#13098 - Public Offering - Securities Regulations (Duke Cox)

Absent an applicable exemption, §5 bars any offers to sell and sales of a security until a registration statement covering the security has become effective

The most salient parts of the registration statement are also set forth in the prospectus, which is an important medium to accompany any written offers to sell the registered security

§11: imposes liability upon the issuer, its principal officers, its directors, and its underwriters for any material omissions or misstatements in the registration statement when it becomes effective. The issuer’s outside accountants are also liable if they have certified materially misleading financial statements that are included in the registration statement

Firm commitment underwriting: one or more investment banking firms agree to purchase the securities from the issuer for resale to the public at a specified public offering price.

1. Typically, investment banking firms organize an underwriting syndicate. Each member of the syndicate agrees to purchase from the issuer a specified amount of the securities and to resell those securities at a specified public offering price. The syndicate is managed by a managing underwriter who, on behalf of the syndicate, executes with the issuer an underwriting agreement. The underwriting agreement spells out the terms of the offering and the amount of securities that each syndicate member is committed to buy or underwrite

   1. The syndicate members also execute an agreement among underwriters that establishes the obligations of each member

2. The difference between the public offering price and the amount received by the issuer is known as the “gross spread”

   1. The spread normally is composed of 3 parts:

      1. the management fee for the managing underwriter;

      2. the underwriting compensation received by the underwriters;

      3. the “selling concession” received for any securities sold to the public by any broker-dealer participating in the distribution

         1. You can earn some of the spread even if you are not a managing underwriter and even if you don’t sell any shares (True or False question)

         2. You’re a standby for risk if someone doesn’t sell their shares, you accept the risk, you’re on the hook

3. The underwriters may elect to “stabilize” the market for the offered security during the distribution

   1. The managing underwriter places in the primary market for the security a syndicate bid to purchase the security that is being underwritten. The bid price is usually set at or just under the public offering price. Stabilization is intended to facilitate an orderly distribution of securities by preventing or retarding a marked decline in the price of the offered security

4. Typically, each syndicate members retains control over and directly places only a portion of the securities it agrees to underwrite. This portion is known as its “retention.” The remainder of the underwritten securities is placed in a general syndicate account, often called the “pot,” under the control of the managing director. During the course of a distribution, the managing underwriter allocates and reallocates securities among syndicate and selling group members

5. A larger syndicate compensates for risk

   1. If they can’t sell, they have to hold the shares

      1. The more sellers, the less risk the risk is divided between more parties

         1. Risk is determined by allotment (e.g. 500k shares) the more shares, the more risk

6. Never close on a Friday

   1. The market might change over the weekend

7. The allotment is just a way of expressing your responsibility for any unsold shares

   1. So even if you sell your shares, if there are still unsold shares, you must accept risk for your proportion of those unsold shares

Best efforts underwriting: broker-dealers do not purchase the securities from the issuer but instead agree for a fee to use their best efforts to sell the securities on behalf of the issuer at the offering price

1. Straight: any securities sold to investors remain sold; there is no minimum amount that must be sold as a condition to the deal closing

2. Mini/maxi: a stipulated minimum amount of all the shares to be sold must be sold during a specific period of time before the offering can close

3. All or none: all the securities must be sold before the deal is completed

Signaling

1. High-reputation underwriters may signal the security’s quality

   1. Information asymmetry: insiders know more about their firm than the market

2. You like a firm commitment underwriting because banks are saying, “we’ll eat our own cooking”

The reputation of the lead underwriter affects nearly every aspect of an offering

Rights offerings: the issuer’s existing stockholders are granted the opportunity (i.e., right) to purchase the new offering of shares, usually at a discount below their current market price

1. Standby underwriting: the banker agrees to purchase any of the offering’s shares that are not subscribed for by the existing shareholders exercising their right.

2. The underwriters incur non-trivial market risks during this time as they stand by to acquire whatever shares remain unsold.

For many high-grade issuers, the presence of institutional buyers and the ability to satisfy the registration requirements quickly through use of the integrated disclosure system, have led to competitive bidding among underwriters for some or all of the shares the issuer will offer the “bought deal”

Dutch auction: issuer solicits bids from institutions and broker-dealers for any amount of securities each bidder wishes to acquire; the bidder states the amount of securities it wishes to purchase and the amount of securities. At closing, the bids are arrayed with the highest bid price first and the lowest bid price last. The issuer first accepts the bid with the highest price for the amount of securities covered in that bidder’s bid, and so on down the line until the issuer has placed all the registered securities. The lowest price accepted by the issuer through this process is the price paid by all the bidders whose bids were accepted through the process

The securities industry consists of firms engaged in activities which can be roughly divided into two categories: retail brokerage and investment banking

1. And the securities industry is characterized by its concentration

Tombstone ads

1. Announce an upcoming (or completed) offering

2. Identifies who interested buyers can obtain a prospectus from

3. The name appearing at the top of the list of syndicate members is the managing underwriter

4. After the manager is the special bracket (bulge group). What they bring to the party is not simply their substantial capital, but also the large institutional investors that make up their stable of clients

5. Following the special bracket is the major bracket, the beginning of which is indicated by the beginning of a new alphabetical order

History of the US capital markets

1. Glass-Steagall Act: separated the functions of banking from those of investment banking repealed by Graham-Leach-Bliley-Act

2. Dodd-Frank

   1. Volcker Rule: banned proprietary trading

   2. Mandated that banks hold at least 5% equity in SPVs

Letter of intent: represents the culmination of the preliminary negotiations and tentative understandings between the managing underwriter and the issuer

1. Reflect the underwriter’s interest in assisting the issuer in its proposed offering; avoids any commitments to the issuer

Underwriting agreement: agreement between the issuer and underwriter

Agreement among the underwriters: formal understanding among members of the syndicate; solidifies the managing underwriter’s authority

Allotment: SA 11(e) limits the liability of each underwriter to the total price at which the securities underwritten by him and distributed to the public were offered to the public

The Shoe: over-allotments occur when more shares are distributed than the underwriting syndicate was obligated to purchase from the issuer. Over-allotments therefore entail the syndicate members’ selling more shares than required by their firm commitment agreement with the issuer

1. Currently, FINRA limits the amount of over-allotments to 15% of the shares the underwriters are obligated to purchase

2. Purpose of over-allotment is to provide shares to syndicate to make sales for shares they don’t currently have

Flipping: occurs when shares in an IPO are quickly resold by the investors (flippers) (flipped) in the market at a profit. Flipping places downward pressure on the distributed security’s price and therefore impedes the syndicate in quickly distributing the offering.

1. The agreement among underwriters frequently imposes a penalty for flipping but rarely enforced

2. Spinning: is a variation of flipping, arising when the underwriter has allocated some of the scarce IPO shares to an executive of a company that may be planning to go public. The executive then flips the shares and thereby usually harvests a nice gain. Through spinning the underwriter seeks to garner favor so as to win future underwriting business

Insider lock-ups: In IPOs, the underwriters customarily extract from the senior management of the issuer a promise by the managers not to sell any of their shares during the 180 days following the public offering

1. Otherwise, may put downward pressure on stocks may signal that company is not very strong

Market Out Clause: clause that permits the underwriters to withdraw any time prior to the public offering and/or the settlement date if one of several exigent changes in circumstances develop (e.g. war, trade...