By Stephen J. Schulte and Steven J. Spencer
There are those who say that nothing in life is free. In the context of "stock giveaway" programs, at least, such naysayers may be right. Some companies give away shares of stock as a creative way to publicize their products or company name. While the marketing concept is not new, it has become increasingly popular in the past year, primarily with small, closely-held Internet companies seeking to attract attention to their Web sites. This article discusses a series of recent no-action letters and enforcement proceedings that reflect the SEC's position regarding this promotional technique.
Last year, a number of small start-up companies initiated "free" stock promotions as a means of increasing their Web site traffic. Their objectives ranged from general branding and increasing market share, to collecting data and strengthening the basis for charging advertising fees. The first well-publicized Internet stock giveaway was sponsored by Travelzoo.com. The company launched its program in April 1998 and, by the end of the promotion, claimed to have given free shares of stock to approximately 700,000 people who had registered on its Web site.
As the popularity of free stock offerings increased, several companies requested no-action letters from the SEC staff, asking the staff to confirm that their proposed giveaways would not violate the Federal securities laws. Even after the staff refused to grant no-action relief, many companies continued to promote their giveaway programs. To drive home its message, the SEC instituted enforcement proceedings against certain individuals and companies promoting four stock giveaway programs.
The history of no-action letters relating to stock giveaways is a long one, dating back at least until the early 1970s. At issue is whether a proposed giveaway constitutes an offer or sale of securities "for value" under the Securities Act of 1933. If so, the company must register the offering or structure it under one of the Securities Act's exemptions from registration. Although the staff's central focus has been whether the proposed giveaway program would involve some form of consideration, it is worth noting that past no-action letters in which the staff permitted stock giveaway programs to proceed typically involved companies:
(1) that were subject to the reporting and information requirements of the Securities Exchange Act of 1934,
(2) whose stock was actively traded, and
(3) that proposed to distribute an insignificant number of shares in relation to the outstanding number of shares of that class.
The recent resurgence of stock giveaways provided the staff with an opportunity to revisit and clarify its position, at least as it applies to small or start-up companies. In the four no-action letters discussed below, the staff explained that stock giveaways, if not exempt, must be registered. One letter, American Brewing Company, related to tying free stock to product sales. Two others, Vanderkam & Sanders and Simplystocks.com, addressed stock giveaway programs keyed to Web site visits. The most recent letter, Jones and Rutten, addressed stock given in exchange for registration with the issuer either through the Internet or U.S. mail. The latter three letters are particularly interesting because they applied the concept of consideration to Internet practices. In general, the four no-action letters previewed the legal analysis that the SEC subsequently employed in its recent stock giveaway enforcement proceedings.
In the American Brewing no-action letter, a closely-held beer distributor proposed to issue one share of non-voting common stock to each customer who purchased a case of the company's beer. The company would cap the maximum number of shares subject to its giveaway at 20% of its equity. The company reasoned that since it would not raise the price of beer as a result of the offering, it would not be offering or selling the shares "for value" and, therefore, need not register them. The staff, however, did not concur, and specifically noted that Section 2(a)(3) of the Securities Act provides, in relevant part, that "[a]ny security given or delivered with, or as a bonus on account of, any purchase of securities or any other thing, shall be conclusively presumed to constitute a part of the subject of such purchase and to have been offered and sold for value."
In the Vanderkam and Simplystocks.com no-action letters, the staff first addressed Internet variations on the theme of stock giveaway promotions. In Vanderkam, a start-up company proposed to issue shares of its stock to individuals who registered on its Web site. The company would give additional shares to each registrant who referred others to the site. In Simplystocks.com, another start-up company proposed to issue shares to winners drawn at random from a pool of visitors who registered on its Web site. The company planned to cap its promotion at 10% of its equity.
The staff's responses in these two no-action letters were substantively identical. In both letters, it concluded that "the issuance of securities in consideration of a person's registration on or visit to an issuer's [I]nternet site would be an event of sale within the meaning of section 2(a)(3) of the Securities Act of 1933." Therefore, the stock offerings would trigger the Securities Act's registration provisions unless an exemption was available.
In the Jones and Rutten no-action letter, the proposed giveaway would not have required a visit to the issuer's Web site. The promoters proposed to form a company and offer shares of its stock to individuals who registered for the offering by submitting personal identifying information to the company either on its Web site or by U.S. mail. Registrants also could earn additional shares by referring others to the giveaway. The no-action request reasoned, in essence, that the company would not receive any consideration or value in connection with the information supplied by registrants because the information would "not be sold, given away, or used for any purpose other than sending notices of annual shareholder meetings, making distributions, etc." The staff, however, maintained that "the issuance of securities in consideration of a person's registration with the issuer, whether or not through the issuer's Internet site, would be an event of sale within the meaning of section 2(a)(3) of the Securities Act of 1933."
Through these four no-action letters, the staff sent a clear message that it would not permit free stock promotions of the type contemplated. In particular, the Vanderkam, Simplystocks.com and Jones and Rutten letters should have closed the door on stock giveaways by small Internet companies. For many of these companies, however, this apparently was a case of message sent, but not received. During the ensuing months a number of companies continued to promote stock giveaways over the Internet without registering their offerings or establishing an exemption. Responding to "a wave of so-called 'free stock' offerings made through the Internet and a resulting flood of investor complaints," the SEC recently took action.
On July 21, 1999, the SEC brought and settled four enforcement proceedings against a number of individuals and companies that offered and distributed free stock over the Internet. The SEC found, among other things, that each stock giveaway violated the registration provisions of the Securities Act. The issuers offered and sold securities for value without registering the offerings or establishing an exemption from registration. Each respondent settled with the SEC and agreed to cease and desist from future violations of the registration provisions of the Securities Act. Commenting on the four enforcement actions, Richard H. Walker, Director of the SEC's Division of Enforcement, said, "[f]ree stock is really a misnomer in these cases. While cash did not change hands, the companies that issued the stock received valuable benefits. Under these circumstances, the securities laws entitle investors to full and fair disclosure, which they did not receive. . . ."
The relevant facts involved in each of the four enforcement actions were substantially similar. In general, investors could register for free shares of stock by visiting the issuer's Web site and completing a registration form. Registrants also could earn additional shares by referring others to the giveaway.
Crucial to the SEC's findings was its determination that actual monetary consideration was not necessary for the offerings to be for value. According to the SEC, an issuer's benefits from a free stock offering can include increased business, publicity and Web site traffic, as well as spawning a public market or generating interest in a future public offering. Interestingly, according to the SEC, one of the giveaway programs even explained that "[w]hen you tell others about the site, you create value for the company. That is exactly why we are offering the shares as a gift."
The message from these no-action letters and enforcement proceedings is straight forward - a stock giveaway can trigger the Securities Act's registration provisions even though it may appear that no value is received for the shares. The SEC and its staff have become increasingly sensitive to what constitutes value. The term has now been clearly expanded to include increased business, publicity and Web site traffic.
The SEC's pronouncements have had a chilling effect on unregistered, non-exempt stock giveaways. Many companies have ended their giveaways; some have filed registration statements covering the offerings, or proceeded on the basis of an applicable exemption. It remains to be seen whether those companies that continue to offer stock giveaway programs in violation of the Securities Act will get the message, slip through the cracks or be the subject of the next SEC enforcement action.
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