Corporate Underwritings

Which statement is TRUE about the use of a "red herring" preliminary prospectus? A. The preliminary prospectus may be sent to a potential customer prior to that customer expressing an indication of interest B. The preliminary prospectus may be sent to a potential customer only after that customer has expressed an indication of interest C. The preliminary prospectus may only be sent to a customer after the registration of the issue is effective D. The preliminary prospectus may only be sent with the confirmation of sale of the issue

The best answer is A. A "red herring" preliminary prospectus may be sent to any prospective purchaser of that new issue once the issue has entered into the "20-day cooling off" period that commences upon filing of the registration statement with the SEC. The use of the "preliminary prospectus" does not constitute an "offer" under the Securities Act of 1933, and the red ink statement on the cover of the preliminary prospectus states this (hence the name "red herring"). The red herring is used to obtain non-binding indications of interest in the issue, and may be sent to anyone during the cooling off period, whether or not that person has previously expressed any interest in the issue.

A U.S. soft drink manufacturer buys a French soft drink manufacturer. This is a: A. horizontal merger B. vertical merger C. diagonal merger D. foreign exchange

The best answer is A. A horizontal merger is where 2 companies in the same industry merge, usually to achieve economies of scale.

A tombstone announcement would show which of the following? I Gross proceeds of a new issue offering to the issuer II Net proceeds of the new issue offering to the issuer III Syndicate member names IV Syndicate member participations A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. A tombstone announcement shows the gross proceeds of a new issue offering. It does not show the net amount received by the issuer (that is, the gross proceeds reduced by the underwriter's spread). It does not show the syndicate member participations, though it does show syndicate member names. It does not indicate whether the syndicate account is Eastern or Western. These items are found in the syndicate agreement.

In a best efforts underwriting, the underwriter is acting as a(n): A. agent B. principal C. dealer D. specialist (DMM)

The best answer is A. In a best efforts underwriting, the underwriter promises to use his or her best efforts to sell the issue but takes no financial liability. Thus, this is an agency relationship. In contrast, firm commitment underwritings are principal relationships.

An underwriting agreement where the syndicate members are liable for any unsold securities is a(n): A. firm commitment underwriting B. best efforts underwriting C. all or none underwriting D. mini-maxi underwriting

The best answer is A. In a firm commitment underwriting, the underwriter buys the issue outright from the issuer, with the intention of reselling the issue to the public at a profit. Thus, the underwriter is a principal in the transaction, and is taking full financial liability. In a best efforts underwriting, the underwriter acts as agent, promising to use his best efforts to sell the issue, but takes no financial liability. In a best efforts - all or none underwriting, the underwriter acts as agent, using his best efforts to sell the issue, but takes no financial liability. However, if a minimum amount is not sold, then the offering is canceled. In a mini-maxi underwriting, a minimum amount of the offering must be sold, otherwise the deal is canceled. Once the minimum is reached, the underwriters will continue to use their best efforts to sell the maximum amount specified in the offering.

In a leveraged buy out: I a public company is taken "private" II a private company is taken "public" III financing for the takeover is provided by a commercial bank or by issuing junk bonds IV financing for the takeover is provided by issuing common stock A. I and III B. I and IV C. II and III D. II and IV

The best answer is A. In a leveraged buy out, an investor group identifies a publicly held company whose shares are underpriced; or one that it believes can be managed more effectively; and arranges for financing (usually from a commercial bank or by issuing junk bonds) to make a tender offer for all of the company's outstanding shares. Given that the existing shareholders tender their shares, the company now is owned by the investor group; who installs a management team that will run the company more efficiently; and who will sell off underperforming corporate assets; using the proceeds to pay off the loan. At a later date, after the company is "cleaned up," the company may be resold to the public in a managed underwriting.

Most of the registration statement filed with the SEC is information that is found in the: A. Preliminary Prospectus B. Underwriting Agreement C. Trust Indenture D. Annual Report

The best answer is A. Most of the registration statement filed with the SEC for a new issue is found in a copy of the prospectus; much of which is financial information about the issuer.

When a customer buys a new stock issue from a syndicate member, the customer pays: A. the Public Offering Price B. the Public Offering Price plus a commission C. a negotiated price that can be at or below the Public Offering Price D. any price because this is a negotiated market offering

The best answer is A. New stock issues are sold under a prospectus that states the Public Offering Price, which is inclusive of any compensation to the underwriter (the spread). Additional commissions or charges above the P.O.P. are not allowed.

Stand-by underwritings are a(n): A. firm commitment underwriting B. best efforts underwriting C. all or none underwriting D. agency underwriting

The best answer is A. Stand-by underwritings are used in connection with rights offerings. If all of the new shares are not subscribed by the existing shareholders, the issuer has an underwriter stand-by on a firm commitment basis to purchase any unsubscribed shares. Thus, the issuer is assured of selling all of the new shares. Best efforts and all or none are types of underwritings where the underwriter is not liable for any unsold shares - the underwriter is acting as agent for the issuer helping in the sale of the offering.

The self-supporting spouse of a registered representative has an account with your firm. Your firm is underwriting the initial public offering (IPO) of ACME Co. common stock, and the spouse inquires about whether it is possible to receive an allocation. The registered representative should inform the spouse that the issue: A. cannot be purchased through the IPO B. can only be purchased through the IPO if the amount purchased is insubstantial C. can only be purchased through the IPO with the approval of FINRA D. can be purchased through the IPO without restriction

The best answer is A. . FINRA prohibits the purchase of equity IPOs (Initial Public Offerings) by industry "insiders." The list of prohibited purchasers includes FINRA member firms for their own accounts, officers and employees of member firms (and their immediate family members), fiduciaries to member firms (such as accountants and lawyers that are retained by FINRA member firms); and investment managers for investment companies, insurance companies, pension plans, who want to buy personally, etc.

A preliminary prospectus may first be sent to a customer: A. prior to the filing of a registration statement with the SEC B. once the registration statement has been filed with the SEC C. once a final price amendment has been filed with the SEC D. once registration is effective

The best answer is B. A "red herring" preliminary prospectus may be sent to any prospective purchaser of that new issue once the issue has entered into the "20-day cooling off" period that commences upon filing of the registration statement with the SEC.

Which of the following statements are TRUE regarding the use of a preliminary prospectus? I The preliminary prospectus may be sent to a potential customer prior to that customer expressing an indication of interest II The preliminary prospectus may not be sent unless a customer expresses an indication of interest for the new issue III The preliminary prospectus may be sent prior to the issue entering the 20-day cooling off period IV The preliminary prospectus may be sent once the issue enters the 20-day cooling off period A. I and III B. I and IV C. II and III D. II and IV

The best answer is B. A "red herring" preliminary prospectus may be sent to any prospective purchaser of that new issue. There is no requirement for the customer to give an "indication of interest" first. The use of the red herring is permitted only when the issue has entered into the "20-day cooling off" period that commences upon filing of the registration statement with the Securities and Exchange Commission. It cannot be sent to prospects prior to this date - as a matter of fact, no communications to customers about the proposed offering are permitted prior to the filing of the registration statement.

An ice cream manufacturer buys a dairy farm. This is a: A. horizontal merger B. vertical merger C. diagonal merger D. leveraged buy out

The best answer is B. A vertical merger is where companies in 2 different (but usually related) industries merge, for some business benefit. In this case, the ice cream manufacturer believes that if it owns its own dairy farm, it can make the milk used in ice cream production more cheaply than it can purchase it.

The Public Offering Price for a new issue is set at $25 per share. Which of the following are likely to be stabilizing bids? I $20.00 II $24.88 III $25.00 IV $30.00 A. I and II B. II and III C. III and IV D. I, II, III, IV

The best answer is B. Stabilizing bids are entered at or just below the public offering price, never above. If the public offering price is $25 per share, bids of $25 and $24.88 can be stabilizing bids. A bid of $20 is too low; a bid of $30 is too high.

In which of the following types of underwriting commitments are the underwriters acting as agents? I Firm II Stand-By III All or None IV Best Efforts A. I and II only B. III and IV only C. II and III only D. I, II, III, IV

The best answer is B. The types of underwriting commitments are: Firm commitment (underwriter acts as principal), Best Efforts, Best Efforts-All or None (underwriter acts as agent in both), and Stand-By (underwriter acts as principal to buy unsubscribed shares in a rights offering from the issuer).

An automobile manufacturer decides to distribute shares of its parts making subsidiary to existing shareholders as a separate operating company. This is a: A. break up B. spin off C. fall out D. leveraged buy out

The best answer is B. This company is "spinning off" a subsidiary to its shareholders as a separate stock company. Larger companies do this when they feel that the subsidiary will be better managed; and have better business opportunities; as a legally separate operating company. Do not confuse a "spin off" with a "break up." A "break up" is a government ordered splitting up of a company; usually as a result of the company engaging in monopolistic practices.

Which statements are TRUE about the use of a "red herring" preliminary prospectus? I A preliminary prospectus may be sent to a prospect before the issue has entered into the 20-day cooling off period II A preliminary prospectus may be sent to a prospect once the issue has entered into the 20-day cooling off period III The preliminary prospectus can be sent to any potential customer IV The preliminary prospectus can only be sent to customers who have previously purchased new issues A. I and III B. I and IV C. II and III D. II and IV

The best answer is C. A "red herring" (preliminary prospectus) may be sent to any prospective purchaser of that new issue once the issue has entered into the "20-day cooling off" period that commences upon filing of the registration statement with the SEC. Prior to the 20 day cooling off period, the filing was not made, so nothing can be sent to prospective customers.

All of the following information would be found in a new issue "tombstone" announcement EXCEPT the: A. names of the underwriters B. aggregate offering price C. net proceeds to the issuer D. type of security offered

The best answer is C. A tombstone announcement is published once a new issue's registration is effective. Under SEC rules, the announcement is very limited in scope, since it cannot be considered to be an "offer or advertisement," as these can only be made through the prospectus. The information in the Tombstone is limited to: Name of issuer; names of underwriters; type of security; public offering price of security; aggregate public offering price of issue; nature of the issuer's business. Any additional information is not allowed. Therefore, the net proceeds received by the issuer after the underwriter's spread is paid, is not found in the Tombstone. Please note, however, that this information is found on the front cover of the prospectus.

All of the following statements are true regarding "indications of interest" EXCEPT indications of interest: A. allow an underwriter to gauge investor interest in the issue B. help the underwriter to decide the final Public Offering Price C. are binding on both the customer and the underwriter D. can be canceled by both the customer and the underwriter

The best answer is C. An indication of interest is taken during the 20 day cooling off period before a new issue's registration is effective. The issue may never "go effective" and the indication can be canceled by the underwriter. Thus, the underwriter can cancel or change the indication. Similarly, the customer can also cancel or change his indication. These are not binding because the issue cannot be legally "offered or sold" until the effective date. Indications are used by the underwriter to gauge investor interest in the issue; and to help establish the proper Public Offering Price for the securities.

Which statement is TRUE about the preliminary prospectus used during the period when a new issue is "in registration?" A. Before contacting a customer by telephone about the offering, that customer must receive a copy of the preliminary prospectus B. The preliminary prospectus, accompanied by a research report, should be sent to all to the firm's clients C. Customers that would be prospective buyers of the offering may be sent the preliminary prospectus D. The preliminary prospectus cannot be sent during the period when the issue is "in registration"

The best answer is C. During the 20-day "cooling-off" period when a new issue is in registration, a new issue cannot be sold, offered, recommended, or advertised. However, it is permitted to send preliminary prospectuses to any interested investors (legally, these are not an advertisement). The sending of a research report is prohibited - this would be advertising. There is no requirement to contact the prospective customer by phone before sending a preliminary prospectus. By sending out preliminary prospectuses, the underwriters can gauge investor interest in the issue, and can determine the final size and Public Offering Price for the deal.

Which of the following activities are prohibited during the "cooling off" period? I Accepting an indication of interest from the customer for part of the issue II Accepting an order for part of the issue in registration III Confirming a certain amount of the issue to a customer IV Accepting a check from a customer for the part of the issue A. IV only B. II and III C. II, III, IV D. I, II, III, IV

The best answer is C. During the cooling off period, an offer or sale of the issue is prohibited. Accepting an order, confirming a certain amount of the issue, or accepting a check from a customer are all considered to be "sales" and are prohibited until registration is effective. Sending a preliminary prospectus or accepting an indication of interest does not legally constitute an "offer" under the Securities Act of 1933, and thus is permitted.

Investment banks perform which of the following functions? I Underwrite new issues on a principal basis II Distribute new issues on an agency basis III Help issuers in publicizing new issue offerings IV Accept time and demand deposits A. II and III only B. III and IV only C. I, II, III D. II, III, IV

The best answer is C. Investment banks are prohibited from accepting time and demand deposits. These can only be accepted by commercial and savings banks. Investment banks can underwrite new issues on a principal basis, an agency basis, and can help publicize the issues underwritten.

In a registered secondary distribution, which statement is FALSE? A. The offering is made at the POP B. The purchaser must receive a prospectus C. The proceeds from the sale go to the issuer D. The issue cannot be purchased on margin

The best answer is C. Underwritten offerings can be primary or secondary offerings (or both at the same time!). Assume that a privately held company wants to go public. The company wants to raise $300,000,000. To do this, the company will be issuing $150,000,000 of new shares (this is the primary portion of the distribution, where the proceeds of the sale go to the issuer) and another $150,000,000 consists of shares being sold by officers and directors of the company (who now want to cash out some or all of there investment in the company). The proceeds from the secondary portion go to the selling shareholders. This is a combined primary and secondary offering. All shares are sold with a prospectus at the POP and full payment is required (which is the case for any prospectus offering).

Which of the following statements are TRUE about the acceptance of an "indication of interest" for a registered offering during the 20 day cooling off period? I The indication cannot be canceled by the customer II The indication cannot be canceled by the brokerage firm III The indication can be canceled by the customer IV The indication can be canceled by the brokerage firm A. I and III B. I and IV C. II and III D. III and IV

The best answer is D. Indications of interest which are accepted prior to the effective date of an issue in registration are not binding. The customer or the firm can cancel the indication at any time without penalty. During the cooling off period, orders cannot be accepted (these are binding) because the final prospectus is not yet available. Under the Securities Act of 1933, an offer or sale can only be made with the final prospectus. The final prospectus is available and sales commence as of the effective date.

Which statement is TRUE? A. A primary distribution is one that first must be offered to retail investors while a secondary distribution is one that first must be offered to institutional investors B. A primary distribution is one that is made using an underwriter while a secondary distribution is one sold directly to the public without the use of an underwriter C. A primary distribution cannot be combined with a secondary distribution D. The proceeds from a primary distribution go to the issuer while the proceeds from a secondary distribution go to the selling shareholder

The best answer is D. Underwritten offerings can be primary or secondary offerings (or both at the same time!). Assume that a privately held company wants to go public. The company wants to raise $300,000,000. To do this, the company will be issuing $150,000,000 of new shares (this is the primary portion of the distribution, where the proceeds of the sale go to the issuer) and another $150,000,000 consists of shares being sold by officers and directors of the company (who now want to cash out some or all of there investment in the company). The proceeds from the secondary portion go to the selling shareholders. This is a combined primary and secondary offering. All shares are sold with a prospectus at the POP and full payment is required (which is the case for any prospectus offering).

In a new corporate bond offering, the lead underwriter selects syndicate members based upon: I geographic location II track record III financial capability IV historic relationships A. I and II only B. III and IV only C. I, II, III D. I, II, III, IV

The best answer is D. When selecting underwriters in a corporate offering, the manager will consider the track record of that firm in previous underwritings; whether the firm has sufficient capital to handle its portion of the offering; whether the firm has participated in underwritings with that manager in the past and; the geographic location of the syndicate members. Geographic location is important because the manager wants to reach as many potential investors as possible.

Syndicate

a group of investment banking firms that, with the lead underwriter(s), shares in the financial responsibility and liability of offering and selling new issues to the public. Each syndicate member firm signs a document in which it agrees to share in the profit and the financial liability associated with the underwriting.

Vertical merger

a merger of two companies in different, but usually related, industries. For example, an ice cream manufacturer that buys a dairy farm is a vertical merger

Horizontal merger

a merger of two companies in the same industry. For example, two ice cream manufacturers merging is a horizontal merger.

Agent

a registered person or business organization that acts as the intermediary in the purchase or sale of a security and charges a commission for the service. A broker, registered representative or account executive is an agent. A brokerage firm may be an agent in an underwriting when it does not take financial liability for the issue, such as in a "best efforts" underwriting

Principal transaction

a trade where a member firm acts as a dealer in the transaction, selling the security to the customer out of the firm's inventory; or buying the security into the firm's inventory from the customer. When effecting a principal transaction, the dealer earns a mark-up when the security is sold to a customer; and a mark-down when the security is bought from a customer. Also, a member firm can be a principal in an underwriting when it takes financial liability for the issue, as in a firm commitment underwriting

Dealer

also called a principal or a market maker, this is a FINRA member firm that makes a market in an over-the-counter security; or an exchange Specialist/DMM that makes a market in an exchange listed security.

Investment banker

also called an underwriter, a securities firm that assists issuers such as corporations or governments in raising capital by issuing securities.

Underwriter

also known as an investment banker, a brokerage firm that assists an issuer of a new security in setting the offering price and in marketing the securities to the public.

Preliminary prospectus

also known as the "red herring" because of the disclaimer printed in red on the cover, this is the preliminary prospectus which may be sent to potential purchasers of a new non-exempt securities issue during the 20-day cooling off period under the Securities Act of 1933. Legally, the preliminary prospectus does not offer the securities, since this is prohibited during the cooling off period. The red herring is used to get an indication of the public's interest in a security before the final price is set and the security is issued

Tombstone

an announcement of a public offering of securities published in financial newspapers and periodicals by the underwriters. So-called, because the announcement looks like a "tombstone," the content is legally limited by the Securities and Exchange Commission for non-exempt securities offerings so that the announcement is not considered to be overly promotional.

Specialist

an exchange member located at the trading post, responsible for maintaining a fair and orderly market in the stock(s) assigned to him or her by the exchange. This person "specializes" in making a market in the stock, hence the name. Specialists buy and sell that stock for their own account, making a continuous market in the stock. In addition, the Specialist performs a second function by maintaining the "book" of open orders for other retail brokerage firms. On the Specialist's book are placed the orders that are "away from the current market" (limit, stop, and stop limit orders). These are executed by the Specialist for the retail broker when the market reaches the price specified on the order. In this capacity, the Specialist is acting as a "broker's broker." In 2009, the NYSE renamed the Specialist the "DMM" - Designated Market Maker.

Red herring

jargon for the preliminary prospectus because of the disclaimer printed in red on the cover, this is the preliminary prospectus which may be sent to potential purchasers of a new non-exempt securities issue during the 20-day cooling off period under the Securities Act of 1933. Legally, the preliminary prospectus does not offer the securities, since this is prohibited during the cooling off period. The red herring is used to get an indication of the public's interest in a security before the final price is set and the security issued.

Cooling off period

the 20-day period following the filing of a registration statement with the SEC for a new non-exempt securities offering. During the "cooling off" period, the issue cannot be sold, advertised, recommended; nor can orders to buy the issue be solicited from customers. During the "cooling off" period, the SEC reviews the filing for "full and fair disclosure."

Leveraged buy out (LBO)

the purchase of all of the outstanding shares of a publicly traded company, with the monies used to purchase the shares coming from a bank loan; or the sale of long term bonds (hence the term Leveraged Buy Out). Once the company has been bought out, new management will reduce costs; and sell assets; to generate funds to pay down the debt incurred in the LBO.