Internet IPOs: They're Here, But the Rules Aren't Clear

You can shop, search, and send e-mail on the Internet. Now you can also raise capital online. Just 18 months ago, Directional Robotics became the first company to attempt a direct, registered initial public offering on the Internet. Small companies have also tried direct offerings that are exempt from registration with the Securities and Exchange Commission. And Internet trading start-ups like E-Trade are helping individual investors get in on the ground floor of underwritten IPOs.
       The technology seems sure to drive more IPOs from the syndicate departments of investment banks onto the Internet. "Companies are trying to let individual investors play a venture capital role," says Constance Bagley, senior lecturer in law and management. She and Robert Tomkinson, MBA Class of 1999, coauthored a detailed article about online securities offerings for the National Law Journal. "Historically, only institutional investors have been able to get in on the first round of investment," Bagley says. Indeed, the notion of online offerings is a good one that seems sure to boost the supply of capital for embryonic companies. Yet Bagley and Tomkinson warn that these new practices raise two serious questions: their legality and their liquidity.
       So far, the Securities and Exchange Commission has permitted several IPO transactions to take place under controlled circumstances. "The SEC has been very welcoming of this new technology," says Bagley. "They are trying to come up with appropriate rules without jeopardizing investor safety." One option is the use of passwords that would protect an IPO site so that only authorized investors can enter.
       All types of offerings and related services are proliferating. The first Web-based public offering surfaced in 1995 when Spring Street Brewing Company, a microbrewery, raised $1.6 million in a do-it-yourself direct IPO, exempt from registration with the SEC. By 1997, E-Trade included IPOs as one of its online investment services. Customers fill out application forms; those selected can read a prospectus and buy shares online. Last November, E-Trade sold out its available shares in the IPO of Sportsline USA, underwritten by traditional bankers. Even companies working with conventional underwriters on large deals are using the Internet to make investor presentations before going public.
       Web sites supporting the issuance of unregistered securities are also common. Most provide lists of issuers and access to offering documents. Some, such as Direct IPO, are affiliated with registered broker-dealers. Others try only to match buy and sell orders but do not negotiate transactions. "Such firms field hundreds of inquiries from potential issuers, but it is not yet clear whether many deals have been com- pleted," report Bagley and Tomkinson.
       In terms of legal issues, executives must be careful how they distribute information about their fledgling companies. For example, there are different rules for the verbal presentation of material about the pros-pects for a startup and the written material printed in a prospectus circulated to would-be investors. Current regulations require executives to be far more conservative about corporate forecasts in a prospectus. So, should projections delivered in a live video "road show" carried out on the Internet meet the stricter requirements for a written prospectus? The SEC already has permitted one company, NET Roadshow Inc., to hold a live conference presenting details of a $55 million registered offering underwritten by traditional bankers. Two hundred authorized institutional investors viewed the road show via password-protected access to a Web site. Because it was carried live as a video broadcast on the Net, the executives were held to the same standards as in regular road shows. However, all related written material on the Net had to conform to traditionally conservative prospectus language.
       Liquidity, of course, is the key to success or failure. For small issuers who might not attract the attentions of a major underwriter, Bagley and Tomkinson believe investors will remain cautious about buying illiquid securities for which there is no market for resale. Until Internet-based services develop established customer bases and access to a liquid market for secondary trading, they pose little threat to traditional Wall Street investment banks that charge clients some 7 percent to underwrite and manage an offering. "The real threat may come from renegade online discount brokers who are willing to risk being frozen out of traditional syndicates for the opportunity to make their names as discount IPO shops," write Bagley and Tomkinson. "Such players could potentially undercut traditional underwriting fees." Those best positioned are companies already doing business online and those that use aggressive pricing.
       The most likely scenario, suggest authors Bagley and Tomkinson, is that traditional underwriters will become partners with existing online brokerages. In such a marriage, the underwriters would guarantee credibility and liquidity while the brokerages would bring technical expertise to the transaction.

By BARBARA BUELL

"Internet Is Seeing Its Share of Securities Offerings," Constance E. Bagley and Robert J. Tomkinson, National Law Journal, February 2, 1998

The SEC has been very welcoming of this new technology, trying to come up with appropriate rules without jeopardizing investor safety.