INTRODUCTION

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

CHAPTER 1

INTRODUCTION

The Internet has created new paradigms for commerce, and so new problems for a legal system which grew out of older paradigms. [1]

Background

1.1 In securities markets, an electronic future is taking shape with growing urgency. In September 1990, the Australian Stock Exchange (ASX) completed the replacement of its state-based trading floors with a national, computer-based, automated share-trading system known as SEATS. Simultaneously, it began a program to replace its essentially paper-based share transfer and settlement system. This program culminated, in September 1994, in the operation of the Clearing House Electronic Sub-register System (or CHESS), which enables securities to be transferred electronically, and automatically updates company share registers.

1.2 In March 1994, Unipalm, a small British software firm, became the first British company to make its prospectus available electronically over the Internet. [2] In February 1995, Spring Street Brewing Co, a small Minnesota brewer, became the first company to offer its shares to investors solely over the Internet, raising approximately $1.6m in the process. [3]

1.3 In September 1995, the Securities and Exchange Commission of the United States (SEC) opened an Internet site. This makes corporate financial information available in electronic form directly from the SEC database, as well as brochures, publications, speeches and other information on the SEC and its operations. [4]

1.4 In late 1995, the Australian Securities Commission (ASC) established its Electronic Commerce Project and, in March 1996, opened its own Internet site. In May 1996, as part of the Project, the ASC set out some draft principles which it would apply when using its discretionary powers in the area of electronic communications. In particular, the ASC outlined measures to facilitate the use of electronic prospectuses on a case-by-case basis. [5]

1.5 In July 1996, the stockbroker Hartley Poynton Ltd became the first Australian company to take advantage of the new ASC policy and publish its prospectus on the Internet. The use of electronic communications apparently reduced the time between the registration of the prospectus by the ASC, and its printing and distribution to investors, from 2 weeks to 1 hour. [6]

1.6 In June 1996, the SEC permitted Real Goods Trading Corporation, a company listed on the Pacific Stock Exchange, to establish a passive "bulletin board" providing information to prospective buyers and sellers of its shares. The SEC did not require the registration of such offers or sales because the "bulletin board" was seen simply as a listing service, with transactions taking place only by direct contact between participants, independently of the company. [7]

1.7 In July 1996, the SEC permitted IPONET, a securities dealer, to make "generic solicitations for accredited or sophisticated investors" who were interested in private placements of shares. Investors who met certain minimum qualification requirements were given access to a password-protected page on the IPONET Internet site. This enabled them to view various offer documents and make investments as a result. [8]

1.8 In September 1996, the ASC announced that, from 1 October, it would enable all companies and other issuers to make their prospectuses available electronically, where:

1.9 By January 1997, one fifth of Australia's stockbroking houses - predominantly smaller or regional brokers - had an electronic 'presence' on the Internet, as did the ASC, the ASX and the Sydney Futures Exchange. Some brokers offered their clients access to share-price quotes and share-trading by electronic mail.

1.10 Approximately 100 listed companies also had sites. [10] Some companies placed financial reports and Stock Exchange announcements on the Internet at the moment of their release. Some mining companies made available regular - sometimes daily - drilling reports. [11] Some bank sites were capable of receiving loan and credit applications; others enabled customers to check account balances, pay certain bills, and transfer money between accounts. [12]

1.11 In February 1997, the ASC hosted Regulating the Marketspace - an international conference on developments in electronic commerce. In addressing the conference, the Chief Executive of the ASX, Mr Richard Humphry, saw the continuing globalisation of securities markets as the culmination of the first stage of an electronic commerce revolution:

1.12 Also addressing the conference, the ASC Chairman, Mr Alan Cameron, observed that the challenge faced by his organisation in this area was:

1.13 In March 1997, the Treasurer announced a Corporate Law Economic Reform Program, specifically referring to the "huge questions" raised by growth in electronic commerce. [15] The Chief Executive of the ASX foreshadowed the development of a system, using the existing ASX Internet site, to match investors with small companies seeking capital. [16] In America, the SEC gave in-principle approval to a proposal from the business group Private Financial Network for the transmission over the Internet of 'roadshows' for public offerings of securities. [17]

1.14 In April 1997, the Federal Government permitted Austock Brokers to begin operating an exempt electronic market in certain specified securities outside ASX regulation. Media reports concluded that such a market might provide an alternative for other companies not wishing to join the official list immediately. [18]

 

Purpose of this Paper

1.15 It is trite, now, to observe that we live in an increasingly global electronic market. Nonetheless, it is self-evidently true, and the ramifications of this trend are rapidly becoming more apparent. While these ramifications remain essentially speculative, they are potentially so extensive and so pervasive that it has become important to anticipate and begin planning for them.

1.16 The purpose of this Paper, therefore, is to discuss some of the implications of the emerging global electronic market, particularly the implications for the regulation of corporations and securities markets in Australia. This Paper seeks to lay the foundations for an inquiry the Committee proposes to undertake in this area. The terms or reference for this inquiry are set out at page v of this Paper, and the Committee welcomes views on those terms of reference.

1.17 While aware that innovation has brought about significant change and convergence in many products traded in financial markets, the Committee has, at this time, chosen to concentrate on the Corporations Law and on equity-related securities. Such an approach enables the Committee to focus on specific issues within its area of expertise, avoiding duplication of the more general work already undertaken by others such as the Wallis Financial System Inquiry. Also, equity-related securities ultimately represent a share in a 'fundamental' or 'real' asset upon which many other financial products are based. And, perhaps most importantly, unlike many other financial products, equities continue to be traded in markets in which a significant number of individual investors - of varying degrees of sophistication - participate. [19] Arguably, a discussion of possible regulatory approaches has the greatest relevance in such markets.

1.18 It should be noted that this Paper is an Issues Paper, prepared from a selection of public, news and other sources. In general terms, it seeks to raise issues, stimulate debate, and canvass some possible regulatory approaches for further consideration. It does not claim to be exhaustive, nor does it represent the concluded views of the Committee.

 

Matters outside the scope of this Paper

Electronic commerce and taxation

1.19 A number of matters related to electronic commerce are outside the scope of this Paper. In particular, it does not examine the implications of electronic commerce for taxation or money-laundering, nor the consequences of developing secure forms of electronic cash. The implications of electronic commerce for the taxation system are currently being considered by, among others, the Australian Tax Office (ATO) [20] and the Joint Committee of Public Accounts. [21] The ATO is apparently seeking technical assistance from the CSIRO to help it prepare a list of possible threats to the tax system, and plans to seek international agreement on how to tax emerging forms of electronic commerce. [22] In his most recent Annual Report, the Commissioner of Taxation observed that:

Electronic commerce, electronic cash and money-laundering

1.20 The implications of electronic commerce for money-laundering and for law enforcement generally are being considered by, among others, the Parliamentary Joint Committee on the National Crime Authority, and the Electronic Commerce Task Force established by the Commonwealth Law Enforcement Board and chaired by the Director of the Australian Transaction Reports and Analysis Centre. Among other things, this Task Force recently reported in detail on the law enforcement implications of various new payment mechanisms (including mechanisms designed to facilitate financial payments and money transfers over the Internet or by the use of smart card technology). [24]

1.21 Similarly, this Paper does not canvass technical or consumer issues related to the purchase or sale of goods and services generally by electronic means. Electronic capital raising and share-trading is obviously facilitated by, but does not depend on, the development of electronic payment methods.

1.22 There are clearly dangers in a multiplicity of groups separately canvassing the implications of electronic commerce in discrete areas. In principle, the Committee sees much force in the observation of the Steering Group of the Electronic Commerce Task Force that:

1.23 However, such a "whole-of-government approach" should be adopted with an awareness of particular problems, and consideration of particular solutions. Of course, particular issues may ultimately prove to be of more general relevance.

 

Structure of this Paper

1.24 The remainder of this Chapter outlines some aspects of developing technology - including the Internet - and their likely effects on corporations and securities markets. Chapter 2 outlines some of the issues raised by these developments. Chapter 3 canvasses the feasibility of some possible regulatory approaches.

 

Technological developments

The Internet

1.25 It has been suggested that the main technological development urging change on corporations and in securities markets is the emergence of networks and associated information technologies. [26] The emergence of such networks, in turn, depends on the continuing development of low cost, reliable, high-capacity communications infrastructure:

1.26 As indicated above, the technological development most often mentioned in the context of electronic commerce is the Internet. Put simply, the Internet is a world-wide network of computer networks used for the carriage and communication of information. That information may be stored on any computer connected to the network and, in theory, is accessible to any other computer connected to the network. The Internet has no real central structure, although there are several groups which provide guidance in formulating operating protocols. [28]

1.27 As a network, the Internet has no single, physical or fixed location. For this reason, the 'place' in which Internet transactions occur is often termed 'cyberspace'. Most notably, the fact that transactions may be conducted across, or outside, national boundaries, and may involve locations different from those assumed by the participants, may lead to a series of jurisdictional problems (which principally involve identifying the law which is to apply to the transaction). The ready accessibility of the network also leads to problems centring on the verifiability and security of transactions, though a number of organisations are said to be working to overcome these problems. [29]

1.28 The term "Internet" is used in popular parlance to refer to a range of information services accessible over the network. These include Web sites (or home pages), electronic mail, newsgroups and "chat rooms".

1.29 An Internet home page is essentially an electronic location or address at which someone makes information available, often with linkages to other sources of information. Some sites are passive, simply providing information; others are interactive (permitting users to communicate with the information provider, or to undertake transactions such as ordering products, transferring money or completing forms).

1.30 As indicated by its name, electronic mail is direct correspondence between users undertaken electronically. An Internet newsgroup is essentially an electronic "bulletin board" on which any user may "post" an opinion and/or comment on opinions expressed by others. A "chat room" enables those electronically "in the room" to "converse" with each other simultaneously by typing messages. There is nothing rigid in these classifications, and various forms of electronic communication often shade into each other.

1.31 Of course, the Internet is simply one means by which electronic commerce may be conducted. Others - including Electronic Data Interchange, ATM terminals, EFTPOS retail transactions, and banking by telephone - are familiar to many, and commonly used. Foreign exchange markets have for a considerable time been conducted globally and electronically. Information has, again for a considerable time, been made available electronically through subscription-based computer networks such as Compuserve or America OnLine (which also enable their subscribers to access the Internet). However, it is the breadth and openness of the Internet (and of its most vital branch - the World Wide Web) that has captured most attention, and which is discussed by way of example in this Paper.

Significance of transactions on the Internet

1.32 Estimates of the significance (and potential significance) of Internet-based transactions vary widely. It has been suggested that there may be some 40 million Internet users worldwide, although no census has ever been taken and this estimate may be inaccurate by tens of millions. [30] Telstra has estimated that, by mid 1998, Internet traffic across the Pacific to North America will exceed telephony traffic. [31] However, in order to connect a home computer to the Internet, a device called a modem is necessary. It has been pointed out that, while 47% of Australian households own personal computers, only 15% have a modem. [32]

1.33 With specific reference to electronic banking, a survey by the Roy Morgan Research Centre indicated that, over a four week survey period, approximately 9% of Australians aged 14 or more (about 1.34 million people) conducted banking by telephone, whereas only 0.6% (or fewer than 100,000 people) linked with a financial institution through a personal computer. [33]

1.34 Another survey of the wider financial services industry, compiled by IBM, predicted a 300% increase in the use of telephone and computer-based services over the next five years. [34] A Business Review Weekly survey of the Chief Executive Officers of major Australian corporations indicated that 100% of those surveyed in the finance sector believed the Internet would play a role in their business by the year 2000. [35]

1.35 In reality, estimates of the potential significance of the Internet remain little more than conjecture. Some see the trend to electronic commerce bringing about significant, almost apocalyptic, change in the immediate future. For example, one commentator observed that:

1.36 Others are somewhat more sceptical, noting, for example, that, just as the Campbell Inquiry was told in 1981 that telephone banking would be common as early as 1985, it will inevitably take much longer for the "brave new world described by so many techno-visionaries" to arrive. [37]

1.37 The Wallis Committee Report summarised the situation in the following terms:

1.38 On this issue, the Committee sees considerable force in the observations of Mr Richard Humphry, the Chief Executive of the ASX: irrespective of whether or not a significant global securities market ever develops on the Internet, those who dismiss the possibility run a large risk of looking foolish, and the very possibility itself provides what might be seen as the ultimate destination of existing trends, and makes us consider what responses should be planned. [39]

Potential effect of the Internet on corporations and securities markets

1.39 Electronic commerce, including the Internet, may affect corporations and securities markets in various ways. These are canvassed more specifically in Chapter 2 of this Paper. In broad terms, the Internet is most likely to be used to convey information and to undertake transactions. It is used by corporations, regulatory authorities, investment advisers and investors to provide and receive information about corporations and securities. As noted above, it is now also used by corporations and others seeking to raise capital through the issue of securities, and by investors seeking to buy, sell or subscribe for securities.

1.40 The potential effects of electronic commerce have been canvassed in general terms by a number of commentators. For example, in March 1994, Mr Charles Sandford, as Chairman of Bankers Trust, elaborated a vision for the year 2020 that included:

1.41 Similarly, in releasing its Electronic Commerce Project documents in May 1996, the ASC predicted that growing technology and globalisation would "drive structural change in Australia's capital markets", and that developments in electronic commerce would fundamentally affect the financial services industry, resulting in:

1.42 The ASC also saw electronic communications between issuers and investors as promising to reduce costs - thereby increasing the efficiency and competitiveness of Australian securities markets - and as enhancing the quality of information available and its timeliness. [42]

1.43 In the United States, the Chairman of the Securities and Exchange Commission saw the new technology facilitating disclosure that was quicker, more direct, more accessible and more useful to investors. [43]

1.44 Others envisage it leading to a 'real' world that more closely approximates the textbook models of neoclassical economics - a world in which:

Electronic commerce and the conclusions of the Wallis Committee

1.45 The Financial System Inquiry established by the Treasurer in June 1996 and chaired by Mr Stan Wallis (the Wallis Committee) was, amongst other things, specifically asked to analyse the forces (particularly technological development) driving further change in the Australian Financial System. In March 1997, that Committee issued its report which contained a number of findings and recommendations. Among other things, the Committee found that:

1.46 With regard to globalisation, the Committee found that Australian financial markets were already closely linked to global markets, and participants at the wholesale level regularly accessed international products. The Committee also found that:

1.47 A key Committee recommendation was that a single agency, the Corporations and Financial Services Commission (CFSC), should be established to provide Commonwealth regulation of corporations, financial market integrity and consumer protection. It should have power to use a combination of regulatory approaches. [47]

1.48 In the broad area of global electronic commerce, the Committee's recommendations included:

1.49 The Wallis Committee concluded that impending changes in the financial landscape "are unlikely to be so revolutionary as to demand a complete overhaul of every element of the regulatory framework," but they will demand a greater emphasis in regulation on competitiveness, efficiency and flexibility. [49] The Committee notes these observations. Many elements of the current regulatory framework will remain broadly applicable in the new electronic environment, and many new problems will be variations on familiar old problems. For example, misleading information may be included in an electronic prospectus as readily as it may be included in a conventional paper prospectus. However, not all new problems will be easily susceptible to old solutions, and it is these potential discontinuities that are canvassed in greater detail in Chapter 2 of this Paper.  

 

Footnotes

[1] Julian Burnside QC, 'Virtual liability', Computers and Law, No 29 (June 1996), p 14.

[2] 'Bankers Trust's 2020 vision' The Economist, 26 March 1994, p 85. A prospectus is a document issued by a company seeking to raise money from the public through the issue of shares or other securities. The Internet is discussed further in para 1.25.

[3] 'Raising capital in cyberspace', Australian Financial Review Weekend Review, 7 February 1997, p 4.

[4] Securities and Exchange Commission, Media Release 95-190, obtainable on the Internet at http://www.sec.gov/news/press/press192.txt

[5] Australian Securities Commission, Media Release ASC 96/74 (6 May 1996), reproduced in ASC Digest, p MR 120.

[6] Martin Roth, The Internet for Investors, Wrightbooks, Victoria (1996) p 15.

[7] R Clarke Hooper, 'US Securities Markets: Dealing with Regulatory Issues', a paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, Sydney, 4-5 February 1997, pp 2-3. In August, permission was similarly extended to PerfectData Corporation, a NASDAQ-listed company.

[8] ibid.

[9] Australian Securities Commission, Class Orders, CO 96/1578.

[10] 'Brokers face up to the virtues of virtual trading' Sydney Morning Herald, 11 January 1997, p 74.

[11] Martin Roth, The Internet for Investors, Wrightbooks, Victoria (1996) p viii.

[12] See, generally, 'Brokers face up to the virtues of virtual trading', Sydney Morning Herald, 11 January 1997 p 74; 'Net loans in', Business Review Weekly, 20 January 1997 p 10; and Martin Roth, The Internet for Investors, Wrightbooks, Victoria (1996) p 73.

[13] Richard Humphry, 'Impact of Electronic Commerce: The Market's Perspective', a paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, (Sydney) 4-5 February 1997, p 2

[14] Alan Cameron, 'The ASC's Experience', a paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, (Sydney) 4-5 February 1997, p 2.

[15] 'The Words' Australian Financial Review, 4 March 1997, p 14.

[16] 'The ASX is talking Net worth' Australian Financial Review, 21 March 1997, p 77.

[17] Roadshows are wide-ranging (usually confidential) opportunities to "explain" initial public offerings of securities to major investors: 'SEC Gives Okay, But Don't Look for Roadshows Any Time Soon', Barrons, 24 March 1997, p 12.

[18] 'New market outside ASX may provide share nursery', Australian Financial Review 15 April 1997, p 23.

[19] A 1997 survey undertaken by the ASX showed that approximately 34% of adult Australians owned shares either directly or indirectly through various investment funds: see 'Women raise stakes in booming $620bn sharemarket game', The Australian, 20 June 1997, p 1.

[20] See, for example, Michael Carmody, International Business Taxation - An Administrator's Perspective: "A Brave New World, Opening Address at the APEC-OECD Joint Symposium on International Business Taxation (30 October 1996).

[21] Joint Committee of Public Accounts, 'Public Accounts Committee Inquiry into Internet Commerce and the Tax System', Media Release, 10 June 1997.

[22] 'Tax Office gears up to fight cyberspace evaders', Australian Financial Review, 21 April 1997, p 27.

[23] Commissioner of Taxation, Annual Report 1995-96 (Canberra) p 34.

[24] Steering Group of the Electronic Commerce Task Force, Report of the Electronic Commerce Task Force to the Commonwealth Law Enforcement Board (November 1996).

[25] Steering Group of the Electronic Commerce Task Force, Report of the Electronic Commerce Task Force to the Commonwealth Law Enforcement Board (November 1996), p iii.

[26] Financial System Inquiry, Final Report, AGPS, Canberra (1997), p 96 (hereafter Wallis Committee Report).

[27] Wallis Committee Report, p 96.

[28] Martin Roth, The Internet for Investors, Wrightbooks, Victoria (1996) p 150.

[29] See, for example, 'Net card to go on trial here this year', The Australian, 23 April 1997, p 24.

[30] Martin Roth, The Internet for Investors, Wrightbooks, Victoria (1996) p 149.

[31] 'The Internet: why Australia can't wait', Business Review Weekly, 24 February 1997, p 38.

[32] Wallis Committee Report, p 102.

[33] 'Betting the bank on an electronic future', Business Review Weekly, 24 February 1997, p 48.

[34] 'Internet will reshape role of industry', The Australian, 23 April 1997, p 24.

[35] 'A tangle of views on the Internet, IT and low-cost competition', Business Review Weekly, 14 April 1997, p 56.

[36] 'The Internet: why Australia can't wait', Business Review Weekly, 24 February 1997, p 36.

[37] Ross Gittins, 'Will Electronic Commerce Drive Structural Change in the Financial Services Industry and Enhance Competitiveness of the Australian Capital Markets?, a Paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, Sydney, 4-5 February 1997, p 1

[38] Wallis Committee Report, p 103.

[39] Richard Humphry, 'Impact of Electronic Commerce: The Market's Perspective', a Paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, Sydney, 4-5 February 1997, p 1.

[40] 'Bankers Trust's 2020 vision', The Economist, 26 March 1994, p 85.

[41] Australian Securities Commission, Media Release 96/74, ASC Digest, p MR 119.

[42] Australian Securities Commission, Concept Paper; Draft Statement of Principles: Electronic Communications Between Issuers and Investors Under the Corporations Law, 6 May 1996, p 1.

[43] Arthur Levitt, 'Investor Education: Disclosure for 1990s', Remarks at the University of Virginia, Charlottesville, 1 November 1995.

[44] Ross Gittins, 'Will Electronic Commerce Drive Structural Change in the Financial Services Industry and Enhance Competitiveness of the Australian Capital Markets?, a paper delivered at Regulating the Marketspace, ASC Electronic Commerce Conference, Sydney, 4-5 February 1997, pp 10-11.

[45] Wallis Committee Report, pp 93-94.

[46] Wallis Committee Report, pp 152-53.

[47] Wallis Committee Report, p 260.

[48] Wallis Committee Report, recommendations 12, 28, 29, 91, 92 and 93.

[49] Wallis Committee Report, p 169.