Skadden Discusses Jumping the Gun: Social Media and IPO Communications Issues

Increasingly, companies are using social media, such as Facebook, Twitter, YouTube and other platforms, to engage with clients, customers, employees, shareholders and other key constituents. Promising a fast and low-cost means of disseminating information, social media also offers the potential for even broader distribution through third-party word-of-mouth advocacy. However, when a company plans an IPO in the United States, social media’s powerful benefits can pose significant risks.

To date, the SEC has not brought an action for violation of its IPO publicity restrictions involving social media; however, as corporate social media continues to proliferate, it is likely only a matter of time before the SEC acts. Companies preparing to go public need to understand the various SEC rules restricting communications during the IPO process. Instituting well-defined policies and procedures governing social media is critical to avoiding inadvertent violations and the penalties that can follow, which may potentially impact the IPO.

Gun-Jumping

“Gun-jumping” is an expression, not defined in the U.S. securities laws, that generally refers to a violation of U.S. securities law restrictions on issuer publicity and communications before, during or after a public offering. U.S. securities laws prohibit communications that improperly stimulate interest in the securities offered in an IPO. For an IPO, the restrictions start as early as the time the company reaches an understanding with the managing underwriter (potentially before the company even holds its IPO organizational meeting) and end 25 days after the pricing of the offering. Gun-jumping consequences can be serious and can include recission, a cooling-off period delaying the IPO or sanctions/fines.

“Gun-jumping” restrictions are wide-reaching: They apply to all forms of communications and cover press releases, media interviews, website postings, emails, internal company announcements, Facebook posts, Twitter tweets, YouTube videos and online commentary. The often casual and spontaneous nature of social media communications, combined with the ability to disperse messages instantly and broadly, heightens the risk of inadvertent gun-jumping. Additionally, companies often subject social media communications to less stringent review than traditional print publications or press releases.

Given the broad application of “gun-jumping” restrictions, it is possible that the SEC could consider seemingly ordinary, noncontroversial communications as “gun-jumping.” For example, if appropriate care is not taken, a significant increase in Internet advertising or a company website revamp immediately preceding an IPO could be viewed as “gun-jumping” if it is deemed to be stimulating interest in the IPO.

While a company is not responsible for third-party commentary posted on its social media platforms (including a company website), re-tweeting a third-party Twitter post could raise a red flag. The same holds true for repackaging posted commentary from third parties in company communications, particularly if the company is viewed as sponsoring or affirming the commentary.

Prominent Gun-Jumping Examples

While the following examples of gun-jumping did not involve corporate social media, they are instructive of the general risks and may point to areas in which future notable violations could occur through the use of interactive platforms.

• Google. In April 2004, approximately one week before Google Inc. filed its IPO registration statement with the SEC, the company’s co-founders gave an interview to Playboy magazine. Four months later, the interview appeared in the magazine with the cover title “The Google Guys: America’s Newest Billionaires.” At the time, the media speculated that the SEC would impose a cooling-off period. While the SEC did not delay the much-anticipated IPO, in the face of SEC comments, Google included the text of the article as an appendix to the prospectus and, as a consequence, assumed prospectus liability for the article’s contents. In doing so, Google (and its lawyers) proceeded with care: After careful review of the article’s text, Google appended an addendum correcting what it believed were factual inaccuracies. The company also included a risk factor in the prospectus, which disclosed that, while Google “would contest vigorously any claim that a violation of the Securities Act occurred,” the company could be subject to rescission claims if its involvement in the Playboy article were held by a court to violate the Securities Act.
• Groupon. In June 2011, Groupon, Inc. filed a registration statement with the SEC for its proposed IPO. The financial media and investment blogs were skeptical of Groupon’s use of a non-GAAP accounting metric that made the company appear profitable. Groupon’s business model also was questioned, as critics cited low barriers to entry into the industry and the potential of deep-pocketed competitors to the company. In August 2011, Groupon’s CEO and co-founder sent an email to employees, which contained impassioned defenses of Groupon’s business. The email leaked and quickly went viral. Because of SEC scrutiny and poor market conditions, Groupon’s IPO was delayed for months. In addition, the SEC required Groupon to include the email as an appendix to the prospectus, and Groupon, like Google, assumed prospectus liability for the email’s contents. Groupon also included a risk factor, which began, “In making an investment decision, you should not rely on an email sent by our Chief Executive Officer to certain employees that was leaked to the media without our knowledge.”

SEC Actions in Other Areas Relating to Social Media Use

While the SEC has not yet brought an action for a gun-jumping violation involving social media, the SEC recently delivered a prominent notice to Netflix, Inc. and its founder and CEO Reed Hastings relating to a personal Facebook post under Regulation FD (an SEC rule adopted in 2000 that prohibits selective disclosure of material, nonpublic information and aims to promote full and fair disclosure).

• Netflix. In December 2012, Netflix received a Wells notice from the staff of the SEC indicating their intent to recommend that the SEC institute a cease-and-desist proceeding and/or bring a civil injunctive action against Netflix and Hastings for violations of Regulation FD and certain Securities Exchange Act provisions. The notice related to Hastings’ post to a personal Facebook page with more than 200,000 subscribers that stated, in relevant part, that Netflix’s monthly viewing exceeded 1 billion hours for the first time.[1] While the materiality of the statement may be debated,[2] the SEC action drew attention as it suggests that a Facebook post — even if distributed to more than 200,000 people and made available on a platform that anyone can access — still is not a recognized method under Regulation FD. Critics of the SEC’s action noted that the Facebook posting likely reached more people and was read more immediately than would have been the case with an SEC filing. Critics also expressed surprise that the SEC took its prominent stance on social media based on facts that, to some, seemed innocuous compared with violations alleged by the SEC in the past.

One takeaway from the Netflix case is clear: Communications on social media platforms are now a focus of the SEC. Accordingly, issuers preparing for an IPO should pay careful attention to their social media activities.

Brief Primer of the Gun-Jumping Rules[3]

Understanding the three distinct periods in which different SEC guidelines and restrictions apply may provide a practical framework for issuers in managing their social media use.

1. Pre-Filing Period: No Offers (Not Even Oral Ones). During the pre-filing period (after the company is “in registration” but before the registration statement is filed), no offer, whether oral or in writing, may be made under Section 5(c) of the Securities Act. Section 2 of the Securities Act defines “offer” as “every attempt or offer to dispose of, or solicitation of offers to buy, a security or interest in a security for value.” Courts have given expansive interpretation to what constitutes an “offer,” which includes any activity that creates a buying interest in an offered security. Most importantly, an issuer’s intent is not required for a violation to be deemed to have occurred.
2. Waiting Period: No Written Offers. During the waiting period (after the registration statement is filed but before effectiveness), issuers may make oral offers, but written offers may only be made through a prospectus that complies with the Securities Act.
3. Post-Effective Period. Once the SEC declares an issuer’s registration statement effective, the issuer must continue to comply with communications restrictions until the end of the prospectus delivery period (25 days after the pricing of the IPO). A prominent example of an issuer navigating this requirement is Facebook, which waited until day 26 to respond to questions on its business model.

Safe Harbors and Exceptions

Numerous “safe harbors” and SEC exceptions to the gun-jumping restrictions do exist (e.g., the JOBS Act allows “emerging growth companies” to test interest in a potential IPO with qualified institutional buyers and institutional accredited investors, Securities Act Rule 169 allows nonreporting issuers to continue regularly released business information excluding forward-looking statements and Securities Act Rule 163A provides a safe harbor for certain communications made more than 30 days before the registration statement is filed).[4] In general, companies planning an IPO should keep the following rule of thumb in mind: The U.S. securities laws are not meant to disturb “business as usual” activities and communications. If the communication consists of factual business information and is consistent with past practice, it generally will not violate gun-jumping restrictions.

Managing Social Media During the IPO Process: A Practical Guide

Before starting the IPO process (or, with respect to certain employees who will not know about the IPO beforehand, immediately after the initial registration statement filing), companies should:

• Identify the group of specific individuals within the company who will be authorized to conduct or sign off on all social media communications. For example, even if a sales force regularly employs social media to pitch products, it is not unusual for companies planning an IPO to temporarily halt or more closely monitor the sales force’s use of social media during the IPO process to institute a measure of control over communications.
• Establish a social media policy that clearly sets forth the company’s expectations with respect to social media communications, and which includes a list of unambiguous “dos and don’ts.” The policy, which should be disseminated to all employees and others who may act on the company’s behalf, should state that responses to any inbound inquiries through social media platforms are restricted to the small group of identified individuals, and to whom any inbound inquiries should be directed.
• Provide training to ensure persons subject to the social media policy understand how to comply. If the CEO or CFO delivers the message, it will help ensure employees and other persons subject to the policy understand and appreciate its importance.
• Make clear that it is everyone’s responsibility to comply with the policy. Each person should understand that a single noncompliant communication could result in poten­tially severe consequences, such as suspension or delay of the IPO.
• Educate front-line managers and supervisors to monitor compliance with the social media communications policy.
• Develop a process to control the type of information (e.g., only factual business information) and how corporate information will be disseminated by social media platforms.
• Instruct company directors that their own personal or professional use of social media must follow company policy.

Finally, companies should consider having internal and/or outside counsel review all information before it is posted on its website or social media outlets. In several SEC actions relating to Regulation FD and the Foreign Corrupt Practices Act (FCPA), the SEC chose not to bring action against the company (and instead brought actions against the alleged infringing individuals only) where the SEC found the company had instituted a “culture of compliance,” which included a written policy, controls and training. While instituting a “culture of compliance” may not prevent an SEC action with respect to an IPO gun-jumping violation, it may influence how the SEC views the violation and mitigate the penalty of noncompliance.

Intent is not required for the SEC to determine that gun-jumping has occurred and, given the number of followers an issuer may have on social media platforms, it may not be difficult for the SEC to find a violation. Thus, the best advice is for issuers to operate within SEC guidelines throughout any process that ultimately may culminate in an IPO.

This article was originally published in 2013 Insights, Skadden’s fifth annual collection of commentaries on the critical legal issues businesses will be facing in the coming year. To see additional articles from Insights, including discussions on capital markets, corporate restructuring, financial regulation, global litigation, global M&A, governance and regulatory issues, please visit this link here.

Reprinted from the upcoming: NY Business Law Journal, Summer 2013, Vol. 17, No. 1, published by the New York State Bar Association, One Elk Street, Albany, NY 12207