Chapter 7: Issuing Securities

The underwriter's considerations include the following:

*Stocks or bonds*: although debt financing comprises the bulk of corpoate financing, if bonds are currently selling with high coupon rates, the company may choose to issue stock> Determining the cheapest cost of capital is a very important role of the investment bank. *Tax consequences of the offering*: The interest a corporation pays on its bonds is tax deductible; cash dividends to stockholders are paid out of after tax profits *Money market financing*: Money market instruments are a short term financing mechanism, typically for one year or less *Capital market financing*: The capital markets represent long term financing for secured bonds, debentures, and preferred or common stock. These securities require registration and sale by prospectus

risks beyond the underwriters control vs. risks that the underwriter must assume

*risks beyond the underwriters control*: and example of this would be the sudden death of the company president *risks that the underwriter must assume*: an example of this would be a Federal Reserve policy shift that leads to a general market decline before the offering

For IPOs (Initial Public Offerings) what is the period of prospectus delivery requirement period? What about for additional issue offerings?

- 90 days if the security is to be quoted on the OTC Pink or over the OTCBB (non-Nasdaq) - 25 days if the security is to be listed on an exchange or quoted over Nasdaq - if the security is listed or quoted over Nasdaq, a prospectus must be delivered only in connection with purchases at the public offering price. Once the distribution is complete, there is no obligation to deliver a prospectus in secondary market transactions - If the security is non-Nasdaq, the prospectus delivery requirement is 40 days

The regulation statement must contain

- A description of the issuer's business - The names and addresses of company officers and directors, their salaries, and a five year business history of each - The amount of corporate securities company officers and directors own and identification of investors who own 10% or more of the company - The company's capitalization, including its equity and debt - A description of how the proceeds will be used - Whether the company is involved in any legal proceedings

An investment banks functions may include the following:

- Advising corporations on the best ways to raise long term capital - Raising capital for issuers by distributing new securities - Buying securities from issuers and reselling them to the public - Distributing large blocks of stock to the public and to institutions - Helping issuers comply with securities laws

List what the final prospectus must use:

- Description of the offering - Offering price - Selling discounts - Offering rate - Use of the proceeds - Description of the underwriting, but not the actual contract - Statement of the possibility that the issue price may be stabilized - History of the business - Risks to the purchasers - Description of management - Material financial information - Legal opinion concerning the formation of the corporation - SEC disclaimer

As part of the due diligence process, investment bankers must:

- Examine the use of the proceeds - Perform financial analysis and feasibility studies - Determine the company's stability - Determine whether the risk is reasonable

The issuer (the party selling the securities to raise money) is responsible for:

- Filing the registration statement with the SEC - FIling a registration statement with the states in which it intends to sell securities (also known as *blue skying* the issue) - Negotiating the securities' price and the amount of the spread with the underwriter

Types of offerings:

- New issues - Additional issues - Primary offering - Secondary offering - Split offering - Shelf offering

Exempt transactions: securities offered by industrial, financial, and other corporations may qualify for exemption from the registration statement and prospectus requirements of the 1933 Act under one of the following exclusionary provisions ...

- Regulation A: corporate offerings of less than $5 million - Regulation D: private placements - Rule 147: securities offered and sold exclusively intrastate - Regulation S: offers and sales made outside the United States by U.S. issuers - Other exempt transactions, including: rule 144, rule 144a, and rule 14

How does the 1933 Act protect investors who buy new issues?

- Requiring Registration of new issues that are to be distributed interstate - Requiring an issuer to provide full and fair disclosure about itself and the offering - Requiring an issuer to make available all material information necessary for an investor to judge the issue's merit - Regulating the underwriting and distribution of primary and secondary issuers - Providing criminal penalties for fraud in the issuance of new securities

Exempt issuers and securities: certain securities are exempt from the registration statement and prospectus requirements of the 1933 Act, either because of the issuer's level of creditworthiness or because another government regulatory agency has jurisdiction over the issuer ... these exempt securities include:

- U.S. government securities - municipal bonds - commerical paper and bankers acceptances that have maturities of less than 270 days - insurance policies and fixed annuity contracts (but no variable annuities) - national and state bank (not bank holding company) securities - Building and loan (S&L) securities - charitable, religious, educational, and nonprofit association issues

What variables may be considered when pricing new issues?

- indications of interest from the underwriters book - prevailing market conditions, including recent offerings, and the prices of similar new issues - Price that the syndicate members will accept - *Price to Earnings (PE) Ratios* of similar companies and the company's most recent earnings report (at what price the shares must be offered so that the PE ratio is in line with the PE rations of other similar publicly

During the cooling off period, underwriters may not:

- make offers to sell the securities - take orders - distribute sales literature or advertising material

During the cooling off period, underwriters may:

- take indications of interest - distribute preliminary prospectuses - publish tombstone advertisements to provide information about the potential availability of securities

What are the 3 steps of the "underwriting sequence"

1. Forming the syndicate 2. Pricing the new issue of publicly traded securities 3. Stabilizing Price

What are the Three Phases of Underwriting?

1. Issuer files registration statement with the SEC 2. Cooling off period 3. Effective date - offering period may begin

5 types of underwriting commitments:

1. firm commitment 2. standby 3. best efforts 4. underwriting compensation 5. over allotments (green shoe option/provision)

Underwriting Syndicate

A group of other broker/dealers to assist in the distribution of the new issues which helps spread out the risk among the syndicate

Prospectus

A prospectus is a formal legal document that is required by and filed with the SEC that provides details about an investment offering for sale to the public

Split offering (combined distribution)

A split offering is a combination of a primary and secondary offering - the corporation issues a portion of the stock offered, and existing shareholders offer the balance

What is a tombstone advertisement?

A tombstone advertisement will show the anticipated gross proceeds of the issue. A final prospectus will show both the gross and the net proceeds to the issuer

What is an Investment Bank

An investment bank is a securities broker/dealer that underwrites new issues

What is an underwriter and what does he do?

An underwriter is a broker/dealer that specializes in investment banking and the distribution of new issues. The underwriter will often advise the issuer regarding the best financing mechanism (equity or debt) in light of current market conditions and tax considerations

The underwriter generally:

Assists with the registration and distribution of the new security and may advise the corporate issuer on the best way to raise capital

Best efforts

Best efforts underwriting calls for the broker to buy securities from the issuer as agent, not as principal this means that that underwriter is not committed and is therefore not at risk

Final Prospectus

Contains finalized background information including such details as the exact number of shares/certificates issued and the precise offering price and is printed after the deal has been made effective

What happens during a "cooling off period"

During a cooling off period, no one can solicit sales during the cooling off period, but indications of interest can be solicited with a red herring

T/F the SEC review examines the prospectus for completeness, guarantee's the disclosure's accuracy, and approves it for security

FALSE; The SEC review examines the prospectus for completeness HOWEVER it does guarantee the disclosure's accuracy or approve the security - it simply clears it for distribution

Public Offering vs. Private Placement

In a public offering, securities are sold to the investing public through one or more broker/dealers A private placement occurs when the issuing company, usually with the assistance of its investment bank, sells securities to private investors as opposed to the general investing public

All or none (AON) underwriting

In an AON underwriting, the issuing corporation has determined that it wants an agreement outlining that the underwriter must either sell all of the shares or cancel the underwriting

Prospectus Delivery Requirement Period

In certain offerings, a final prospectus must be delivered by all members to buyers in the secondary market for a specified time following the effective date

Mini max offering

Is a best efforts underwriting with a floor and a ceiling on the dollar amount of securities the issuer is willing to sell. The underwriter must locate enough interested buyers to support the minimum (floor) issuance requirement. Once the minimum is met, the underwriter can expand the offering up to the maximum (ceiling) amount of shares the issuer specified

New issue market

Is composed of companies going public by selling common stock to the public for the first time in an initial public offering (IPO).

Secondary offering

Is one in which one or more major stockholders in the corporation are selling all or a major portion of their holdings

Primary offering

Is one in which the proceeds of the underwriting go to the issuing corporation - and it may do this at any time and in any amount, provided the total stock outstanding does not exceed the amount authorized in the corporation's bylaws.

Over allotments (green shoe option/provision)

Legally referred to as an over allotment option, this provision, found in the underwriting agreement, gives the underwriter the right to sell investors more shares than the issuer had originally planned. The option allows the underwriters to sell up to 15% more shares than the original number set by the issuer and would normally be done if the demand for a security issue proves higher than expected

Additional issue market

Made up of new securities by companies that are already publicly owned

What are control securities?

Owned by directors, officers, or persons who own or control 10% or more of the issuer's voting stock

What is the Securities Act of 1933 also referred to as?

Paper Act, Full Disclosure Act, New Issue Act, Truth in Securities Act, and the Prospectus Act

Phase 1 of Underwriting: Issuer files registration statement with the SEC

Prior to the filing of the registration statement, no sales can be solicited and no prospectus can circulate

What is due diligence?

Reasonable steps taken by a person or group in order to satisfy a legal requirement, especially in buying or selling something

Regulation A: Small Offerings

Regulation A permits issuers to raise up to $5 million in a 12 month period without full registration - which allows a small company access to the capital market to raise a small amount of money without incurring prohibitive costs

Rule 144

Rule 144 regulates the sale of control and restricted securities, stipulating the holding period, quantity limitations, manner of sale, and filing procedures

Phase 3 of Underwriting: Effective Date

Sales can now be solicited, but the firm must use a final prospectus

What did the Maloney Act do?

The Maloney act amended in the Securities Exchange Act in 1938 and established self regulatory bodies to help police the industry (such as FINRA, MSRB, and CBOE)

Regulation D: Private Placements

The SEC does not require registration of an offering if it is privately placed with: - accredited investors (someone who has a net worth of $1 million or more, not including net equity in a primary residence or has an annual income of $200,000 or more in each of the two most recent years (or $300,000 jointly with a spouse) and who has a reasonable expectation of reaching the same income level during the current years) that do not need SEC protection or a maximum of 35 individual (nonaccredited) investors

Who are the main participants in a new issue?

The company selling the securities and the broker/dealer acting as the underwriter

Underwriting Agreement (UA)

The contract that establishes the relationship between the issuer and the underwriters, setting forth their respective rights and obligations and the terms and conditions upon which the issuer is required to sell and the underwriters are required to purchase the securities

Firm commitment

The firm commitment is a widely used type of underwriting contract and under its terms, the underwriter contracts with the issuer, selling investors, or both to buy the securities described in the contract at a specified price and quantity range on or about a given date. The TERMS are detailed in a *letter of intent (LOI)* signed by the underwriter and the issuer during the early stages of negotiation

Preliminary Prospectus

The first offering document provided by a security issuer and includes most of the details of the business and transaction in question

Forming the syndicate

The syndicate and selling group may be assembled either before or after the issue is awarded to the underwriter in *competitive bidding*, the syndicate is assembled first, and syndicate members work together to arrive at the bid In *negotiated underwriting*, the syndicate may be formed after the issuer and the underwriting manager have negotiated the terms of the offering

What do advertising and sales literature include?

They include: - any notice - circular - advertisement - letter - other communication published or transmitted to any person

The Securities Exchange Act of 1934

This act addresses secondary trading of securities, personnel involved in secondary trading, and fraudulent trading practices. This act also created the Securities and Exchange Commission (SEC) to oversee the industry.

The Securities Act of 1993

This act regulates new issues of corporate securities sold to the public and requires securities issuers to provide enough information for investors to make fully informed buying decisions. This information must be filed with the SEC and published in a prospectus. The act prohibits any fraudulent activity in connection with the underwriting and issuing of all securities.

Preliminary Prospectus/Red Herring

This can be used as a prospecting tool allowing underwriters and selling group members to gauge investor interest and gather indications of interest

What are restricted securities?

Those acquired through some means other than a registered public offering - a security purchased in a private placement is a restricted security

Shelf offering

Through a shelf offering an issuer who is already a publicly traded company can register new securities without selling the entire issue at once - once filed, the registration is good for two years and allows the issuer to sell portions of a registered shelf offering over a three year period without having to register the security

market out clause

To limit its risks, a market out clause in the underwriting agreement specifies conditions under which the offering might be canceled

What is the only advertising allowed during the cooling off period?

Tombstone advertisement (which is a simple statement of facts regarding the issue)

An offering is identified by who is selling the securities and whether the company is already publicly traded ... T/F

True

T/F ... After the issuer files a registration statement with the SEC, a 20 day *cooling off period* begins

True

T/F ... An issuer must file with the SEC a registration statement disclosing material information about the issue

True

T/F an investor can see a copy of the final prospectus by logging on to the SEC website

True

Rule 147: Intrastate Offerings

Under Rule 147, offerings take place entirely in one state are exempt from registration when: - the issuer has its principal office and receives at least 80% of its income in the state - at least 80% of the issuer's assets are located within the state - at least 80% of the offering proceeds are used within the state - the broker/dealer acting as underwriter is a resident of the state and has an office in the state - all purchasers are residents of the state

Underwriting compensation ... what are the *underwriting proceeds*, *public offering price*, and *underwriting spread*?

Underwriting proceeds: the price the issuer receives Public offering price: the price investors pay underwriting spread: difference between the two prices, which consists of the *manager's fee, underwriting fee, and selling concession*

Standby

When a company's current stockholders do not exercise their preemptive rights in an additional offering, a corporation has an underwriter *standing by* to purchase whatever shares remain unsold as a result of rights expiring

What is the effective date of a security?

When the security begins to trade

"pegging" or "fixing"

When the stabilization bid is made at a price higher than the public offering price

Competitive bid

in a competitive bid, a state or municipal government invites investment bankers to bid for a new issue of bonds. The issuer awards the securities to the underwriter(s) whose bid results in the lowest net interest cost to the issuer

Private placement is also referred to as __________ __________ due to this investment letter

lettered stock