Spring 2013
Securities Regulation
Linda Boss
Module III Notes
February 13, 2013
4. PUBLIC OFFERINGS
Relevant Rules & Statutes
1. Sections of the Securities Act
a. 2(a): Definitions
b. 4: Exempted Transactions
i. 4(4) if you’re not selling from your allotment, you’re exempt from § 5 because it’s not a solicitation.
c. 5: Prohibitions Relating to Interstate Commerce and the Mails
- 7(a): Information Required in Registration Statement
e. 8: Taking Effect of Registration Statements and Amendments Thereto
f. 10: Information Required in Prospectus
2. Rules of the Securities Act
a. 134: Communications not deemed a prospectus
i. identifying statements (a) issuer offering info (b) legended + where to get preliminary prospectus (c) unless tombstone or accompanied w/ preliminary prospectus
b. 135: Notice of proposed registered offerings
- 137: publications or distributions of research reports by brokers or dealers that are not participating in an issuer’s registered distribution of securities
- 138: publications or distributions of research reports by brokers or dealers about securities other than those they are distributing
e. 139: publications or distributions of research reports by brokers or dealers distributing securities
- 153: definition of ‘preceded by prospectus’ as used in section 5(b)(2) of the Act, in relation to certain transactions
g. 163: exemption from section 5(c) of the Act for certain communications by or on behalf of well-known seasoned issuers
h. 163A: exemption from section 5(c) of the Act for certain communications made by or on behalf of issuers more than 30 days before a registration statement is filed
i. 164: post-filing fee writing prospectuses in connection with certain registered offerings
i. you can say what you want as long as no confliction w/ filing, legended, unseasoned and non-reporting issuers must accompany preliminary prospectus, and file w/ SEC
j. 168: exemption from sections 2(a)(10) and 5(c) of the Act for certain communications of regularly released factual business information and forward-looking information
k. 169: exemption from sections 2(a)(10) and 5(c) of the Act for certain communications of regularly released factual business information
l. 172: delivery of prospectuses
m. 173: notice of registration
n. 174: delivery of prospectus by dealers; exemptions under section 4(3) of the Act
- 193: review of underlying assets in asset-backed securities transactions
- 405: definitions of terms
- 409: information unknown or not reasonably available
- 412: modified or superseded documents
- 413: registration of additional securities and additional classes of securities
- 415: delayed or continuous offering and sales of securities
- 420: legibility of prospectus
- 421: presentation of information in prospectuses
- 424: filing of prospectuses; number of copies
- 430: prospectus for use prior to effective date
- 430A: prospectus in a registration statement at the time of effectiveness
- 430B: prospectus in a registration statement after effective date
- 430C: prospectus in a registration statement pertaining to an offering other than pursuant to Rule 430A or Rule 430B after the effective date
- 431: summary prospectuses
- 433: conditions to permissible post-filing fee writing prospectuses
- 460: distribution of preliminary prospectus
- 461: acceleration of effective date
- 462: immediate effectiveness of certain registration statements and post-effective amendments
3. Form S-1
4. Form S-3
5. Regulation S-K Items
- 512(a): Undertakings
- 1100: asset-backed securities in general
- 1104: sponsors of asset-backed securities
- 1111: pool assets
6. Securities Exchange Act
- Rule 15c2-8: Delivery of prospectus
7. Regulation M Rules
- Regulations issued by the Federal Reserve
I. Economics of Public Offerings
a. a public offering is the first time someone becomes public to sell its stock
b. if a company sells more common stock, pre-existing common stockholders are left w/ a smaller proportionate share of the profits—known as dilution.
c. A brief description of the public offering process
i. Investment bankers may approach boards, or boards may approach investment bankers, depending upon the market for IPOs
ii. The role of investment banks as underwriters
1. Underwriters provide advice on the structure of the corporation, the securities to be offered, the offering amount, and price
2. Guide companies through SEC’s registration process
3. Market securities to the public
iii. “Effective” = when the SEC approves the IPO/the moment when the registration statement is effective and the offering can commence
iv. “Green Shoe” option—if more people want to buy than initially believed, then the underwriter has the option to offer more shares and sell them—this is limited to 15%--it’s a rule of FINRA –we don’t want a huge option so you make all your money from over-allotment
v. “firm commitment” = this is at the moment of effectiveness when issuer and underwriter signs final agreement—you can have resale price maintenance
vi. issuer proceeds = what the issuer gives up—spread between what issuer gets and securities are sold for. That’s to cover fees for the underwriter and distributions process
1. what does the spread go toward
a. selling concession—retail investor who sells the shares—they get a large commission
b. if managing underwriter sells, they get both the selling concession and the managing underwriter portion of the spread
c. expenses—big chunk is underwriter’s counsel
vii. Different types of offerings
1. Firm Commitment
a. Underwriter guarantees the sale of the offering
b. Underwriter will purchase the entire offering from the issuer before turning around and reselling the securities to investors
c. Underwriter purchases securities from issuer at a discount for helping to sell the offering and taking on the risk
d. Makes investment more likely to be profitable for the investors
2. Best Efforts
a. Investment bank agrees only to use its ‘best efforts’ to sell the offering
b. Investment bank acts purely as a selling agent, receiving a commission on each security sold
c. Investment bank assumes less risk and issuer retains more risk
d. Investors face greater risks
i. Investors have less confidence in the securities’ valuation
ii. Issuer may not sell out entire issue—obtaining only a fraction of the expected offering proceeds may jeopardize the business plan
e. Straight
i. You just sell as much as you can at that IPO price
f. Mini-max
i. I’ll sell a minimum of this, if not it goes away, but I won’t sell more than that [you won’t be one of millions of shareholders]
g. Conditional best efforts [All-or-nothing]
i. Underwriters and issuer promise to rescind all sales if the offering is not sold out
3. Direct Public Offering
a. Public offering without an underwriter
b. Very rare, because—
i. Many issuer lack necessary expertise
ii. Many issuers lack a pre-existing network among securities dealers and large institutional investors
iii. Investment banks play a gatekeeping role
1. Screen out poor or fraudulent offerings
2. Investors are likely to discount substantially the price they’re willing to pay
4. Dutch Auction Offering
a. Issuer and underwriter do not fix a price for the offering
b. Investors place bids for a desired number of shares at a specified price
c. Issuer chooses highest price that will result in offering completely selling out
d. If you have enough to clear a price, but you can’t have them all, you do a pro rate percentage
e. Investment bankers should be doing this before it declares an IPO price; there’s a de facto dutch auction inquiry before a firm commitment
viii. the underwriters
1. well-known underwriters are known as the ‘bulge bracket’
2. after successful issuance of securities, a ‘tombstone’ advertisement is released with details of the offerings
3. the tombstone lists underwriters in brackets, w/ bulge bracket up top
4. many new underwriters in recent year, which increases competition but might result in bulge bracket making bad investment decisions and damaging reputation
ix. the underwriting process
1. typically syndicate of underwriters will share the offering
a. they will sign agreement among themselves
b. lead underwriter can act on behalf of the syndicate
2. 1-3 underwriters will be managing underwriter
a. responsible for allocating offered shares to investors
b. gets issuer ready for public offering
c. ensures registration statement is filed and effective
d. prices the offering
e. performs due diligence
f. negotiates with issuer on behalf of syndicate
g. manages ultimate distribution of the securities
3. one investment bank will take primary role
4. the agreement among underwriters is being all underwriters; whereas the underwriting agreement is between the lead/managing underwriter on behalf of every other underwriter and the issuer
5. initially issuer and managing underwriter sign letter of intent
a. will not specify price
b. it states mutual intentions that the issuer and lead underwriter give to each other
i. issuer says we intend to use the underwriter
ii. underwriter says we intend to be your underwriter
iii. it can’t be a K yet because if they did it would be a sale, and there can’t be any sales until the SEC gives its blessing
iv. this is part of the ‘clubbish’ and ‘gentleman’s’ behavior
6. comfort letters
a. company/issuer counsel to the underwriter—let me give you legal comfort
b. who pays for this? The issuer.
c. The underwriter wants this to protect itself from liability. If anything false is said in this comfort letter, the law firm is being sued
7. housekeeping—
a. fixing your business [see capital structure below] to make your shares look positive for investors
8. each underwriter receives a selling concession in proportion to the # of shares that the underwriter purchases from the issuer
9. just before offering is made to the public, issuer and lead underwriter sign formal underwriting agreement
a. includes # shares to be sold by issuer to underwriters
b. public offering price
c. gross spread
d. overallotment option
e. issuer indemnification of underwriters
x. underpricing
1. very odd phenomenon where IPO shares are underpriced and overpriced at the same time
2. companies going public for the first time on average experience a large first day jump in stock price from IPO price—why do they underprice the shares?
3. Underpricing is greater during ‘hot’ issues markets when many IPOs are brought to market
4. Winners in traditional offering are initial IPO purchasers who purchase underpriced stock and profit by reselling in secondary market
5. Dutch Auction process
a. Eliminates underpricing
b. Winners are issuers
c. Market will still fix price though and issuer might give offering price exceeding company’s value
6. If we have efficient markets, explain why stocks rise a lot then fall then flatten?
a. Underwriters are pushing these investments to investors, making it a positive picture
i. Bad gatekeepers
b. The variability depends upon prospectus disclosure
i. If it’s positive—higher bump. If prospectus is neural—lower bump.
ii. This is debated
c. Proof of no efficient markets
xi. capital structure
1. investors will question an offering by a company with no assets, no prior owners, and no operating history
2. companies typically come to an IPO with at least some, and often extensive, operating and financial history
3. not all businesses are structured as corporations, but investors in public capital markets typically prefer a simple corporate structure
4. investors typically prefer companies incorporated in DE
d. public offering disclosure
i. primary problem for investors is valuing the enterprise
1. insiders have informational advantage
2. risk for outside investors is that issuers may sell overvalued shares using this information
ii. disclosure documents
1. registration statement & statutory prospectus
iii. registration statement forms
1. three categories—
a. transaction-related information
b. company information
c. exhibits and undertakings
2. S-1
a. Available to all issuers
b. Contains all 3 categories of disclosure
c. Those that are Exchange Act reporting issuers can incorporate company-related information by reference from prior SEC filings
3. S-3
a. Available to issuers that have—
i. Been a reporting company for one year
ii. Current in SEC filings
iii. Have over 75 million of voting and non-voting common equity in the hands of non-affiliates
1. Unless you limit sales in any 12 month period to maximum of 1/3 issuer’s public float of voting and non-voting common equity
b. Can incorporate by reference company-related information contained in prior SEC filings, as well as information contained in Exchange Act reports that are filed after the effective date of the Form S-3 registration statement [“forward incorporation by reference”]
iv. plain English disclosures
1. SEC requires prospectus be drafted in a ‘clear, concise and understandable manner’
e. America Depository Receipts
i. Don’t want to be listed directly on a US stock exchange
ii. You reserve 10% of the company to be part of a bank, which lists ADRs, and trades them just like stocks on the stock exchange.
iii. So they sell you receipts, which are they traded on the exchange (ADRs)—if you want stock you have to buy it on the exchange. The ADR is sold at the IPO stage.
iv. Each ADR represents a certain # of shares
v. The only point of this is because of complications w/ currency exchanges—makes things simple
f. What is a registration statement?
i. Part of an integrated disclosure system
1. The ’33 Act tells you what goes in the registration statement [S-1; S-3]
2. The ’34 Act deals w/ proxy statements [14A] and periodic reports [10-K; 10Q; 8-K]
3. These are combined in Regulations S-K and S-X
II. The Gun-Jumping Rules [Controlled Disclosure During Registration]
a. To understand disclosure in a public offering, you have to understand the statutory scheme, what the definitions mean in that statutory scheme, and the layer of SEC rules that provide further definitions and clarification [sometimes w/ rules; sometimes releases]; and then you also have to take into account new 2005 public offering rules that change a lot of previous rules reflecting technological realities of today
b. Three goals of gun-jumping rules
i. Registration process focuses on two mandatory disclosure documents—formal registration statement and statutory prospectus
ii. Requires distribution of the statutory prospectus to investors in the offering, as well as other investors for a specified period of time thereafter