West Orange, New Jersey


© 1996 A. Jared Silverman. All rights reserved.


In Being Digital, Nicholas Negroponte, Founding Director of the MIT Media Lab, posits that world trade is changing from exchanging atoms, i.e. things physical, to exchanging bits, i.e. electronic information. He believes that this change is irrevocable and happening at an exponential rate. He points to the movement away from the dissemination of information in atom form, "ink squeezed onto dead trees" or publications, toward its dissemination in bit or electronic form such as multimedia and the Internet. Negroponte notes the globalization of the digital world and cites the financial community as one of two communities that are leading the world in their global and on-line nature.

The SEC’s Electronic Document Delivery Guidelines

Although postdating Negroponte’s book (Negroponte, himself, notes the irony), in October 1995 the Securities and Exchange Commission (SEC) provided an example of how the financ ial community is taking a leadership role in the digital world by publishing an interpretative release on the use of electronic media for the dissemination of information to investors and financial markets pursuant to the federal securities laws (Release No. 33-7233, et al.).

The term "electronic media" as used by the SEC in its guidelines is broad and specifically includes audiotapes, videotapes, facsimiles, CD-ROM, electronic mail, bulletin boards, Internet Web sites and computer networks.

Documents covered by the guidelines are divided into two categories, (1) those which are included in the term "document" as used in the guidelines, and (2) those which may be included. The reason for the distinction is not given. Those documents which are covered include annual reports to securities holders and proxy or information statements required to be furnished pursuant to Section 14 of the Securities Exchange Act of 1934 (the Exchange Act). The qualified category includes annual reports on Form 10K and other reports required to be furnished on request to a security holder.

The SEC guidelines are based on the premise that electronic information delivery should approximate information delivery on paper. Thus, when looking at whether electronic delivery meets the legal requirements pertaining to delivery of documents, the SEC considers two factors, notice and access.

Electronic communications should provide timely and adequate notice to investors. Electronically delivered documents should be prepared, updated and delivered consistent with the provisions of the federal securities laws in the same manner as paper documents.

An electronic document, such as e-mail, should be self-contained. If the document is on a Web site, separate notice of the existence of the document at the site would be necessary unless the issuer can otherwise evidence that delivery to the investor has been satisfied or the document is not required to be delivered under the federal securities laws.

The guidelines also state that recipients who are provided information electronically should have access comparable to that provided by postal mail. Therefore the use of electronic media should not be so burdensome that the intended recipients cannot access the information. If disclosure is made on the Internet or similar means, the document should be accessible as long as the delivery requirement applies.

Finally, issuers and others using electronic delivery must have reasonable assurances that the delivery requirements have been met. Procedures involving this assurance might include: (1) obtaining the informed consent of an investor to receive the information through a particular electronic medium while assuring the access and notice requirements are met; (2) obtaining confirmation that the investor actually received the information by return receipt or other form of confirmation; (3) disseminating information by facsimile; (4) an investor obtaining the document through a hyperlink; and (5) using forms and other materials available only by accessing the document.

No state securities administration has issued guidelines similar to those of the SEC. Therefore, the SEC guidelines may have marginal benefit unless they are recognized by state securities regulators.

Proxy Delivery - The Easy Part?

The interpretive release gives a number of examples, Examples 23-26, 28, which address proxy delivery by companies. In reviewing them, keep in mind the factors that the SEC deems important in electronic delivery: (1) timely and adequate notice similar to that provide by paper; (2) the electronic document should be self-contained; (3) access should be comparable to postal (snail) mail; (4) use of the electronic medium should not be burdensome; (5) the electronic document should be updated similar to its paper counterpart; and (6) there should be reasonable assurance that delivery requirements have been met.

In Example 23, the Company places its annual report and proxy soliciting materials on its Web site and sends notice to all record holders of availability at the site location. This would not constitute delivery to all record holders because the Company cannot assume that all record holders have Internet access. Thus, in absence of factors such as written consent, this would be insufficient to constitute delivery to record holders and the company would have to furnish paper copies of the materials to record holders.

In Example 24, the Company places all its materials on its Web site. An Investor expressly consents to delivery of all documents through the Web site. The Company places its proxy soliciting materials on its Web site and advertises their availability in the Wall Street Journal. The advertisement coupled with the consent is insufficient to assume delivery of the proxy statement to the Investor. It can not be assumed that publication in a paper or an electronic bulletin board is sufficient notice to the Investor. The Company must be able to show either direct delivery of the materials or of the notice of their availability on the Net.

In Example 25, in September the Investor consents to delivery of all future corporate communications, including proxy statements and annual reports, through the Company’s Web site. The consent form states that the annual report and proxy statement will be available about April 1 the following year. On that date the promised materials are placed on the Company’s Web site. Ordinarily this would be insufficient notice because it does not approximate notice by mail where the materials are received in close proximity to the time shareholder action is required. However, this could be considered effective notice if the Company has specific reasons to reasonably expect that this would be effective delivery to the Investor.

In Example 26, the Investor has consented to delivery to all documents via the Company’s Web site. On April 1, the Company gives notice to the Investor that its annual report and proxy materials are on its Web site. Four days later, the Investor requests paper copies from the Company because of a broken computer. The Company should provide paper copies because electronic delivery would be ineffective. The consent to electronic delivery need not be withdrawn.

In Example 28, The Company places its annual report and proxy materials on its Web site and provides notice to all record holders that previously consented to electronic delivery via the Web site. Record holders are instructed to print the proxy card and then mail it back to the Company. This procedure is consistent with the proxy rules.

The paper equivalency requirement poses some interesting problems for electronic delivery -- typeface requirements and the proxy card itself. The proxy rules (e.g., Exchange Act Rules 14b-3 - 14b-5) have various requirements for type size, font, legibility, ink color and bolding. This can be a problem when applied to electronic delivery.

In an accompanying release to its electronic delivery guidelines, the SEC proposed technical amendments to certain of its rules to accommodate electronic delivery of information (Release No. 33-7234, et al.). Formatting and the handling of graphic material were among the problems addressed. As to formatting, the SEC proposed that in the electronic version of the document, the issuer may comply with the rules by presenting the information in a format readily communicated to investors. Highlighted material, e.g. red ink or bold print, in electronic documents may be presented in any manner reasonably calculated to draw attention to it.

Additionally, recognizing that not all media can accommodate graphics, the SEC declared that all versions of a document should convey substantially equivalent information to investors. Thus, where one version of the document contains graphics, other versions should include a fair and accurate description or transcript of the omitted information. This can pose problems where companies want to use the multimedia capabilities of the World Wide Web (WWW).

The presentation of the document to the investor can vary with the protocols used by the Company to place the document on its Web site or on a server and with the Internet navigational software used by the investor. For example, a file transfer protocol (ftp) document retrieved from a server will look differently from a hypertext WWW file created in hypertext markup language (html) and accessed via the hypertext transfer protocol (http). One difference is html’s ability to handle graphics. Whether an investor who receives an html document will actually see the graphics depends on whether the user has disabled the images feature in the Internet navigational software used to access the Web. (A person who has disabled image downloading from a Web site in order to increase the speed of downloading will not be able to see the graphics in the document and must enable the feature and reaccess the document in order to view the graphics.).

Meanwhile, on the Shareholder’s Side

Presumably, your company has the resources to it create and maintain a Web site and place documents covered by the SEC’s guidelines on the site. Your shareholder will need a computer, a modem, a communications line, an Internet access or service provider (ISP), Internet navigational software and a printer to access your site and to retrieve documents in the form specified by the guidelines in a convenient manner.

However, convenience is a subjective measure. Annual reports and proxy materials can be large files, in the order of hundreds of kilobytes. On-line review of such documents, even with the ability to navigate them through hypertext, is unlikely. It is more likely that such documents will be downloaded for later off-line review and/or printing. Thus, speed and convenience of downloading is important.

The speed of the download will depend on the processing speed of the shareholder’s computer; the amount of available memory in the computer; whether memory is cached; the speed of the modem or equivalent device; and the type of communication line used (telephone line, integrated services digital network (ISDN), T1, etc.) to connect to the ISP

Importantly, ease of access and speed of downloading will depend on the proper configuration by the company of its Web site. The company will have to anticipate what speeds will be used to access the site, average connect time, the number of access attempts that will be made in a given time period (what will be the busy hour?), and the number of users who will be able to access the site during the busy hour. The equivalent of busy signals, excessive holding and connect times, and dropped connections with lead to shareholder dissatisfaction and complaints about whether electronic delivery is equivalent to paper delivery.

The On-line Proxy - The Next Step?

Although the SEC has made proposals about electronic document delivery to the shareholder, it has been silent about electronic document delivery from the shareholder to the company. In Example 28, the Company’s annual report and proxy materials are on its Web site and record holders are instructed to print the proxy card and then mail it back to the Company. Why?

Rule 14a-4 sets forth the requirements for the proxy. Like other rules governing proxy solicitation, it contains formatting requirements. The technical revisions proposed by the SEC did not include revisions to Rule 14a-4. (Revisions to Rule 14a-3, governing information to be furnished to security holders, and to Rule 14a-5, governing presentation of information in a proxy statement, were proposed.) Since the printed version of the proxy, at best, could only duplicate what the shareholder sees on the monitor, this implies that the proxy printed by the record holder in Example 28 must be the exact duplicate of the printed proxy. This may be difficult due to different software packages and printer capabilities. While the SEC guidelines state the procedure is consistent with the proxy rules, there is a open question of whether the proxy printed and mailed would be acceptable if not in Rule 14a-4 format.

Not only do the federal securities laws apply to proxies but state law applies as well. By way of contrast to the federal proxy rules, Delaware Corporation Law does not prescribe a particular form of proxy. However, there is case law on the use of a form of electronic proxy, the "datagram."

In 1989, the Delaware Court of Chancery considered the validity of the datagram proxy, a procedure which a record shareholder, using a toll-free number, communicates his vote in telegraphic form. The court stated that a proxy’s genuineness and authenticity are presumptively established by the presence of a signature or signature equivalent, such as a signature stamp, on the proxy. The court found that the datagram was not presumptively valid because there was no mark evidencing, in some verifiable way, that the proxy originated with the record stockholder. A year later, in 1990, the Delaware proxy statute was amended to permit a shareholder to authorize a proxy by telegram, cablegram or other means of electronic transmission. Presumably this would include a proxy transmission by e-mail. Despite the amended statute, in 1991 the Chancery Court held that a signature or other indication of authenticity is still required for a valid proxy.

A Schema for Electronic Proxies (Atoms to Bits)

A model for electronic proxies where both the proxy materials delivered to, and the proxy sent from, the record shareholder must encompass a number of factors: (1) there must be consent to delivery of documents by electronic means; (2) the delivered documents must be the substantial equivalent of the paper documents; (3) such documents must be delivered to the designated recipient in a timely fashion; (4) they must be delivered to the correct person; (5) the proxy must have the equivalent of a verifiable signature; (6) the integrity of the proxy must be preserved from the time it is sent by the shareholder, i.e. it must be free of alteration; and (7) the proxies must be held in a secure facility. The second and third factors have been discussed earlier. The last factor, security, has been discussed extensively in the literature and will not be discussed here.

The SEC guidelines strongly suggest that the investor consent (preferably in writing) to delivery of documents by electronic means. Therefore, a special database of consenting record shareholders must be established. To do this, notice of the availability of an electronic delivery alternative should be given to all record holders. Remember, in Example 24, publication of in a paper or on an electronic bulletin board is insufficient notice. A signed consent form from the shareholder would be the best evidence of consent. Consent could be given on-line if there were assurances of the validity of the consent such as a digital signature (discussed below).

Once the database is established, it must be maintained. Provisions for updating the database could include removal of persons who are no longer record holders and those which have not accessed any electronic documents within a specified period of time. The latter is important because it is an indicator of lack of delivery. Additionally, notices to an investor who accepts electronic delivery should be sent by "registered" e-mail to ensure that the investor’s e-mail address is current and that delivery has been made to the address designated by the investor.

As with other forms of electronic commerce, you want to know the true identity of the other party to the transaction. Thus, the company, when it receives the initial consent to deliver documents electronically, have some method of verify the validity of the consent. The method of verification probably need be no different than that method the company currently uses to verify similar types of transactions with the shareholder, e.g. a signature. And obviously, as the Delaware cases illustrate, some form of verification and authentication is necessary for a valid proxy. Therefore, some methodology would need to be developed to identify the shareholder to the company.

Various forms of digital identification are available for such a purpose. Personal identification numbers, or PINs, or some other password specified by the customer are common, but they are subject to compromise and hacking. People dealing with electronic commerce and electronic document interexchange, or EDIł have been concerned with similar issues: confidentiality - no one but the sender and the designated receivers have access to the message; authentication - assurance of the actual identity of the sender of the message; message integrity - the message was not modified, intentionally or unintentionally, between the time of sending and the time of receipt; non-repudiation - the sender cannot deny the message was sent and the receiver cannot deny that the message was received; and time-date stamping - when was the message created, sent and/or received.

Public key encryption is a methodology which addresses many of these problems. Each user creates two mathematically linked "keys." One key is private and kept secret; the other is publicized. One key is used for encryption and the other for decryption depending on the application.

To achieve confidentiality, the sender encrypts the message with the receiver’s public key. The receiver decrypts it with the recipient’s private key. Reversing the process creates a digital signature. The sender uses the sender’s private key to affix a digital signature. The receiver applies the sender’s public key to message, simultaneously achieving authentication of the sender and preventing non-repudiation. The receiver can verify message integrity by using a "hash algorithm" which condenses the message into a unique "hash" in combination with digital signature techniques and comparing the transmitted hash result (the decrypted message) with the hash result that the receiver prepared from the transmitted message with the receiver’s own keys.

However, at the current stage of development, most forms of digital signature and encryption have their own problems, such as administrability, software compatibility, user interfaces and security holes..

Will Bits Replace Atoms?

Not immediately and, in the long-run, probably not entirely. While the technology to digitize the proxy process is available today, there are a number of factors which impede the wide use of an end-to-end digital process. The costs of the necessary hardware, software and communications medium are still a barrier to many. While not a significant factor for institutional and larger investors; cost may prove to a barrier for smaller investors. Similarly, technical sophistication and user-friendliness could be hurdles that many individuals may not be able or willing to overcome. This factor, as Negroponte points out, is generational and should be decreasing as people become more comfortable with computers, with digital forms of communication and as more user-friendly systems are developed. However, there always will be those who will prefer communications by atoms instead of bits. But, as a proportion of the investing population, that number should be decreasing over time. This is the time to start planning for an electronic future.


© 1996 A. Jared Silverman. All rights reserved.

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