Margaret Sheehan is a partner with the Washington D.C. branch of the law firm, Alston & Bird LLP of Atlanta, Ga. Sheehan's practice focuses on electronic commerce compliance. She represents several financial service firms including Invesco and American Express. Sheehan recently discussed current regulatory and compliance issues surrounding electronic commerce with Mutual Fund Market News reporter, Andrew Greene. An edited account of their conversation follows.
MFMN: What are the primary compliance and regulatory issues that fund companies and financial service firms need to be wary of in regards to the Internet and e-commerce strategies?
Sheehan: Right now I think there are several things they need to be focusing on. I would say one big area is content of websites and use of electronic communication to communicate to shareholders, making sure you have appropriate consent for that. Making sure that you're meeting prospectus delivery requirements if you are doing those electronically. Taking care to think about hyper-linking issues and how they can impact your liability or potential liability for content.
MFMN: Are those issues that your clients are raising with you, or are those issues that the SEC has begun to pay greater attention to?
SHEEHAN: It goes both ways. In many ways, the SEC is my greatest source of work. For example, the SEC issued its release in May regarding electronic delivery of electronic communications. And that meant that primarily there were two focuses. One was whether you could use e-mail for required disclosures to customers and the other was website content and your liability for hyper-linked information. So, a lot of the questions that I get are spawned by things that the SEC will say or do, but I don't get questions sort of in a vacuum. Generally, it will be the SEC takes a position and then your clients will want to implement that or have it interpreted for them.
MFMN: In your opinion, is the SEC taking a hard line approach toward electronic communication on the Internet or do they take each situation on a case by case basis?
SHEEHAN: Well, that's interesting. I would think that if you are otherwise a compliant shop and not being viewed as using the Internet or e-mail to perpetrate fraud, I don't think the SEC is being particularly hard line. I think they are trying to be very flexible and frankly, sort of industry friendly. They are trying to come up with solutions that work for people and they are trying not to be particularly heavy handed in respect to rule making or taking really hard line positions before all the information about how people are communicating is really known. On the other hand, they have been very proactive on some issues that have been very helpful. That May release is a very good example of that. In most ways, it was a very permissive release. It was meant to clarify when electronic communication is permitted, it was meant to clarify some misconceptions. I'll give you a perfect example: People would say, Geez, if we have something that is sort of sales literaturey sitting next to our prospectus, is that going to be deemed, because of the proximity to the prospectus, to be part of the prospectus?' And the SEC sort of cleared that up.
MFMN: In the case of electronic communication and online materials?
SHEEHAN: Yes. There was some concern that if you had non-prospectus information literally located on your site too close to a prospectus, or a link
to a prospectus, that non-prospectus content was going to be deemed to be part of the prospectus or subject to the anti-fraud provisions. And the commission basically said no, you have to do something to affirmatively state that something is part of a prospectus before it will be treated as part of a prospectus. Like if you have a prospectus online with a hyperlink embedded in it, that link is considered to be part of the prospectus.
MFMN: Is a fund company responsible for the information that it allows visitors to its site to link with through hyperlinks and web portals?
SHEEHAN: Well, because the SEC is full of lawyers, the answer is a lawyerly, it depends. But I did think they did have a very thoughtful response. They are trying to do something more than be completely ad hoc but at the same time be reasonable and flexible, and this is a good example of that approach. What they've said is that if you hyperlink to third party content through your website, you may, but will not necessarily, become responsible for that content. And you will if one of two things are true: If you have adopted that content, or if you are deemed to have become so entangled in the content that the customer can't tell if it's yours or someone else's so it's reasonable for the customer, and therefore the SEC, to believe that you've taken responsibility for that.
Look and feel issues come into play here, big time. If you have a splash screen that said, You are now leaving our site ... and this is not our content and we don't take any responsibility for it,' that's a good thing. Obviously if you've wrapped some third parties' content around your look and feel and it could potentially disguise that it is a link, that's a bad thing. Let's say you have someone who provides research and they are always providing research for your company. If you only put a hyperlink on your website when that information is favorable and you pull it when it's not favorable, the commission takes a position that you have essentially adopted that information because you are doing more than just serving as a conduit. You are selectively linking with the information. Which is an interesting thing because I bet you it's happening. I bet you it is happening and people don't realize that what that means is you've got liability for that content as if it were your own.
MFMN: How closely is the SEC monitoring the Internet for issues like this?
SHEEHAN: It's really hard to tell. The commission has certainly ramped up its Internet team generally, but that doesn't necessarily mean the Internet and mutual fund sites. It could be any issue and anybody that has a website. Of course, the Internet is ripe for potential fraud situations, so I'd say that generally the SEC is very much focusing on Internet issues. Whether they are focusing on mutual fund, investment advisor, broker-dealer compliance with this kind of stuff, I don't think is clear. There have not been a lot of enforcement proceedings brought, but that may merely be a function of time. And also it may be the case that the SEC, like anybody else, can be motivated by outside forces like disgruntled shareholders, to take action and in a market where people are making a whole lot of money, there may not be a whole lot of disgruntlement going on. So, it's hard to say what's really motivating them to sort of be in this position now of pronouncing things but not really taking a lot of enforcement action. It may just be where we are in the cycle.
MFMN: Certainly ten years ago, this wasn't an issue whereas today it's huge and almost limitless. When did some of these issues start becoming real concerns?
SHEEHAN: I would say between 1995 and 1996, was when issues particularly issues relating to electronic delivery of information, became a concern. Because people started using e-mail before they started launching websites, which is sort of strange. So there were issues and some concern of whether we could communicate with our customers. The SEC did a reasonable job at the time of addressing those issues with certain releases. And then the web content stuff came later. I would say in the last three years that has gotten a lot of attention. And when I came into the industry in the late 80's and early 90's, it just didn't exist. So in my career it has gone from non-existent to, as you said, sort of limitless.
MFMN: How did you get involved in this type of practice?
SHEEHAN: I got involved in it because my clients did and anybody that wants to do a good job of representing their clients will either learn it themselves or refer them to someone who knows it and given that choice, it's always better to keep clients and make them happy with respect to all of the various ways that you represent them.
I think it remains to be seen whether people buy pet food online, but I think people will be buying and selling stocks and more importantly than even that, accessing websites for information with respect to their account holdings, share prices, Morningstar ratings and that kind of stuff. That is where the Internet is really a huge value to an investor. Not just the ability to execute trades, but the ability to get information that is personalized and timely in a really efficient and inexpensive manner.
MFMN: Do you feel the Internet and a lot of the new technology out there has made it easier for fund companies to operate from a marketing and distribution standpoint as well as on the compliance side of the business?
SHEEHAN: Yeah. I think that if you are thoughtful and creative (the Internet) in some ways, could be a leveling factor in the sense that there are not a whole lot of barriers to entry to having a website. And there is a sense that customers value a good website. Probably not as much as good performance but it's something in which fund families feel they need to be competitive. Another words, if you're a fund company and you are not online, you have to have a very good reason for why you are not.
There is a huge opportunity for mutual funds in cross-selling or just marketing generally. The web is a great way to communicate not only with respect to required communications, but also with respect to giving the customer the information they want so you either directly or indirectly cause them to want to either stay with your funds rather than go into another or buy into another fund.
MFMN: So you can really personalize communications to a point where there is a strong incentive for the investor to stay with the fund that they currently have?
SHEEHAN: Yeah, exactly. Personalization is king right now, generally speaking, but particularly on the web. It's got everybody excited. I mean, its gotten customer excited and therefore, of course, it has gotten the fund companies excited.