

The SEC justified adopting the IDS based on the efficiency of the capital markets.[163]  Since the market price of a security reflected all the public information about that company, investors already had the information that the basic registration requires.[164]  Therefore, it was unnecessary to require those companies to disclose repetitive information in their registration forms.[165]

 

Registration System

The duel system of registration enacted in the 1930’s requires a company to register the same information twice when making an offering to the public.[166]  Section 5 of the Securities Act requires all companies making a public offering to register with the SEC, unless exempt.[167]  Section 78o(d) of the Exchange Act requires each issuer that files a registration statement, and which becomes effective, under the Securities Act to file under the Exchange Act.[168]  As this paper illustrated in a previous section, the information required under both acts is nearly identical. 

 

The SEC’s IDS “eliminated overlapping and unnecessary disclosure required by the Securities Act and the Exchange Act” for some companies.[169]  It accomplishes this in two ways.  First, the IDS allows some companies to “incorporate by reference” information in their Exchange Act filing into their Securities Act registration.[170]  Second, the IDS permits some companies to pre-register securities and place them on the “shelf” before they are offered to the public.[171] 

 

I                    Incorporate by Reference

The first way that the SEC has used to implement the Company Registration system of the IDS allows some companies to “incorporate by reference” information in their Exchange Act filing into their Securities Act registration.[172]  Under Rule 415, registration forms S-2 and S-3 allow companies that trade in an efficient market to shorten the registration process.[173]  The SEC recognized that duel registration was not necessary for many companies.[174]  Therefore, the SEC allowed “seasoned” issuers to “incorporate-by-reference.”[175]  Forms S-2 and S-3 were designed for just such an issuer.[176]

 

Incorporation-by-reference is a procedure whereby an issuer makes reference to information submitted via Exchange Act filings, into their Securities Act registration.[177]  Thereby, shortening the registration process for eligible companies.[178] 

 

Issuing companies that qualify to use Form S-2, may incorporate the information from Exchange Act form 10-K into the required prospectus.[179]  In addition, the company may also incorporate an annual report into the prospectus, rather than providing a potential investor with a paper copy of the report.[180]

 

Issuing companies that qualify to use Form S-3, only have to provide transaction specific information.[181]  All of the other information required in both parts of the registration form may be incorporated by reference.[182]

 

II                Shelf Registration

Under Rule 415, shelf registration is available to issuing companies that qualify to use basic registration Form S–3.[183]  These are the most widely traded companies.  Therefore, the information about the company is already widely disseminated.[184]  

 

Shelf registration permits issuing companies to register securities then offer and sell them continuously at the current market price.[185]  The company may “shelve” shares that equal up to ten percent of the aggregate dollar amount of its voting shares.[186]  However, the issuing company must reasonably expect to sell the securities in the next two years.[187] 

 

Issuing companies may register the securities with an abbreviated version of Form S-3, so long as the issuing company:

 

(1)            had continuously reported under the 1934 Act for at least one year, and

(2)            had at least a $ 75 million public float (owned by non-affiliates) if engaging in a primary offering for cash.[188]

 

The abbreviated form must contain certain transactional information and any material changes to the issuing company’s business.[189]  The rest of the basic registration information is incorporated by reference to past and future Exchange Act reports.[190]  A qualifying company need only file the abbreviated form before selling any shares in a new offering.[191]  

 

Prospectus Delivery

Section 5 of the Securities Act requires that a prospectus be delivered to an investor before shares are sold.[192]  However, IDS Company Registration nearly does away with the traditional delivery of a prospectus to potential investors for companies that are eligible to participate in the “incorporation by reference” and “shelf registration” programs.[193]  Eligible companies are presumed to trade in efficient markets.[194]  Therefore, investors already possess “prospectus” type information about the company.[195]  Delivering a prospectus would not further the SEC goals of full and fair disclosure and protecting investors.[196]

 

Using the Internet to Expand Company Registration

The SEC’s IDS Company Registration method relies on an efficient market to liberate larger companies from the strict requirements of the Securities Act.  Reasoning that investors already have access to the information that the Securities Act registration discloses. Since the IDS was adopted in 1982 the Internet has transformed MIT. 

 

Two important developments promise to free all companies from the burden and expense of the Securities Act.  First, the SEC embraced a computer-based record system.  Second, the SEC permitted electronic prospectus delivery.

 

EDGAR

Chairman Cohen predicted the demise of the Securities Act as soon as MIT allowed “greater accessibility and usability of the enormous stores of information that the continuous disclosure system has been accumulating and will continue to accumulate.”[197]

 

In 1984 the SEC implemented Chairman Cohen’s vision with the development of a computer-based system used to file and distribute SEC records.[198]  That year, the SEC began an experimental program that allowed about 500 volunteer companies to forego paper disclosure documents and submit their SEC filings via computer.[199] 

 

The program was quickly expanded to include a greater number of companies.[200]  Finally, as of May 6, 1996, all companies and others who are required by law to file forms with the SEC are required to file Exchange Act filings electronically, unless they have a hardship certificate that relieves them of the obligation for a limited time.  The computer-based system is used to collect, validate, index, accept, and forward submissions to the proper registration authority, and to the general public.[201]

 

The computer-based system is known as the Electronic Data Gathering, Analysis, and Retrieval system, or EDGAR.[202]  EDGAR’s “purpose is to increase the efficiency and fairness of the securities market for the benefit of investors, corporations, and the economy by accelerating the receipt, acceptance, dissemination, and analysis of time-sensitive corporate information filed with the agency.” [203] 

 

At first, access to the information in the system was restricted to those who paid for the privilege.[204]  After years of public complaints about the limited access to the electronic system, the SEC entered into a contract with the National Science Foundation (NSF) to produce an Internet site.[205]  In turn, the NSF issued a grant to New York University School of Business and the Internet Multicasting Service to make most EDGAR documents available on the Internet.[206]  The SEC “began its own separate Internet service on September 28, 1995” at http://www.sec.gov.[207]  Today, “EDGAR filings as well as certain Commission releases and announcements” are available to any one with Internet assess.[208]

 

I                    Edgar Filings

Currently, filers have to “submit electronic filings to the EDGAR system in a text-based American Standard Code for Information Interchange (ASCII) format.”[209]  Since the SEC started accepting electronic documents, ASCII has been the standard format.[210]  ASCII is convenient for the filers and the SEC.  First, filers do not need any special software to produce or view ASCII documents; a standard word processor will suffice.  ASCII documents are also easily transferred from one computer-based system to another, even at the 300-baud rate of the 1980s.[211]  

 

On June 28, 1999 the SEC will implement a major upgrade to the EDGAR system.[212]  The system will begin accepting documents in Hypertext Mark-up Language (HTML) in addition to ASCII.[213]  Filers will also be allowed to supplement their submissions by including unofficial copies in Portable Document Format (PDF).[214]  Eventually, the new formats will allow EDGAR documents to convey information graphically; ASCII documents are limited to text.  The SEC also plans to replace nearly all documents in HTML rather than ASCII.

 

1.    Hypertext Mark-Up Language

HTML is a language that uses ASCII text plus a “defined set of commands (known as tags) to create most of what you see on a World Wide Web page.”[215]   “A Web page is an Internet ‘document’ that can be accessed by Internet users with an HTML browser” and may include audio, animation, video, images, and hyperlinks to other documents.[216]  Initially, filers will only be allowed to submit one HTML document.[217]  Also, the HTML document may not link to animation, video, audio or any other HTML files.[218]  However, the SEC plans to change that policy in the near future.[219]   

 

2.    Portable Document Format

In addition to HTML documents, a filer may supplement the official filing with an unofficial filing in PDF format.[220]  PDF presents a document in a full digital version of printed material, “complete with layout, fonts, colors, and graphics.”[221]  Because PDF documents look exactly like a printed paper version, by supplementing an official file with a PDF document a filer may control the look of the document on the investors monitor, and even if the investor chooses to print the document.[222]  In contrast, viewing or printing an HTML document can vary, depending on the combination of the hardware and software used.[223]

 

An investor will be able to access an HTML and / or PDF SEC filing that includes more than just text.  Most investors do not have the level of sophistication of an investment banker or accredited investor.  By allowing unsophisticated investors access to documents with charts, graphics and spreadsheets, the complex information presented is made clear.  Therefore, the investor may better understand about the filing company, its products, its officers, and its future.  The more fully the information is conveyed to investors, the more fully the SEC has fulfilled its goal of full disclosure and protecting the individual investor.

 

Electronic Prospectus

The drafters of the Securities Act never envisioned electronic documents.  However, the SEC, through a series of no-action letters, defined an “electronic prospectus.”

 

The SEC articulated its position on electronic delivery of prospectuses in a February 1995 Brown and Wood SEC no-action letter (Brown & Wood).[224]  In that letter, the SEC ruled that “it is the [SEC]'s view that the term ‘prospectus’ as defined in Section 2(10) of the Securities Act of 1933 . . . includes a prospectus encoded in an electronic format (an ‘electronic prospectus’).” [225] 

 

The SEC issued a detailed interpretation, effective October 6, 1995, of an “electronic prospectus” which spelled out the two primary requirements: notice and access.[226]  

 

I                    Notice

In order to satisfy the notice requirement for a prospectus that is available for downloading from a web site, an issuer must have evidence of delivery.[227]  Evidence of delivery can be obtained in a number of ways.[228]  For example: (1) the issuer may obtain an informed consent from the investor to deliver the prospectus electronically.  (2) The issuer may offer proof that the investor printed, downloaded, or accessed the prospectus from the web site.  (3) The investor may send a return e-mail confirmation of receipt.  (4) The investor may use forms or other materials included in the electronic prospectus.  The examples listed here are not the only ways to meet the notice requirement.[229]

 

II                Access

Regardless of the availability of an electronic prospectus, a paper prospectus must be available to every investor.[230]  This requirement is a precautionary measure, in case of an electronic breakdown.[231]  However, an investor may request a paper prospectus for any reason.[232] 

 

The electronic prospectus must also be readily accessible.[233]  If the prospectus is available on the issuers web site, it may not be too “deep” into the site.[234]  For example, if the document can only be reached through a series of complicated menus, the document may be deemed “inaccessible” and fail the access requirement.[235]

 

Since the SEC implemented the electronic prospectus definition, a number of companies have developed Internet sites dedicated to presenting and making available to investors issuing companies prospectuses.[236] 

 

Conclusions

The primary purpose of the Securities Act is to ensure “full and fair disclosure” about the offering before the investor purchases any shares.  In the 1930’s the strict restrictions of the Securities Act may have served that purpose.  Today, however, with the proliferation of information, the Securities Act restrictions only act to impede efficient capital formation.

 

To begin with, Congress must recognize that the world of information has changed.  Congress must enact a comprehensive integrated securities plan.  Or, in the alternative, repeal the Securities Act.  If the SEC has the discretion to enforce, or not enforce, chosen provisions on a select group, securities regulation will never be coherent, or efficient.[237]

 

In the mean time, the SEC Internet site has been “online” for nearly 5 years.  In that time the number of web sites on the Internet has increased by more than 10 times.[238]   Today, as reported by U.S. Intelliquest in March 1999, 38% of Americans over 16 are online.[239]  That is an estimated 79.4 Million people in America alone.[240]  The increase is expected to continue for the foreseeable future.[241]

 

Because the Internet has become the primary resource for information in America, the SEC Internet site should use the EDGAR system to integrate securities regulations into a full Company Registration Method.  Here are my suggestions.

 

First, the dual registration requirements should be abandoned.  As pointed out in this paper, the information required by the Exchange Act and the Securities Act is nearly identical.  Also, nearly every company that registers under the Securities Act is also required to submit an Exchange Act filing, even if the issuing company is filing a limited registration or is otherwise exempt.  The SEC gets the same information twice.  An issuing company should submit an Exchange Act filing.  The system can still relay the information to the proper desk within the agency in order to review the registration.

 

Next, prospectus delivery should be abandoned.  The Securities Act registration and the Exchange Act information are nearly identical.  Therefore, the delivery of the prospectus, even electronically, is no longer necessary.  Now that EDGAR will be allowing HTML and PDF documents, the very same information can be found on the SEC’s site as on a private site. 

 

Once a company submits the registration on EDGAR, the two requirements for an electronic prospectus delivery (notice and access) can be more easily accomplished if investors could assess the prospectus on EDGAR.  If shares of a company are available, the investor would be on “notice” that a prospectus is available on EDGAR.  In addition, because it is available on EDGAR, access would be easier.  As it is, an investor may not be able to locate the electronic prospectus, even if it is available. 

 

Third, as an alternative, every company ought to be able to incorporate by reference information available on EDGAR into any documents delivered to a potential investor. The agency believed the requirements were unnecessary for “seasoned” companies because investors have ready access to company information from other sources.  The reasoning behind allowing “seasoned” issuers to incorporate by reference, now holds true for any company the has information on file with EDGAR.  The information is available for all to see.

 

Finally, rule 135d ought to be enacted.  The rule allows all issuing companies to “test the waters.”  Trying to stifle information in today’s world does not further the goal of “full and fair disclosure.”  In fact, prohibiting information may aid in misinformation.

 

Modern Information Technology has transformed the way information is gathered, analyzed and disseminated.  Our laws, especially our securities laws, ought to reflect this reality. The Securities Act of 1933 no longer furthers the goals it was enacted to serve.  Therefore the Securities Act should be repealed.