Study guide
Function 2 of the official outline covers underwriting, new financing transactions and registration, and represents about 20 of the 75 scored questions. This chapter follows a security's path to market, through SEC registration or an exemption from it, and then examines the FINRA rules that police underwriting terms, conflicts of interest and trading around distributions.
Registration Under the Securities Act of 1933
The Securities Act of 1933 requires that securities offered publicly be registered with the SEC unless an exemption applies. Its philosophy is disclosure: the SEC never approves a security's merits; it reviews whether the registration statement gives investors full and fair disclosure. The registration statement contains the prospectus plus supplemental information, and the timeline divides into three periods. In the pre-filing period, offers are prohibited, and publicity that conditions the market is gun-jumping. During the waiting period, after filing but before effectiveness, the SEC staff reviews the filing and issues comment letters while the syndicate markets with the preliminary prospectus. Once the registration statement is declared effective, sales may occur with delivery of the final prospectus. Issuers use different forms. Form S-1 is the long-form registration statement for IPOs and for issuers not eligible for anything shorter. Form S-3, the short form, lets seasoned reporting companies incorporate their Exchange Act reports by reference; primary offerings for the issuer's own account generally require a public float of at least 75 million dollars. Form S-4 registers securities issued in business combinations and exchange offers. Rule 415 shelf registration lets an issuer register securities today and take them down over roughly three years as market windows open. A well-known seasoned issuer, or WKSI, generally one with at least 700 million dollars of public float, may file an automatic shelf that becomes effective immediately upon filing. An emerging growth company, one with annual revenue below a threshold of roughly 1.235 billion dollars, may submit its IPO filing confidentially and provide scaled disclosure.
The IPO: Book-Building, Pricing, and the Greenshoe
In a firm commitment underwriting, the syndicate buys the entire issue from the issuer and resells it to investors, bearing the risk of unsold shares. The underwriters' profit is the gross spread, the difference between the public offering price and the proceeds to the issuer, traditionally split into a management fee, an underwriting fee and a selling concession. In a best efforts arrangement, the bank acts only as agent, selling what it can without purchase risk; variations include all-or-none and mini-max structures in which the offering is cancelled if a minimum is not sold. An IPO begins with an organizational meeting, followed by drafting sessions, due diligence and the S-1 filing. During the waiting period the management team and bankers conduct a roadshow, presenting to institutional investors while the bookrunner builds a book of nonbinding indications of interest at various price levels. Book-building shows the syndicate where demand clusters, and the final price is set at pricing, typically the evening the registration statement becomes effective, balancing the issuer's proceeds against the goal of a healthy aftermarket. The overallotment option, universally called the greenshoe after the company that first used it, lets underwriters buy up to 15 percent additional shares from the issuer at the offering price for 30 days. The syndicate typically oversells the deal by that amount: if the stock trades up, they exercise the greenshoe to cover the short position, and if it trades down, they buy shares in the market instead, which supports the price. Insiders customarily sign lock-up agreements, commonly 180 days, restricting their sales after the IPO.
Exempt Offerings: Regulation D, Rule 144A, Regulation S, and PIPEs
Not every offering is registered. Regulation D governs private placements. Under Rule 506(b), an issuer may raise unlimited amounts from an unlimited number of accredited investors plus up to 35 non-accredited but financially sophisticated purchasers, with no general solicitation or advertising permitted. Rule 506(c) allows general solicitation, but every purchaser must be accredited and the issuer must take reasonable steps to verify that status. Accredited investors include institutions and natural persons meeting income tests, generally 200,000 dollars individually or 300,000 jointly in each of the two most recent years, or having a net worth over 1 million dollars excluding the primary residence, along with holders of certain professional licenses. Issuers file a Form D notice with the SEC within 15 days of the first sale. Securities sold privately are restricted and generally resell publicly only under conditions such as the holding periods of Rule 144. Rule 144A creates a liquid institutional market: it provides a safe harbor for resales of unregistered securities to qualified institutional buyers, or QIBs, institutions that own and invest at least 100 million dollars in securities of unaffiliated issuers. Underwriters commonly buy a debt issue and immediately resell it to QIBs in a 144A offering, often paired with a Regulation S tranche. Regulation S provides that offers and sales made in offshore transactions to non-U.S. persons, with no directed selling efforts in the United States, fall outside the registration requirement, subject to distribution compliance periods before the securities can flow back. A PIPE, private investment in public equity, is a private placement by an already-public company, usually with an agreement to register the shares for resale promptly after closing.
FINRA Corporate Financing Rules: 5110 and 5121
FINRA polices the fairness of underwriting arrangements through Rule 5110, the corporate financing rule. For most public offerings in which a member participates, the required documents and details of the underwriting terms must be filed with FINRA no later than three business days after the registration statement is filed with the SEC, and no member may participate unless FINRA has issued a no-objections opinion on the underwriting terms. The rule limits underwriting compensation to amounts FINRA considers fair and reasonable given the offering's size and type, and compensation is counted broadly: discounts, fees, expense reimbursements, warrants and other securities received in connection with the offering. Securities received as underwriting compensation are generally subject to a 180-day lock-up following the commencement of sales. Certain offerings are exempt from the filing requirement, including offerings by seasoned issuers meeting specified criteria and investment-grade rated debt. Rule 5121 addresses conflicts of interest: a member generally may not participate in a public offering of its own securities, an affiliate's securities, or an offering in which at least five percent of the proceeds are directed to the member, unless the conflict is prominently disclosed and, in most cases, a qualified independent underwriter, or QIU, participates in preparing the offering document and exercises the usual standards of due diligence. The QIU requirement is excused when other protections exist, such as securities rated investment grade or securities with a bona fide public market. Rule 5121 also prohibits selling such offerings to accounts where the member exercises discretion without the customer's specific prior written approval.
Regulation M, Stabilization, and Prospectus Delivery
Regulation M prevents participants in a distribution from propping up the price of the security they are selling. Rule 101 restricts underwriters and other distribution participants from bidding for or purchasing the offered security during a restricted period, and Rule 102 applies similar restrictions to the issuer and selling security holders. The restricted period begins one business day before pricing for securities with an average daily trading volume of at least 100,000 dollars and a public float of at least 25 million dollars, and five business days before pricing for less liquid securities. Actively traded securities, those with ADTV of at least 1 million dollars and a public float of at least 150 million, are excepted from Rule 101 entirely. Rule 104 permits one narrow exception to the no-support principle: stabilization. A single stabilizing bid may be entered to prevent or slow a decline in the market price, never above the offering price, and the possibility of stabilization must be disclosed in the prospectus. Related syndicate tools include short covering through the greenshoe and penalty bids, which reclaim selling concessions from brokers whose customers immediately flip their shares. Prospectus delivery obligations survive the offering itself. Under the access equals delivery framework of Rule 172, filing the final prospectus with the SEC generally satisfies delivery for most transactions. Dealers, however, have aftermarket prospectus delivery obligations when trading a recent offering: 25 days for an IPO that will be listed on a national securities exchange, with longer periods applying to securities that are not exchange-listed.
Key terms
- Form S-1
- — The long-form Securities Act registration statement used for IPOs and by issuers not eligible for short-form registration.
- Form S-3
- — The short-form registration statement allowing seasoned reporting issuers to incorporate Exchange Act reports by reference; primary offerings generally require 75 million dollars of public float.
- Shelf registration (Rule 415)
- — Registering securities for continuous or delayed offerings, allowing the issuer to sell portions over roughly three years as conditions permit.
- Well-known seasoned issuer (WKSI)
- — A large issuer, generally with at least 700 million dollars of public float, eligible for automatic shelf registration effective upon filing.
- Emerging growth company (EGC)
- — An issuer below a revenue threshold of roughly 1.235 billion dollars eligible for confidential IPO submissions, scaled disclosure and relief from research quiet periods.
- Firm commitment underwriting
- — An underwriting in which the syndicate purchases the entire issue from the issuer and bears the risk of reselling it to investors.
- Greenshoe (overallotment option)
- — An option letting underwriters buy up to 15 percent additional shares at the offering price for 30 days to cover oversold positions and support the aftermarket.
- Accredited investor
- — An investor meeting Regulation D standards, such as income of 200,000 dollars (300,000 joint) or net worth over 1 million dollars excluding the primary residence, or qualifying institutions.
- Qualified institutional buyer (QIB)
- — An institution owning and investing at least 100 million dollars in securities of unaffiliated issuers, eligible to buy in Rule 144A resales.
- PIPE
- — Private investment in public equity: a private placement by a public company, typically followed by a resale registration for the investors.
- Qualified independent underwriter (QIU)
- — An independent member that prepares and performs due diligence on an offering document when a participating member has a Rule 5121 conflict of interest.
- Stabilizing bid
- — The single permitted syndicate bid under Reg M Rule 104 to slow a price decline during an offering; it may never exceed the offering price and must be disclosed.
Exam tips
- Match the forms fast: S-1 for IPOs and long-form filers, S-3 for seasoned issuers incorporating reports by reference, S-4 for mergers and exchange offers, Rule 415 for shelf takedowns.
- Keep the small numbers straight: greenshoe up to 15 percent for 30 days, lock-ups commonly 180 days, Form D within 15 days of first sale, and Rule 5110 filings within 3 business days.
- Contrast 506(b) and 506(c): (b) forbids general solicitation but allows up to 35 sophisticated non-accredited purchasers; (c) allows advertising but requires verified accredited purchasers only.
- For Regulation M, remember the restricted period is one or five business days depending on liquidity, actively traded securities are excepted, and a stabilizing bid can never be above the offering price.
- Rule 5121's QIU requirement disappears when the securities are investment grade or have a bona fide public market; that exception is a recurring question.