SIE Chapter 5: Investment Banking

FINRA Rule 5130

covers restrictions on the Purchase and Sale of Initial Equity Public Offerings (IPOs) by "restricted persons" and their immediate family members.

The following accounts or persons are allowed to purchase a new issue of common stock and are not considered "restricted":

1. An Investment Company registered under the Investment Company Act of 1940 2. A Trust Fund which has investments from 1,000 or more accounts and is not primarily made up of Restricted persons 3. An Insurance Company that received premiums from 1,000 or more policyholders and is not primarily made up of Restricted persons 4. An account if the beneficial interest of restricted persons does not exceed 10% of the aggregate value of the account

Broker-dealer personnel

1. Any officer, director, general partner, associated person, or employee of a member or any other broker-dealer and their immediate family members. 2. Any agent of a member or any other broker-dealer and their immediate families or if the agent is supported by an immediate family member.

Factors used to determine price of a new issue include:

1. Comparison with similar issues on the market 2. The outlook and attractiveness of the new issue's industry classification 3. Estimate of the corporation's E.P.S. for the next year 4. Estimate of the dividends per share the new issue will probably pay

Stabilization or Pegging the price

1. Done by managing underwriter at or below the public offering price. This would be done if the market price fell below its original offering price. 2. After purchasing shares to stabilize, the manager may only resell the shares at the public offering price.

Types of Underwriting Agreements

1. Firm Commitment 2. Stand-by Agreement 3. Best Efforts Agreement— The underwriting group acts as an Agent in trying to distribute the new issue to the public. It does not buy or take the securities in its inventory. 4. All or None Agreement

Managing Underwriter's responsibilities include:

1. Forming the underwriting syndicate and selling groups. 2. Running the books and keeping the syndicate records 3. Establishes the underwriter's retention 4.Allocating the issue among the syndicate and selling group members 5. Stabilizes the issue, if necessary.

Restrictions on Sales- a member or person associated with a member:

1. May not sen a new issue of common stock to any account in which a •restricted person• has beneficial interest. 2. May not purchase a new issue in any account in which such member or person associated with a member has a beneficial interest. 3. May not hold new issues acquired by the member as an underwriter, selling syndicate member, or selling group member.

Note the following regarding the red herring:

1. RRs cannot confirm a sale or accept funds for the issue with a preliminary prospectus. 2. It cannot be altered in any way (attach business card, highlight certain text, etc.). 3. It cannot be accompanied by a research report. The preliminary prospectus is the only document that can be sent to interested investors. 4. It does not include or declare a final public offering price. It may include a potential price range. 5. Must be sent to clients who have given the registered representative an indication of interest in the offering. 6. Indications of interest are not binding commitments on the prospective clients, syndicate members or the corporation. 7. It will include a brief history about the issuer, its management, and use of the proceeds.

The following transactions are allowed:

1. Sales or purchases from one selling group member to another selling group member that are incidental to the distribution of the new issue that will be sold to a non-restricted person at the public offering price. 2. Sales or purchases of shares that are to be sold to a non-restricted customer at the public offering price by a broker-dealer that is not a member of the underwriting syndicate. 3. Purchases of a new issue at the public offering price by a broker-dealer that has been formed as an investment partnership, provided that the capital accounts of the partners Of the partnership do not exceed in the aggregate 10% of the account.

During the Cooling Period:

1. The Selling Group is formed. Selling group members do not have any financial responsibilities regarding the issue. Selling Group members enhance the marketing of new issues and are invited by the syndicate manager(s). 2. Blue Sky: the issue means the issue is qualified by the underwriter's counsel in each state in which it will be sold. 3. The Due Diligence Meeting: is held by the issuer and its investment banking team to review the offering, deficiency letters, and the final prospectus. The meeting is held near the end of the cooling period. The public offering price is not determined at this meeting.

Standby purchasers are allowed to purchase or sell shares of the new issue provided that:

1. The stand-by agreement is disclosed in the prospectus. 2. The stand-by agreement is a written agreement. 3. The managing underwriter represents in writing that it was unable to find any other purchasers for the securities. 4. Securities sold pursuant to the stand-by agreement are subject to a 3-month "locked-up" period, meaning the securities cannot be sold for 3 months after purchase.

Tombstones:

1. are the only form of advertising permitted to announce the new issue. 2. are not required to be filed with the SEC or FINRA prior to publication. 3. contain the names of the issuer, managing underwriter and the amount of the issue. 4. can only contain statements of fact, no solicitation. 5. must indicate where a prospectus can be obtained. 6. do not show selling group members. 7. do show the public offering price.

unsolicited orders only

Between the filing date and effective date of a registration statement, member firms participating in selling a new issue of its own stock or selling the stock of a company may accept ______________________________. They may send out a preliminary prospectus in response to a request or an order.

margin for 30 days

Broker-dealers that participate in the distribution of a new issue must wait 30 days after the closing date of syndicate before extending credit to customers on the new issue (It cannot be purchased on __________________________).

Issuers

Corporations distributing new issues are considered to be _______________, not customers.

Manager's fee

Fees for running the books and keeping the syndicate records

"Access equals delivery"

Once the final prospectus is filed with the SEC, it can be viewed at EDGAR on the SEC's website. Therefore, access to the final prospectus equals delivery of the final prospectus.

broker-dealer's research department

Personnel working in a _____________________ cannot be supervised or compensated by the firm's investment banking department.

Types of Offerings

Primary and Secondary

Corporation

The ____________________ determines which broker-dealer will be the managing underwriter through negotiated or competitive bidding. 1. Negotiated is used for corporate equity issues. 2. Competitive is used for certain debt issues.

All customers

The final prospectus must be received by __________________ who purchase the new issue not later than with their purchase confirmation. The SEC permits electronic delivery of the prospectus.

All or None Agreement

The issue is canceled unless it can be completely sold to the public. Always an Escrow account established. Acts as Agent.

Firm Commitment

The syndicate buys the entire issue and resells it to the public. type of agreement carries the greatest risk because the underwriters could end up With all unsold shares. The firm acts as a Dealer because it takes the offering into its inventory.

Stand-by Agreement

The underwriter agrees to purchase and distribute any pan of an issue not purchased by stockholders who received pre-emptive rights. Used only with Rights Offering the firm acts as a Dealer.

Best Efforts Agreement

The underwriting group acts as an Agent in trying to distribute the new issue to the public. It does not buy or take the securities in its inventory.

Components of the Spread —

The underwriting spread is the difference between the proceeds an issuer of a new security receives, and the price paid by the public. It includes: a. Manager's fee b. Underwriter's Compensation (or Retention) c. Selling Concession d. Reallowance — paid to broker-dealers that are not syndicate or selling group members e. Syndicate expenses are allocated according to each underwriter's participation

"eliminated"

These quiet periods are ___________________ for IPOs of Emerging Growth Companies as per the JOBS Act.

The prospectus delivery requirements

continue to apply to broker-dealers that participate in the distribution of a new issue and then become market-makers in the issue (acting as principals) for 90 days for unlisted (OTC) offerings and 25 days for listed (NYSE, Nasdaq) offerings (for most offerings) from the closing date of the syndicate.

JOBS Act

Under the ______________________, the issuer or a broker-dealer representing an issuer may contact potential investors before a registration statement is filed with the SEC and engage in oral or written communications with Qualified Institutional Buyers (QIBs) and Accredited Investors (AIS) to ascertain investor interest.

under-subscribed

When a new issue is ______________________ (there are not enough orders to sell all shares), underwriters may place a portion of the public offering in their own investment account if they are unable to sell those shares to the public.

Preconditions for Sale—

a member firm may not sell a new issue of common stock to any account unless within the last 12 months it has in good faith obtained verification that the account is eligible to purchase the new issue (i.e., verify that it is not a restricted account or restricted person).

Issuers are comprised of various entities which sell securities to the public. Types of issuers include:

a. Domestic and foreign corporations (issue stocks and corporate bonds) b. The U.S. government (issue U.S. government securities or 'Treasury' securities) c. State and local governments (issue municipal securities)

Restricted Person

a. Member firms or other broker-dealers b. Broker-dealer personnel c. Finders and Fiduciaries (attorneys, accountants, and financial consultants) and their immediate families d. Portfolio Managers and their immediate families

All of the following are violations of The Securities Act of 1933:

a. Misstatements made in a final prospectus b. Sending sales literature with the preliminary prospectus or altering the prospectus in any way. c. Sending excerpts of the prospectus to customers. d. Accepting a customer's order for the purchase of a new issue before the effective date of the registration statement.

Immediate Family Members

a. Partners, spouse, and siblings b. In-laws (mother, father, brother, sister, daughter, son) c. Children and any other individual to whom the person provides material support.

Some of the primary functions of an investment banker are:

a. Raise capital for the corporation through the issuance of securities and give advice on what type of security to issue. b. For new issues of securities, the investment banking firm will serve as the underwriter, sponsor, distributor, and/or a syndicate member. c. Advises corporations on mergers and acquisitions. When a corporation purchases another corporation, it may need to raise significant capital to do so. The investment banker will often help the acquiring company raise the funds. It also advises the selling companies to obtain the highest selling price for the company (or asset).

Factors that determine the amount of the spread:

a. Size of the issue b. Type of security involved c. Financial strength of the issuer d. Type of commitment made by the investment banker

Tombstone Ads

announce the availability of a new issue for sale.

Issuers

are companies that sell securities (e.g. stocks, bonds) to the general public for the purpose of financing its new ventures or operations. The offering or issuing of stock for the first time by private companies is called an initial public offering (IPO) and is often referred to as "going public." When privately-owned company transitions to become a public entity through the sale of securities to the public, it is referred to as "going public." The offering or issuing of securities is regulated SEC. Public companies are obligated to report their financial conditions, material developments, and any other operational activities.

Eastern agreements

are signed severally and jointly (undivided liability).

Western agreements

are signed severally but NOT jointly (divided liability).

Selling Group members

do not have a say in the pricing of the new issue (No financial responsibility).

"Immediate Family Members"

does not include Aunts, Uncles, and Grandparents.

Investment Bankers

firms hired by corporations to help them with various financing and corporate-related matters.

Secondary Distribution

is a redistribution of a large block of securities held by a few owners (Insider selling - Institutional selling). The proceeds are paid to the sellers. Secondary shares may be purchased on margin.

The Agreement Among Underwriters

is an agreement between managing underwriter and syndicate members. There are two types of agreements: Western or Eastern Agreement.

A market-out clause

is an escape clause that allows the underwriters to be released from their commitments if a material adverse development affects the securities markets.

The Chinese Wall (also known as Information Barriers)

is an imaginary barrier between the investment banking department, research department, and trading/market making departments. Its main purpose is to prevent material, non-public information from being shared between departments within a broker-dealer, thereby promoting confidentiality and trust with the investing public.

Red Herrinq or Preliminary Prospectus

is an initial version of the prospectus included with the registration statement filed with the SEC. It is used to solicit indications of buyer interest in the distribution during the 20-day cooling period prior to the security becoming "effective."

Registration Statement

is filed with the SEC by the managing underwriter for the corporation. It must contain a full and fair disclosure of all relevant facts of the company and the offering. It describes the issuer's business and the use of the proceeds. It is not sent to investors. Investors get a prospectus once the registration is "effective." The SEC does not approve or disapprove of the registration but may reject the statement if it finds that the statement is deficient.

A Syndicate Group or Syndicate Desk

is generally a group of broker-dealers who agree to handle the distribution of new issue of common stock (equity issue) by the issuer (the company) to the investing public. The Group or Desk does research, advises on the required filings with regulatory agencies like the SEC and FINRA, maintains a record of orders (order book), and the Syndicate Manager will allocate the new issues of stock to each syndicate group member.

The Due Diligence Meeting

is held by the issuer and its investment banking team to review the offering, deficiency letters, and the final prospectus. The meeting is held near the end of the cooling period. The public offering price is not determined at this meeting.

Primary Distribution —

is the distribution of authorized but previously unissued shares to the public. The proceeds are paid to the The stock is new stock and has never been publicly held. Primary shares cannot be purchased on margin. An initial public offering (IPO) is considered a primary offering and requires SEC registration before being sold to the public.

"20" Day Coolinq Period

is the minimum waiting period required by the SEC before the issue can become 'Effective." Distributions of new issue shares may not begin before the "effective date."

Issuers of new issues

may direct sales of shares to anyone who does not meet the definition of a restricted person.

Restricted persons

may purchase shares if such a purchase is done to maintain a proportionate share of ownership in a company in which the restricted person already has ownership.

The Final Prospectus

must include the date of the prospectus, a statement as to possible stabilizing transactions, any penalty clauses, and a statement that the SEC neither approves nor disapproves of the securities. Copies of the underwriting agreement and opinions of counsel are NOT included in the prospectus.

Quiet period

no member may publish research reports regarding a subject company for which the member acted as manager or co-manager of: 1. an initial public offering for 10 calendar days following the date of the offering or 2. a secondary Offering, for 3 calendar days following the date of the offering.

Stabilization or Pegging the price

of a new issue occurs when the managing underwriter attempts to halt the decline in the market price of a new issue by stepping away from the syndicate and becoming a buyer in the secondary market to offset the effect of an immediate and unexpected flow back of securities into the market. (Regulation M)

Reallowance

paid to broker-dealers that are not syndicate or selling group members

c. Selling Concession

paid to selling group members

Underwriter's Compensation (or Retention)

paid to underwriting syndicate members; the difference between the underwriter's compensation and the selling concession is the retention.

Standby purchasers

person who would normally be restricted

Blue Sky

the issue means the issue is qualified by the underwriter's counsel in each state in which it will be sold.

Research Analysts

under the JOBS Act, _________________________ covering emerging growth companies involved in an IPO may: I. Attend meetings with the issuer's management and investment banking personnel, including "pitch" meetings. Although they cannot solicit investment banking business, they can outline their research factors considered in the analysis of a company and ask follow-up questions. 2. Publish research reports immediately before and after the IPO "quiet period" without the research reports being considered "offers" by the SEC.