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Consider this alarming scenari A company’s annual report, filed on EDGAR with the Securities and Exchange Commission, contains a hyperlink to a favorable analyst report. The analyst report itself includes a hyperlink to a database of industry statistics. The company finds itself liable under the federal securities laws not only for misinformation in the analyst report, but also for any material errors in the remotely linked database. Even more alarming is a scenario in which, after the company includes a link to the analyst report in its EDGAR document, the analyst subsequently amends its report to include the link to the remote database. Again, the company faces civil and antifraud liability under the federal securities laws for material errors in the remote database — although it may not even know of the indirect hyperlink. A CHAIN OF HYPERLINKS ACROSS THE INTERNET It seems improbable that remotely linked misinformation could give rise to liability. Yet according to guidance from the SEC staff, a filer who hyperlinks to a third-party Web site will be liable not only for any misinformation found on that third-party Web site, but also for any misinformation in other, more remote Web sites hyperlinked to the third-party Web site. “EDGAR Filer Information: Electronic Filing and the EDGAR System: A Regulatory Overview,” which was published on the SEC Web site in November 2000, states: Linked material is not part of the official filing for determining compliance with reporting obligations. Such material, however, is subject to the civil liability and antifraud provisions of the federal securities laws whether or not the hyperlink is permitted by the Commission’s rules. Moreover, if a company hyperlinks to a hyperlink, which, in turn, links to another hyperlink, the company will be treated as making all the hyperlinked material its own [emphasis added]. Also, if a hyperlinked document is corrected or updated by means of a new filing, the document containing the hyperlink also may have to be amended. This staff guidance, if followed by the SEC, would seem to expand the scope of liability for hyperlinked misinformation well beyond what the SEC enunciated in earlier releases. In an extreme example, one could imagine a chain of increasingly remote links crossing the vast expanses of the Internet. It is unclear when the SEC would view this potentially infinite chain of hyperlinks as sufficiently attenuated to shield the original filer from liability. WHAT ARE HYPERLINKS? On the World Wide Web, hyperlinks are like the strands of a spider’s web, enabling rapid navigation between one web site and another. A hyperlink is usually expressed as a Web site address placed within the text of an electronic document. By clicking on the address, a reader is transported to another Web site, often that of a third party. The transition may be so seamless that the viewer believes he or she is still in the original document. As investors turn increasingly to the Internet to research their investment decisions, documents electronically filed with the SEC via EDGAR become increasingly important communication tools for public companies (documents that a public company might be required to file on EDGAR include prospectuses for the sale of securities, annual and quarterly reports, and the like). And, in ensuring that these documents reflect well on the company, it is tempting to include “hyperlinks” to other places on the World Wide Web where favorable third-party information about the company can be found — analyst reports or news articles, for example. An EDGAR document may state, “See the recent analysis of our company’s position found at www.bigbroker.com,” and a mere click of the mouse takes the visitor to the relevant spot on the analyst’s Web site. But the third-party information may be inaccurate, or it may not fairly represent the total mix of information prepared by outsiders about the company. An investor may be led to buy company stock in reliance on the misinformation, to his or her financial detriment. COMPARING THE MAY 2000 RELEASE WITH THE NOVEMBER 2000 GUIDANCE If the company itself had issued such erroneous information, it would face securities fraud liability under Rule 10b-5 of the Securities Exchange Act of 1934. In its interpretive release “Use of Electronic Media” (May 4, 2000), the SEC made it clear that issuers who give investors easy access to misinformation via hyperlinks may face similar liability, because they may be deemed to have “adopted” or “ratified” the misinformation. In other words, the affirmative act of creating the hyperlink to another party’s information is equivalent to adoption or ratification of the other party’s information. Particularly in the case of documents required to be filed with the SEC, the May 2000 release emphasized that filers would be presumed to have adopted any third-party information they chose to hyperlink to their own filings. The November 2000 guidance is troubling, however, because it appears to go significantly beyond the May 2000 release and the key legal concepts on which that release is based. TRADITIONAL BASES FOR LIABILITY FOR THIRD-PARTY MISINFORMATION There is a formidable body of law that has evolved over several decades on the question of when an issuer may be held responsible under the federal securities laws for erroneous information disseminated by third parties. There are four ways liability may arise — if an issuer of securities: � Has been so involved in the third party’s preparation of the material that it can be deemed to have helped author it (the “entanglement” theory); � Has participated with the third party in a two-way exchange of information — for example, when an analyst prepares a report, shares it with the subject company and obtains its approval (the “adoption” theory); � Has ratified the third party’s information by some post-publication affirmative act, such as distributing the information to prospective investors (the “ratification” theory); or � Has knowingly or recklessly provided false information to the third party, in essence using the third party as a tool for the dissemination of the misinformation (the “conduit” theory). As noted above, the May 2000 release makes specific reference to the adoption and ratification theories as bases for liability when an issuer chooses to include periodic disclosure documents, or a hyperlink to a third-party Web site in its offering or on its company Web site. TRACING RESPONSIBILITY FOR HYPERLINKED MISINFORMATION If we trace the body of law that gave rise to each of these theories, the ratification theory is the clearest basis of liability for hyperlinked misinformation. Creating the hyperlink to the third-party site is the affirmative, ratifying act that in effect “blesses” the third party’s information about the issuer. While there may be times when an issuer’s behavior also displays the element necessary to liability under the entanglement or adoption theories — that is, prepublication involvement with the third party in crafting or approving the erroneous information — when there is a hyperlink to the misinformation, we need go no further in our analysis: The hyperlink itself indicates ratification. However, the November guidance goes significantly beyond this traditional line of analysis of responsibility. When a third party embeds a hyperlink in its Web site, it is the third party — not the original EDGAR filer — that has chosen to ratify the remote information. Where is the affirmative adopting or ratifying act with respect to all possible remote links? One could argue that the filer should have examined the third-party site carefully for remote links, prior to creating a hyperlink from the EDGAR filing to the third-party site. But as shown in the second of our two scenarios, that third party may embed the remote hyperlink in its Web site after the EDGAR filing. The EDGAR filer will have no notice of the change. There will have been no affirmative act of adoption on the part of the EDGAR filer with respect to the remotely linked information. The SEC considers the problem of investor confusion caused by hyperlinks to be serious that it would hold an original filer responsible for misinformation only remotely available to an investor through a chain of links. THIRD-PARTY MISINFORMATION While the November 2000 guidance with respect to hyperlinks may seem to come from left field, it is in fact supported by the body of law addressing a different question: When does an issuer have a duty to update or correct information that, although true when released, later becomes inaccurate? It is well established that if the information was disseminated by the issuer, and if it is material information on which an investor would likely make a decision to purchase or sell securities, then the issuer has a duty to correct or update the information when it becomes inaccurate. On the other hand, if a third party provided the information — and if the issuer neither involved itself in its preparation nor did anything to indicate adoption or ratification of the information, pre- or post-publication — then there is no duty to update or correct. As discussed above, the May 2000 release identifies an issuer’s creation of a hyperlink to third-party information as an “adopting” or “ratifying” act. Thus, if that information is accurate when provided but later becomes inaccurate, the duty to update or correct comes into play, just as if the third-party information had been published by the issuer itself. The May 2000 release does not specifically address whether hyperlinking creates a duty to update or correct third-party information. But by placing the discussion within the context of the adoption and ratification theories of liability, the SEC leaves little doubt as to the answer. The courts have found consistently that there is a duty to correct or update third-party information that an issuer adopts or ratifies as its own. Returning to our second, and more alarming, scenario, let us say that an EDGAR filer creates a hyperlink from its annual report to an analyst report. At the time of the EDGAR filing, the filer checks the hyperlinked information with care. From the issuer’s perspective, it is accurate, and it contains no hyperlinks to remote sites. A week later, however, the analyst adds a link to industry statistics on a remote site. The statistics happen to be materially incorrect. Because the EDGAR filer has ratified the analyst report by means of the hyperlink, the filer has taken on a duty to update and correct the analyst report going forward. It will need to police the linked analyst report continually, just as it would have to monitor, on an ongoing basis, information it provides directly to investors. Indeed, if the SEC and the courts choose to follow the SEC staff’s guidance on this issue, our EDGAR filer may have to police for material accuracy an increasingly remote chain of Web sites. This could be a dauntingly burdensome and risky task. REQUIRED DISCLOSURE DOCUMENTS RECEIVE THE STRICTEST TREATMENT It should come as no surprise that the SEC would impose this burden on, and allocate this risk to, an issuer filing on EDGAR. The SEC emphasized in its May 2000 release that its strictest standards will be applied to hyperlinks found in documents a public company must file under the federal securities laws — for example, reports on Forms 10-K, 10-Q or 8-K; proxy statements; or prospectuses. These documents, after all, constitute the basic threshold information a public company must disclose to the investing public. The SEC has emphasized that in the case of these required documents, it will always deem an issuer to have adopted any hyperlinked third-party information. The November 2000 guidance arises in the context of the SEC’s ongoing modernization of its EDGAR filing system, scheduled for completion in April 2001. For the first time, the EDGAR system now has the capacity to permit embedding of hyperlinks in its documents. While the SEC includes on the face of the November guidance its routine disclaimer of responsibility for opinions of its staff, the SEC has nonetheless chosen to publish the November guidance on its official Web site. The message is clear: Until the SEC addresses, or the courts interpret, the issue of remotely linked misinformation that is raised by the November guidance, a public company concerned about potential liability would be wise to avoid altogether the use of third-party hyperlinks within documents it files electronically on the SEC’s new EDGAR system — or take on a potentially unbounded burden of correcting and updating information on remote Internet sites. Eileen Smith Ewing is a partner in Kirkpatrick & Lockhart LLP’s Boston office.

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