SOME ISSUES FOR CORPORATIONS AND SECURITIES MARKETS

VIRTUALLY NO LIABILITY?: SECURITIES MARKETS IN AN ELECTRONIC AGE AN ISSUES PAPER
Table of Contents


CHAPTER 2

SOME ISSUES FOR CORPORATIONS AND SECURITIES MARKETS

Introduction

2.1 In Chapter 1 of this Paper, the Committee outlined, in broad terms, some of the potential effects of technological change on Australian corporations and securities markets. This Chapter deals with these effects in more detail.

2.2 In summary, it is suggested that, as a result of the development of an international electronic market in the trading of shares and related securities, the amount of corporate and investment information that is readily available, and the quality of that information, should increase. However, insubstantial 'information' such as gossip or rumour may also increase and will circulate more widely. Information from all sources should appear in a much more timely fashion. The ability to manipulate and interpret that information may also be enhanced, possibly assisted by specifically developed computer software and by new information intermediaries.

2.3 The new technology is also likely to bring about structural changes in securities markets. Many of the roles intermediaries now perform - which are explicitly recognised in, and specifically regulated by, the Corporations Law - may change, or even disappear, as investors or fund-raisers take on those roles directly, perhaps again assisted by computer software. However, there is scope for new types of intermediation and for new classes of intermediaries which are not yet recognised in the Law.

2.4 Given these developments, some of the problems currently faced by regulators may also change, or disappear. However, many new problems will arise - principally as a consequence of the internationalisation of markets, and of transactions that cross jurisdictional borders, or take place outside those borders. Some matters currently subject to regulation may, in the future, be more difficult (or even impossible) to regulate.

2.5 Given that developments are taking place in an international context, there will be an obvious need for widely accepted standards. These standards will be needed to govern the technology itself, the software it utilises, the manner in which information is presented, and the legal environment which will apply to transactions undertaken.

2.6 Finally, international markets are likely to bring with them a greater depth of choice for investors in, and issuers of, securities, and may include a greater range in the 'products' offered, including many novel products not currently contemplated by the legislation.

2.7 This remainder of this Chapter discusses these likely effects in greater detail.

Information

2.8 Currently the Corporations Law regulates the way in which information about corporations, their activities and their securities may be provided. Much of the information disclosed by companies must satisfy prescribed requirements. [1]

2.9 The Law also regulates those who may offer information or advice about securities, and imposes certain qualifications on the content of that advice. In general terms:

2.10 The rationale for licensing investment advisers was set out by the ASC in its Licensing Review Report Good Advice. While noting that its role was not to be a risk regulator, nor to protect investors from financial losses, the ASC observed that:

Licensing and the Wallis Committee

2.11 It should be noted that the Wallis Committee also considered the issue of licensing. The approach advocated by that Committee involved the establishment of a single regime to license advisers providing investment advice and dealing in financial markets, with separate categories of licence for investment advice and product sales, general insurance brokers, financial market dealers, and financial market participants. [6] Under this licensing approach, the CFSC should:

2.12 Subject to the outcome of a review, real estate agents providing investment advice would be required to hold a financial advisory licence. However, professional advisers such as lawyers and accountants would not be required to hold such a licence if they provided investment advice only incidentally to their other business and rebated any commissions to clients. [8]

Implications of the electronic dissemination of 'official' information

2.13 Clearly, both 'official' and 'non-official' information may be made available electronically. Under recently introduced or proposed procedures, information such as profit or company announcements may be lodged electronically with the ASX and the ASC, and may be disseminated electronically by them. Consideration is being given to proposals to enable the electronic delivery of notices of meeting to shareholders and the electronic lodgment of proxies by shareholders. Indeed, in a recent report, this Committee recommended that the Corporations Law should more extensively recognise electronic forms of communication between companies and their members, and regulatory authorities. [9] Such recognition would enable information to be disseminated more quickly, at a lower cost, and to be more readily searched and analysed.

2.14 Technology also has the potential to make information such as real-time share prices and trading volumes, and details of regulatory or enforcement action, much more widely available. Where such information is presently restricted to market professionals, in the near future it is likely to be available to anyone with basic Internet access.

2.15 However, a number of subsidiary issues may arise where 'official' information is made available electronically. Broadly, these involve:

Some issues:

Implications of the electronic dissemination of other information

2.16 'Non-official' information about companies and their securities is difficult to categorise. It may extend from considered financial analysis, through investment advice, to advertising for share purchases, and to rumour and speculation. Information in all these categories is now commonly found in electronic form on the Internet.

2.17 The growing availability of stockbrokers' analysis is noted in para 1.9 above. Information and advice from investors or interested members of the public is also available. For example, in September 1996, 'Australian Stocks and Shares', an Internet site operated by Mr Gerry Pauley, was voted Australia's most popular destination in the inaugural AFR/Telstra Australian Internet Awards. The site was based on personal share trading, and included company information, educational material and graphs. [10] No charge was made for the advice provided, and the site also contained a disclaimer that its operator was not a financial adviser.

2.18 In spite of this, in October 1996 the site was closed after the ASC insisted that its operator obtain a dealer's licence:

2.19 The ASC's action followed an earlier incident in which misleading information was published on the Internet. In March 1996, Mr Ron Gully, the operator of a Geelong-based Internet site, published a report predicting that the price of shares in three named oil exploration companies would skyrocket after the discovery of a "monster oil find in Manila Bay". He removed the report after four hours and suspended the service because of "legal problems" after one of the exploration companies notified the ASX that the report was "absolutely false". Mr Gully explained that he had received an anonymous tip from someone claiming to represent people on the drilling rig, but had not contacted the companies involved to confirm the tip.

2.20 In June 1996, the ASC issued a Media Release dealing with investment advice on the Internet. This observed, in part:

2.21 Problems continue to emerge in spite of such warnings. For example, as recently as May 1997, the "chat room" HotCopper (also operated by Mr Gully) published a series of comments about the shares of Carpenter Pacific Resources NL (Carpenter), which had released drilling results suggesting a significant gold discovery. These comments included hints of a possible takeover for Carpenter, and claims that a named broker, and officers of another company with an interest in the prospective mine, had indicated that the release of further positive drilling results was imminent.

2.22 Asked whether he had provided the information disclosed, the named broker stated that the particular Internet contributor had "caused a storm in a teacup by writing provocatively about what he has heard" but that there was "probably substance in what he has written". [14] Media reports of the incident suggested that:

2.23 There is a more substantial history of similar activities in the US, often involving newsgroups or bulletin boards rather than home pages. The SEC Internet site reports a number of occurrences including:

2.24 In November 1996, in response to serious questions raised about OmniGene Diagnostics Inc, the SEC temporarily suspended over-the-counter trading in the company's securities and also posted information about the suspension on a message board that discussed OmniGene stock. A media release issued on behalf of the SEC noted:

2.25 There is a proliferation of general information about companies and their securities, both domestic and international, on the Internet. [21] One investor bulletin board - The Motley Fool - claims a regular readership base of 400,000:

2.26 Some of the information provided is unexceptionable, and represents the work of licensed advisers. Other information represents the work of thoughtful (but unqualified and unlicensed) amateurs. Other sources provide a forum for rumour and gossip, about which one observer recently noted:

2.27 To date, the approach chosen by the ASC seems to have required the operators of all Australian-based Internet sites to comply with the licensing provisions of the Law. However, little action seems possible in the case of "bulletin boards" or "chat rooms". There are obviously many competing considerations, including allowing investors full access to the information potential of electronic communications while minimising the opportunities for market manipulation and investment fraud.

2.28 Some other jurisdictions have attempted to draw distinctions between different forms of electronic communication. For example, the US National Association of Securities Dealers (NASD) regards an Internet World Wide Web site, a site on a commercial online service (such as America OnLine) and communications posted on electronic bulletin boards as forms of advertising. Group electronic mail is regarded as sales literature. Individual electronic mail is regarded as correspondence, and a "chat room" is regarded as a public forum using an electronic medium. Different filing, review, approval and disclaimer guidelines seem to apply in each case. [24]

2.29 The information potential of the new technology is likely to be further enhanced by developments in software. The Wallis Committee referred to the future importance of "intelligent software" to make searching, obtaining and analysing information more manageable over public and private networks. [25] A recent report from one group of technology analysts reportedly forecast that "mobile units of intelligent software that search for customised information on the [World Wide] Web will transform the Internet into a finely tuned forum for electronic commerce generating almost US$5 billion of revenue by 2006". [26] Other reports refer to software programs known as 'smart agents', 'intelligent agents' or 'program navigators' which will allow investors to examine financial products and services, and select and purchase them. [27] In the areas of interest to this Committee, one example of the development of a program designed to analyse the information disclosed in a prospectus is referred to in para 2.60 below.

2.30The information potential of the new technology also seems to challenge the enforcement abilities of regulators such as the ASC. In addition to comments made within Australia about Australian shares, it is highly likely that comments about Australian shares (or overseas shares traded on the ASX) will be made on Internet sites, "bulletin boards" and "chat rooms" based outside Australia - challenging the jurisdictional reach and enforceability of the Law. It is also possible that comments about shares traded overseas may be made on Australian sites or through an Australian-based Internet service provider. It may be that there is a general need to re-evaluate the operation of the Law as it applies to investment advice and comments about securities.

Some issues:

Footnotes

[1] For example, the information required to be included in a company's annual return is set out in s 335 and Form 316 of the Law. Information required to be included in a prospectus is governed by ss 1021 and 1022. The ASX Listing Rules provide a further regulatory structure for disclosure by listed companies.

[2] Corporations Law ss 780, 781. While the Law speaks of 'carrying on an investment advice business', such a business need not be carried on for profit.

[3] Corporations Law s 851.

[4] Corporations Law s 849.

[5] Australian Securities Commission, Good Advice, reproduced in ASC Digest SPCH 163.

[6] Wallis Committee Report, p 273.

[7] Wallis Committee Report, pp 273-4.

[8] Wallis Committee Report, pp 275-6.

[9] See Parliamentary Joint Committee on Corporations and Securities, Report on the Draft Second Corporate Law Simplification Bill 1996, Canberra, (November 1996), pp 10-14.

[10] 'Stocks site shuts amid Net tangles', Sydney Morning Herald, (31 October 1996) p 25.

[11] 'Stocks site shuts amid Net tangles', Sydney Morning Herald, (31 October 1996) p 25.

[12] 'Internet share tipping draws ASC attention', Australian Financial Review, 26 March 1996.

[13] Australian Securities Commission, Media Release 96/121, reproduced in ASC Digest, pp MR 172-3.

[14] 'ASC frowns on Net talk', Australian Financial Review, 19 May 1997, p 60.

[15] 'ASC frowns on Net talk', Australian Financial Review, 19 May 1997, pp 28, 60.

[16] Securities and Exchange Commission v William B Sellin II, Zaitech Holdings Inc and Baccaratt Holdings Inc: SEC Litigation Release No 15012, 12 August 1996.

[17] Securities and Exchange Commission v Wye Resources Inc and Rehan Malik: SEC Litigation Release No 15073, 26 September 1996.

[18] Securities and Exchange Commission v Western Executive Group Inc, Cash Systems USA Inc, Charles R Reitz, Robert R Parrish, Robert J Struth and R Stephen Edgel: SEC Litigation Release No 15106, 3 October 1996.

[19] Securities and Exchange Commission v Scott A Frye: SEC Litigation Release No 15139, 29 October 1996.

[20] Securities and Exchange Commission, 'Commission Posts OmniGene Notice on America OnLine' Media Release 96-133, 20 November 1996.

[21] See, generally, Martin Roth, The Internet for Investors, Wrightbooks, Melbourne (1996) pp 54-71 and pp 124-140.

[22] 'Investor bulletin boards threaten retail networks', The Australian 9 October 1996, p 34.

[23] 'Regulators still nervous about rules of cyberspace', Australian Financial Review 13 February 1997, p 23.

[24] See, generally, National Association of Securities Dealers, NASD Regulatory & Compliance Alert, April 1996, pp 4-5.

[25] Wallis Committee Report, p 107.

[26] 'Smart agents on the Web to track down specialist data', Australian Financial Review 4 April 1997, p 23.

[27] 'Freed is good', The Bulletin, 11 March 1997, p 48.

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