Can a company give away stock without registering it with the SEC?
Why has the SEC staff been criticized for requiring that free stock be registered?
When can a company rely on an exemption to avoid registering a free stock offering with the SEC?
How does a company register free stock with the SEC?
How much does it cost to conduct a free stock offering?

C. State Law Considerations in Free Stock Offerings

Can a company issue free stock under state law?

D. How Established Public Companies Can Conduct Free Stock Offerings

Has an established public company conducted a free stock offering?
Why would an established public company conduct a free stock offering?
How could an established public company conduct a free stock offering?
What are the arguments that a free stock offering conducted by a public company does not involve a "sale"?

E. Private Issuer's Consequences of Conducting a Free Stock Offering

If a private company conducts a free stock offering, does it trigger ongoing periodic SEC reporting and stockholder delivery obligations?
What may the SEC do if a company gives away stock without registering the offering?

F. Who Has Conducted Registered and Exempt Online Free Stock Offerings

Which companies have registered free stock with the SEC?
Which companies have offered free stock exempt from registration?

A. Understanding Free Stock Offerings

What is a "free stock offering"?

Fairly self-explanatory - when a company gives stock to someone for no money (or other traditional types of consideration).

Although a few companies have conducted free stock offerings over the years through off-line channels, the Internet initially increased their popularity as part of a marketing strategy - mainly due to the ability to easily and inexpensively communicate with large groups of people. As the dot com economy has faded, so has the popularity of these offerings.

Why would a company want to give away stock for free?

Many reasons - to create an online community, build a brand, or cross-market products or services. Drawing eyeballs to a Web site is crucial for e-commerce oriented companies - free stock is one way to lure visitors to a Web site.

So far, only private companies in the Internet industry have conducted online free stock offerings - more traditional companies have not done so. See more @ ways that public companies can conduct free stock offerings.

What should a company consider before giving away stock? Beyond the practical, administrative headache of keeping track of a large base of stockholders, there are corporate and securities law considerations, such as:

whether a company has to go through the costly and time-consuming process of registering the stock with the SEC - and possibly with state or foreign government agencies;
whether a company will be required to regularly file quarterly and annual reports with the SEC - as well as annually deliver proxy statements and glossy annual reports to stockholders; and
whether the applicable state law requires that stock be issued for "consideration" and how that law is interpreted. See more @ what is "consideration" under state laws.

There also can be unexpected problems. A good example relates to the first online free stock offering conducted by Travelzoo.com in April 1998. Reportedly, the company subsequently had difficulty locating the people who received free stock when it sought to conduct an exchange offer - primarily because the only contact information it had for many stockholders was e-mail addresses (many of which had changed and did not have forwarding information).

B. Whether and How to Register Free Stock Offerings with the SEC

Can a company give away stock without registering it with the SEC?

Probably not - because the SEC staff and courts have broadly interpreted the definition of "sale" in Section 2(a)(3) of the Securities Act of 1933.

It's probably considered a "sale" if the free stock offering meets one or more of the following factors:

the stock is given to someone just for registering as a member on a Web site,
the offering is designed to generate business for the issuer,
the offering is clearly conducted to create publicity for the issuer,
the offering creates a public market for the issuer's stock, or
the offering is intended to condition the market for an IPO to be conducted later.

If there is a "sale," the company has to either register the stock with the SEC before giving it away or ensure that there is a federal exemption from registration available.

In addition, a company should consider applicable state or foreign laws and whether registration is required with agencies in those jurisdictions before making a free offer online - or risk enforcement action from these regulators.

Source:The SEC staff has rejected requests for concurrence that online free stock offerings do not need to be registered in three no-action letters: Vanderkam & Sanders (January 27, 1999)(stock given in exchange Web site registration and referrals); Simplystocks.com (February 4, 1999)(stock given after random drawing entered through Web site registration); and Andrew Jones and James Rutten (June 8, 1999)(stock given in exchange for member registration - either through a Web Site or by postal mail - and referrals). The SEC staff maintained the same position regarding free stock offerings in an off-line context in another no-action letter, American Brewing Co. (January 27, 1999)(stock given for proof of beer purchase sent by postal mail). An excellent summary of the history of free stock offerings is in J. Schwartz, "Looking a Gift Horse in the Mouth: An Analysis of Free Internet Stock Offerings," The Michigan Telecommunications & Technology Review at www.mttlr.org/volsix/schwarz.html.

Why has the SEC staff been criticized for requiring that free stock be registered?

Because some commentators disagree with the SEC staff's analysis. These critics believe that simple online activities - such as registration as a member on a Web site - do not create sufficient value to create a "sale."

Source:One critical analysis of the SEC staff's no-action letters is presented in Denis Rice, "Free Stock on the Internet is Not a Menace," Insights (October 1999).

When can a company rely on an exemption to avoid registering a free stock offering with the SEC?

By relying on either of the following limited exemptions:

Rule 504 under Regulation D - no SEC filing is required (other than a simple notice filing on Form D) which means no SEC staff review, but the offering may have to be registered in the state in which the stock will be offered. See more @ eligibility requirements of Regulation D.
Regulation A - essentially, a mini-registration statement since an offering circular must still be filed with the SEC, which likely will be reviewed by the SEC staff (and the offering may have to be registered in the state in which the stock will be offered). See more @ eligibility requirements of Regulation A.

Note that Rule 504 under Regulation D used to be popular for companies to conduct online offerings. But the SEC revised the rule in 1999 so that a company could not make a general solicitation under the Rule - unless the company registered the offering in one or more states that require the filing and delivery of a substantive disclosure document before any sales are made.

Source:The SEC's new requirements are in Rule 504(b) of Regulation D.

How does a company register free stock with the SEC?

If a free stock offering is not eligible for the limited exemptions provided in Rule 504 or Regulation A, a company must file with the SEC's Division of Corporation Finance either a:

Form SB-2 (only if the company is eligible as a "small business issuer")
Form S-1, or
Form S-3 (only if the company is eligible to use a streamlined registration statement).

Companies hoping to use Form SB-2 must be a "small business issuer" under Rule 405 - which, among other criteria, requires the company to have less than $25 million in both revenue and market capitalization.

Among other criteria, companies hoping to use Form S-3 must have at least a $75 million market capitalization (held by non-affiliates) and be public for one year.

Form S-1 is a "catch-all" form to be used by companies that are not eligible to use other forms.

Source:Offering circulars under Regulation A can be filed with the SEC on paper. Registration statements on Forms SB-2, S-1 or S-3 must be filed electronically through the SEC's EDGAR system (except for foreign private issuers).

How much does it cost to conduct a free stock offering?

The SEC's filing fees are nominal for free stock - $250 under the current SEC filing fee formula.

The other costs can vary, primarily depending on how much a company's legal and financial advisors charge. These fees depend on the complexity of the preparation of the registration statement, such as how much work is required to ensure that the financial statements meet SEC requirements.

For example, two companies that have registered their free stock offerings -YouNetwork and DoctorSurf.com - disclosed their fees and expenses as follows:

	YouNetwork	DoctorSurf.com
Total fees and expenses	$160k	$70k
Legal fees	$100k	$40k
Accounting fees	$25k	$2.5k
Transfer agent fees	$20k	undisclosed
Printing fees	$10k	$10k
SEC filing fees	$250	$250

See more @ free stock offerings that have been registered.

C. State Law Considerations in Free Stock Offerings

Can a company issue free stock under state law?

It depends on whether the applicable state stock issuance law (i.e. the state in which a company is incorporated) requires that stock be issued for "consideration."

If so, it's important to determine whether member registration or any other activities that someone must perform to get free stock is sufficient "consideration" under state law.

Since most of these laws allow a company's Board of Directors to set the consideration at their discretion, this issue normally can be fairly easily resolved because the Board determines what is sufficient consideration. To satisfy these state laws, a Board should pass a resolution to this effect - after sufficient deliberation to meet its fiduciary duties.

Note the possible conflict between a board resolving that there is consideration for state law purposes - and arguing that there is no consideration in an attempt to avoid registering the free stock with the SEC. See more @ SEC staff's position of whether online free stock offerings should be registered.

Source:Examples of state stock issuance laws include: Section 153 of the Delaware Corporation Code (consideration must at least be equal to a stock's par value and if there is no par value, at a Board's discretion); Section 504 of the New York Business Corporation Consolidated Laws (consideration must at least be equal to a stock's par value and if there is no par value, at a Board's discretion); and Section 409 of the California Corporations Code (at a Board's discretion, unless the certificate of incorporation provides that the shareholders must make the determination).

D. How Established Public Companies Can Conduct Free Stock Offerings

Has an established public company conducted a free stock offering?

So far, no public company appears to have conducted an online free stock offering.

Deterrents may include the administrative costs of establishing and maintaining such a program - or the negative media coverage stemming from the SEC's enforcement actions against private companies that offered free stock without registration. See more @ SEC enforcement actions involving free stock offerings.

Another consideration is the level of dilution that a free stock offering entails - this depends on the relative size of the free stock offering compared to the company's outstanding number of shares.

Why would an established public company conduct a free stock offering?

Same reasons why private companies are doing them - to help it build or enhance a brand name or an online community, to lure eyeballs to a Web site, or to cross-sell products and services.

How could an established public company conduct a free stock offering?

By offering whole or fractional shares of stock - perhaps akin to a frequent flier mile program.

Larger public companies could register a free stock offering on a Form S-3, a streamlined registration statement - and even obtain consents to electronic delivery when a visitor accepts an online free stock offer to further reduce costs (i.e. delivery of prospectuses as well as subsequent annual reports and proxy statements). See more @ what are the Form S-3 requirements.

However, even with reduced printing and mailing costs, a free stock offering still would result in administrative, recordkeeping and other costs - as well as the legal and accounting costs of registering the offering with the SEC. See more @ how much do registered free stock offerings cost.

Based on no-action letters and related releases that were issued by the SEC before the Web existed, it's possible that the SEC staff may concur that a free stock offering conducted by a public company does not involve a "sale" - so that the offering is not required to be registered with the SEC at all. The SEC has not publicly addressed these issues in the Internet context.

Since these letters dealt with facts and issues not quite in the same context (and before the proliferation of free stock offerings by private companies that some argue border on fraud), a public company should contact the Office of Chief Counsel of the SEC's Division of Corporation Finance at (202) 942-2900 before planning an unregistered free stock offering. See more @ arguing that a free stock offering is not a "sale."

Source:The no-action letters that relate to whether there is a "sale" in a free stock offering conducted by a public company include: Xircom, Inc. (available June 10, 1997); Smith's Food & Drug Centers, Inc. (available August 4, 1993); Progressive Corp. (available May 16, 1988); Dr. Pepper Co. (available October 2, 1980) and American Express Co. (available November 30, 1979). The related releases are Release 33-6281 (January 15, 1981) and Release 33-6188 (February 1, 1980).

What are the arguments that a free stock offering conducted by a public company does not involve a "sale"?

The factors applied by the SEC in pre-Internet no-action letters and releases that arguably could apply in the online free stock offering context are:

the company is a SEC reporting company,
the stock is actively traded, and
the amount of free stock is small as a percentage of the company's outstanding stock.

Source:These no-action letters and releases include: Xircom, Inc. (June 10, 1997); Smith's Food & Drug Centers, Inc. (August 4, 1993); Progressive Corp. (May 16, 1988); Dr. Pepper Co. (October 2, 1980) American Express Co. (November 30, 1979) - as well as Release 33-6281 (January 15, 1981) and Release 33-6188 (February 1, 1980). An excellent article discussing this issue is Stephen J. Shulte and Steven J. Spencer, "Free Stock: Considerations in Giving it Away," Mondaq Business Briefing (February 28, 2000).

E. Private Issuer's Consequences of Conducting a Free Stock Offering

If a private company conducts a free stock offering, does it trigger ongoing periodic SEC reporting and stockholder delivery obligations?

It depends on whether a free stock offering was registered with the SEC or conducted under a limited exemption, such as Regulation A or Rule 504 of Regulation D.

If a company files a registration statement, it then will be required to file quarterly and annual reports with the SEC and deliver glossy annual reports and proxy statements to stockholders for at least a year (and then terminate its reporting obligations, if eligible). The obligations to file periodic reports with the SEC arise under either Section 15(d) or Section 12 of the Securities Exchange Act of 1934.
If a company files an offering circular under Regulation A, it's required to deliver glossy annual reports and proxy statements to stockholders - but it's not required to file these documents with the SEC (absent a Section 12 filing obligation as noted below).
If a company relies on Rule 504 under Regulation D, it's not required to file or deliver any periodic reports - absent triggering a Section 12 filing obligation.
A Section 12 filing obligation is triggered if stock is given to more than 500 holders of a class of securities and the company has more than $10 million in assets as of the end of its last fiscal year - or the stock is listed on the New York Stock Exchange, American Stock Exchange, or Nasdaq.

Source:The Section 12(g) periodic reporting obligation threshold consists of two parts. Section 12(g)(1) of the Securities Exchange Act of 1934 sets forth the threshold for number of equity holders (500) and Rule 12g-1 sets forth the asset threshold ($10 million). If a company's stock is listed on an exchange, Section 12(b) imposes a periodic reporting obligation

What may the SEC do if a company gives away stock without registering the offering?

Ask a lot of questions. Unregistered free stock offerings receive a lot of attention from the SEC's Division of Enforcement, so a company should be prepared to prove that an exemption from registration is available.

In 1999, the SEC settled enforcement actions against four companies who gave away unregistered free stock through their Web sites in exchange for free member registration and referrals.

See: These four settlements are described in the following SEC litigation releases: Joe Loofbourrow, Release 33-7700 (July 21, 1999); Web Works Marketing.com, Inc., Release 33-7703 (July 21, 1999); WowAuction.com Inc., Release 33-7702 (July 21, 1999); and Theodore Sotirakis, Release 33-7701 (July 21, 1999).

F. Who Has Conducted Registered and Exempt Online Free Stock Offerings

Which companies have registered free stock with the SEC?

Since the SEC made it clear that free stock offerings should be registered or eligible for an exemption, two companies have registered free stock offerings:

In early 1999, YouNetwork Corporation, an online retailer, registered an offering of free stock on a Form SB-2 (SEC File No. 333-71949). Shares were given to the first 250,000 visitors who registered as members on its Web site - and these members then could earn additional shares by buying products or by referring new members.
In late 1999, Doctor Surf.com, an online medical community, registered an offering of free stock on Form SB-2 (SEC File No. 333-80475). Shares were given to the first 250,000 doctors who registered as members on its Web site.

Which companies have offered free stock exempt from registration?

After the SEC made it clear that free stock offerings should be registered or eligible for an exemption, quite a few companies abandoned free stock offerings that were not registered (including exit23B.com, E-Compare, MonsterBook.com, and WebWorksMarketing.com).

USPages.net, Inc. reportedly offered free stock to customers and Web site visitors by registering the stock in 27 states - in an offering exempt from SEC registration under Rule 504.

Source:The UsPages.net offering is discussed at www.uspages.net/free_stock.wphp.