The arrival of on-line securities offering and trading promises a revolution in corporate finance. Investors will gain instant access to vital company information and directly place trades without paying fees to traditional brokers. Corporations will be able to directly address millions of Web surfers. However, there is no cyberspace exception to the securities laws. Unlike many other business activities now routinely conducted in cyberspace, the business of offering and trading securities is subject to an exacting regulatory web. That web has been untangled a bit by the SEC's staff's initial pronouncements with regard to cyberspace securities trading. The staff's initial comments also offer a glimpse into the future, where companies seeking to raise capital will simply post the relevant information on their websites.

Recent media attention has focused on a New York microbrewery's Internet-based initial public offering and trading system. See "Microbrewery Uses the Internet to Post Circular on its IPO," Wall Street Journal, Feb. 24, 1996, Sec: B, P. 5B. Founded in 1992, the Spring Street Brewing Company brews and markets a premium Belgian recipe beer under the name Wit Beer. Like most start-up companies, Spring Street needed to raise capital to market its product. Spring Street decided to use its site on the Internet's World Wide Web to raise funds directly from the public. See Spring Street Brewing Home Page, http://plaza.interport.net/witbeer/.

In February 1996, Spring Street completed a securities offering under Regulation A of the Securities Act of 1933, which generally allows non-public companies to offer up to $5 million of securities by means of an abbreviated registration statement. The offering materials were posted on Spring Street's Web site. Eventually, $1.6 million was raised, with no underwriters, exchanges, or commissions paid to any brokers.

On March 1, 1996, the company went one step further and established "Wit-Trade," a novel on-line bulletin board-based mechanism for its investors to trade shares in the company among themselves without ever using a Wall Street broker. See Wit-Trade link at Spring Street Brewing Home Page, supra. The Wit-Trade bulletin board contained a number of separate sites which provided investors with information regarding trading activity, recent financial reports, and the like. Interested investors placed buy orders on the buyersÕ bulletin board and sell orders on the sellers' bulletin board. Offers and acceptances were processed by e-mail, with Spring Street holding the money exchanged between the buyers and sellers.

While the Securities and Exchange Commission was generally supportive of Wit-Trade, it was concerned that Wit-Trade's cybertrading system did not afford sufficient protections to small investors. On March 22, 1996, the SEC issued an informal letter requesting that trading be suspended until it could review the Wit-Trade system for compliance with federal securities laws. See Securities Regulation & Law Report, March 29, 1996, pp. 437-438. The letter advised Spring Street that it could resume trading through Wit-Trade if it complied with certain investor protection precautions.

On March 25, Spring Street voluntarily halted trading in response to the SEC request for time to study the practice. In its press release, Spring Street's President Andrew Klein stated that the company would modify the program to bring it "in-line with the positions expressed by the staff. . ." and that after revising its trading mechanism it would seek a staff no-action response. See Spring Street Internet statement regarding SEC recommendations, http://plaza.interport.net/witbeer/new_page/suspend1.html. The staff told Spring Street that "[b]ecause of the innovative nature of the system and the issues raised, we believe that interpretive relief is appropriate for your situation . . . [W]e look forward to working with you in anticipation of providing this relief." As of the date of this article trading has not yet resumed, presumably because Spring Street is implementing the requested changes and preparing its no-action request.

In its March 22 letter, the SEC staff praised Wit-Trade as an "innovative mechanism that has the potential to provide Company shareholders with greater liquidity in their investments." "Nevertheless," the staff cautioned, "we believe that, without certain modifications, investors using your system may not be adequately protected. In particular, the staff was concerned "that investor funds be handled appropriately, that investors understand the risks involved in purchasing non-liquid and speculative securities, that buyers are aware of last sale prices, and that investors are provided with ongoing disclosure about the Company."

The SEC staff noted that because Spring Street is not a registered broker-dealer, it should modify its system to eliminate control over investor funds by using a bank, escrow agent, or other independent agent to receive checks from purchasers. In addition, the staff directed that checks should be made payable to the bank or the seller, not to Spring Street.

Next, the SEC staff directed Spring Street to provide additional information for first time investors, such as the risks of investing in non-liquid securities and to disclose that, since its stock is not traded on a registered securities exchange or through Nasdaq, there is no guarantee investors will be able to sell Spring Street's shares at the price they paid for them, "or at any particular published indication of interest." In addition, the staff suggested that users of the system should be informed that they could be considered a "dealer" of securities if they choose to post quotations of the buyer and seller bulletin boards simultaneously.

The staff also suggested that "a transaction history would allow investors to make more informed investment decisions," and that price and number of shares for recent transactions should be disclosed through the system. The staff added, "To deter manipulation, it would be helpful if you kept records of all quotations posted on Wit-Trade and of all securities transactions effected through use of the system and make them available to us upon reasonable request."

The SEC staff then suggested that the sale of securities through Wit-Trade is akin to matching services that facilitate the exchange of non-publicly traded limited partnership interests. The staff stated that like some of such matching services, Wit-Trade "appears to involve an offer or sale by Spring Street" under the Securities Act of 1933. For guidance on how to avoid such a finding (and the attendant registration requirements), the staff referred Spring Street to its November, 1992 no-action letter, which discussed the application of the 1933 Act registration requirements in this regard. King & Spalding, Fed. Sec. L. Rep. (CCH) P76,295 (November 17, 1992).

The King & Spalding letter advised that matching services would not require registration if: (1) the limited partnerships fulfill their reporting duties under the 1934 Securities Exchange Act; (2) the matching services are not actively promoted; (3) sell orders are not solicited and purchase orders are carefully circumscribed; (4) sponsors do not take any action that would effectively set or affect the price of the limited partnership interests; and (5) sponsors do not execute transactions other than as an agent for a buyer or seller. Given that the majority of online stock issuers, such as Spring Street, will likely be small and will seek to attract investment by promoting the liquidity of their shares through mechanisms like Wit Trade, compliance with the second factor may be difficult to satisfy.

The staff also stated that absent an available exemption, Spring Street would be required to register under the 1933 Act and to keep the registration statement "evergreen" during Wit-TradeÕs existence. The staff acknowledged that the exemption afforded by Regulation A may be used in connection with the Wit-Trade mechanism, but that the offering circular used in connection with the Regulation A exemption should be delivered and updated in accordance with Regulation A.

Finally, the staff noted with approval that Spring Street used electronic delivery in its original Regulation A offering, but directed the company to the SEC's October, 1995 release regarding electronic delivery for guidance. Use of Electronic Media for Delivery Purposes, Securities Act Rel. No. 7234, Fed. Sec. L. Rep. (CCH) P 85,702 (October 6, 1995). In that release, the SEC proposed a set of modifications to its existing formatting and distribution rules which would permit the electronic dissemination of SEC required documents if they are "in a format readily communicated to investors."

As one observer has noted, cyberspace trading "could well trigger a wave of similar offerings by small companies ... It's the ultimate way of shotgunning a deal." Wall Street Journal, February 24, 1996, p. 5B. Corporate executives, attorneys and investors can soon expect additional guidance from federal and state authorities setting the rules for offering and trading securities over the Internet. Of particular interest will be the response from state securities regulators, since by use of the Internet securities offerings reach all 50 states at once. Most states require the issuer to register those shares with state authorities, a burdensome requirement for a small issuer when multiplied by 50.

However, once the rules are established, the Internet could fundamentally restructure the way small companies raise capital. While the revolution is not yet here, it may be just around the corner.

Anthony De Toro and Eric Berkowitz are attorneys at the law firm of Fenigstein & Kaufman, in Los Angeles. They can be reached by e-mail at ericdb@earthlink.net.

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