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Public Offering Outline

Law Outlines > Securities Regulations (Duke Cox) Outlines

This is an extract of our Public Offering document, which we sell as part of our Securities Regulations (Duke Cox) Outlines collection written by the top tier of Duke University School Of Law students.

The following is a more accessble plain text extract of the PDF sample above, taken from our Securities Regulations (Duke Cox) Outlines. Due to the challenges of extracting text from PDFs, it will have odd formatting:


a. Underwriting i. Absent an applicable exemption, SS5 bars any offers to sell and sales of a security until a registration statement covering the security has become effective ii. 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 iii. SS11: 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 iv. 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 a. 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" a. The spread normally is composed of 3 parts: i. the management fee for the managing underwriter; ii. the underwriting compensation received by the underwriters; iii. 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 a. 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


vi. vii. viii.

ix. 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 a. If they can't sell, they have to hold the shares i. 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 a. The market might change over the weekend

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


xi. xii.

xiii. 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 a. Volcker Rule: banned proprietary trading b. Mandated that banks hold at least 5% equity in SPVs

b. Underwriting agreements, commissions, and fixed price offerings i. 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 ii. Underwriting agreement: agreement between the issuer and underwriter iii. Agreement among the underwriters: formal understanding among members of the syndicate; solidifies the managing underwriter's authority iv. 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 v. The Shoe: over-allotments occur when more shares are distributed than the underwriting syndicate was obligated to purchase from the issuer. Overallotments 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 vi. Flipping: occurs when shares in an IPO are quickly resold by the investors (flippers) (flipped) in the market at a profit. Flipping places downward


viii. ix.

x. xi.

xii. xiii. xiv.

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 embargo, economic shock, etc.)

1. Market-out clauses that are too broad are impermissible a. You're only going to have market-out clauses in a firm commitment ?if it has too many contingencies that allow you to withdraw, then it doesn't look like a firm commitment Indemnification Clause: requires the issuer to indemnify the underwriters for any liability they may incur under federal or state laws because the registration statement or prospectus is materially misleading ?shifts the cost of liability from the underwriters to the issuer Contribution Clause: contribution is a means for liability to be shared among equal wrongdoers Comfort Letters: various requirements in underwriting agreement that prior to the registration statement's becoming effective certain individuals provide the underwriter with comfort letters covering certain specified representations made in the registration statement. Thus, through the comfort letter, the underwriters create a device by which they can recover on a theory of negligent or fraudulent representation of the comfort letter for any liability the underwriters incur to investors, provided the sued-upon misrepresentations were also the subject of a comfort letter FINRA reviews all public offerings of underwritten securities to assure that member broker-dealers do not receive unfair or unreasonable compensation The offering price must be stated in the prospectus Fix price offering: price is fixed, so large institutional buyers cannot get a discount on price for buying large quantities

1. Ways to compensate large institutional buyers: a. Distributing underwriter promises to provide free goods or research service b. Overtrade or swap: buyer swaps securities in its portfolio for the security being distributed by the underwriter c. Recapture: institution will form a broker-dealer subsidiary that upon joining FINRA can purchase the offered securities from the underwriting syndicate at the customary dealer discount. The subsidiary then sells the securities at fixed price to the parent institution

c. The IPO Market i. The volume of IPOs is trivial in amount in comparison with that of other types of trading transactions

1. The volume of IPOs, nevertheless, is a visible sign of both the health of the economy and investor optimism ii. How are IPOs underpriced and overpriced at the same time?

1. The initial offering price is low ?shares close higher than their offering price

2. But, in the long run, the shares do not exhibit as much growth as other stocks

3. So IPO shares are a great buy in the short run, and a bad buy in the long run iii. Laddering (prohibited): allocating shares in hot IPOs to purchasers willing to purchase additional shares in the aftermarket ?abuse of the IPO process

1. To get these IPO shares, you have to go into the secondary market and buy additional x shares

2. Drives up the price in the aftermarket

3. Enables flipping iv. A troubling phenomenon of IPOs is underpricing, which occurs when the immediate trading market price for IPOs is significantly higher than their initial offering price v. Firms tend to time their public offerings to take advantage of surges in investor interest in public offerings

1. You want to issue the IPO when the market is at its peak ?maximize your capital

2. Scarcity: feeling of scarcity may also drive up IPO price vi. FINRA bars investment banking departments from supervising or controlling analysts (so that they are not pressured to provide "buy" or "strong buy" recommendations for the clients)

1. The new rules also prohibit analysts' compensation being linked to investment banking transactions. The rules further bar firms from issuing research reports on an issuer until 40 days after the IPO if the firm managed the offering

2. At the time of making their recommendation, analysts must disclose any conflicts of interest, including whether the analyst owns securities in the company that is the subject of the report

3. Regulation A-C: requires that analysts certify that their recommendations accurately reflect their personal views regarding the issuer's performance and prospects, and requires disclosure whether the analyst's compensation is dependent on the views expressed about the issuer

4. JOBS Act: attempts to remove analysts from promotional process
?want to make analysts independent from underwriters vii. Seasoned Equity Offering (SEO): public company offering more shares to raise more capital

d. The Registration Statement and SEC Review i. The central objective of the Securities Act is the preparation of a registration statement for securities offered to the public

1. There is little cause to doubt the Commission's power over the form and content of the '33 Act registration statements and prospectuses ii. The information that must be included in a registration statement can roughly be divided into four categories:

1. information bearing on the registrant,

2. information about the distribution and use of its proceeds,

3. a description of the securities of the registrant, and

4. various exhibits and undertakings that must be filed as part of the registration statement a. Only information within the first three categories must be reproduced in the prospectus (issuer, proceeds, issuer's securities) iii. In the registration of securities the standard forms are S-1 (p204) and S-3 (p212). S-1 is the default form because it applies when the issuer cannot meet the eligibility requirements of S-3

1. Regulation S-K contains detailed guides for what precisely must be disclosed with respect to each item iv. Information with respect to the registrant

1. Disclosures entail a fairly penetrating and detailed description of the registrant's business, property, and management

2. Must disclose the principal factors that make the offering speculative or one of high risk (risk factors)

3. "Plain English" is favored, and the summary and risk factor portions must be written in plain English a. Six plain English principles: short sentences, everyday language, active voice, tabular presentation of complex material, no legal jargon, and no multiple negatives

4. Must include audited financial statements

5. Management must identify trends and developments that it has reason to believe will affect the registrant v. The distribution and its proceeds

1. Underwriters must disclose the general terms of their agreement and their compensation

2. Must disclose net expected proceeds, and if there are plans for the proceeds, those must be disclosed vi. Securities of the registrant

1. Set forth the rights, privileges, and preferences of the security being offered vii. Exhibits and undertakings

1. Numerous exhibits must be filed as part of the registration statement, including the registrant's articles of incorporation, bylaws, attorney's opinion as to the legality of the securities registered, and any 10-K or 10-Q reports incorporated by reference into the statement viii. Registrants file their registration statements and period reports under the '34 Act electronically with the SEC via EDGAR ix. Timeline:

1. Pre-filing period a. The "quarterback" in preparing the registration statement is

normally the attorney for the company b. Gather information, secure underwriter, prepare financial statements, secure accounting firm (get audit), get affairs in order (become a corporation, get rid of unnecessary business)

2. File with the SEC

3. Waiting Period

4. Letter of comment ?from SEC a. Suggests ways you can fix your registration statement i. Issuers have absolute liability for any material misstatement/defect in registration statement ii. Generally issued within 30 days, but can take much longer

5. Registration statement becomes effective

6. Post-effective period x. The greatest amount of regulation occurs pre-filing; the least regulation occurs post-effective xi. JOBS Act: provides relaxation of several reporting requirements for "emerging growth companies"

1. SA 2(a)(19): defines emerging growth company as a registrant with less than $1 billion in total annual revenues (provided the issuer does not have a public float above $700 million). As a practical matter this category encompassed all but the very largest issuers in their initial years after an IPO

2. Exempt during their incubation period from several Dodd-Frank mandated provisions

3. Reduce from three to two years the audited financial reports for emerging growth companies and lifts during the incubation period the SOX requirement that the auditor opine on management's assessment of internal controls

4. Prohibits any FINRA and SEC rules and regulations that restrict communication or participation by analysts in an IPO by an emerging growth company a. No SEC or FINRA rule can prohibit the publication or distribution of research reports related to the IPO of an emerging growth company xii. Delaying amendment: upon filing the registration statement with the SEC and paying the filing fees, under 8(a) the registration statement can, barring any other actions, become effective automatically 20 days after filing, or 20 days after any amendment to the registration statement is filed with the SEC

1. Delaying amendment: delays effectiveness of the registration statement ?so that statement does not become effective while the SEC is reviewing it? effective 20 days after withdrawing the delaying amendment OR, when the issuer is ready to initiate the public offering, the issuer will request the SEC to "accelerate" the effective date of the registration statement a. Otherwise, the statement becomes effective automatically in 20 days

2. Thus, any information that was accurate when the registration statement initially became effective, but that is rendered false by a supervening event, can be the basis for liability under SS11 if a posteffective amendment is made to the registration statement without correcting the information rendered false by the supervening event

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