Chapter 2 - Issuing: Primary Market

Question 1

Registration statement

Answer 1

Required to bring a new issue to the primary market. Must include a description of the issuer’s business, and shares owned by officers, directors and underwriters, identify all parties who own more than 10% of the securities (control persons), biographies of directors and officers, the companies, capitalization and financial statements, and proposed use of the issue’s proceeds.

Question 2

Deficiency letter from the SEC

Answer 2

If a registration statement has material deficiencies, the SEC can issue a deficiency letter to postpone the issue, or a stop order to prohibit the sale of the security until the deficiency is cleared up. Requires the issuer to provide additional information.

Question 3

Final prospectus (or statutory prospectus)

Answer 3

A disclosure document given to investors when the offering becomes effective and the security is available for sale to the public. It contains material aspects of the investment and ensures that investors have sufficient information to make an informed investment decision.

Contains official price and effective date. May not be highlighted or altered in anyway. Must be issued for every sale.

Must be issued within:
-25 days for an existing issuer
-40 days for a newly registered issuer
-90 days for unlisted/over the counter securities

Question 4

Cooling off period

Answer 4

20+ day period of time after the registration statement is filed with the SEC. Is when the red herring can be issued. Neither offers nor sales may be made during the cooling off period.

Question 5

Red herring

Answer 5

Incomplete initial prospectus. Does not contain an offering price, but may contain a recommended range. Does not include an effective date or date securities will be available. Can generate indications of interest, which are not binding.

Question 6

Tombstone announcement

Answer 6

Announcement during the cooling off period. Includes probable price range, description of the issue, and members of the syndicate.

Question 7

The three methods of blue sky registration

Answer 7

1. Notification – issuer simply files a notice with the state.
2. Coordination - done in coordination with the issue’s SEC registration.
3. Qualification - issuer files a full registration statement to the state and is qualified by the state.

Question 8

Filing date

Answer 8

The date the SEC receives the registration statement, which starts the cooling off period.

Question 9

Due diligence meeting

Answer 9

Issuers, officers and directors, underwriter, and syndicate members meet just before the end of the cooling off period. Review all aspects of the issue to confirm that due diligence has been exercised in all areas.

Question 10

Effective date

Answer 10

Date the SEC releases securities for sale, marking the end of the cooling off period.

Question 11

Restricted period

Answer 11

Time when offering participants may not engage in secondary market trading of a security, or doing anything that may influence the price of the underwritten security

Question 12

Quiet period

Answer 12

With a new issue, it’s a period of time when new research on the issue may not be published and there may be no public analyst appearances.

For IPOs, usually 10 days after the effective date. 3 days for add-on public offerings (APOs)

Question 13

Underwriter

Answer 13

The investment banker broker/dealer that helps bring securities to the market. Contracted agreement with the issuer. Responsible for keeping the due diligence file and executing proper disclosures. May form a syndicate.

Question 14

Underwriting spread

Answer 14

Difference in market price and what the issuer receives. The spread is made up of
1. Manager’s fee (smallest), for the managing underwriter.
2. Syndicate fee - to syndicate members
3. Selling concession (largest) - to the firm actually selling the shares

Question 15

FINRA Rule 5130

Answer 15

Broker dealers and registered persons are prohibited from buying an IPO from the syndicate. Also applies to accountants/attorneys of managing underwriter and immediate family members of broker/dealer personnel (spouse, siblings, kids, parents, in-laws). Excludes aunts/uncles, grandparents or cousins.

If a restricted person owns a portion of an established portfolio, that portfolio may still purchase the IPO, as long as the restricted individual does not own more than 10% of the portfolio

Question 16

Carve out provision - FINRA Rule 5130

Answer 16

Allows restricted individuals to participate in 10% of shares purchased through the IPO and any remaining shares be divided among the other portfolio investors.

Ex: restricted individuals collectively own 30% of the portfolio. Portfolio purchases 1 million shares of an IPO. Restricted individuals only participate in 100,000 shares. Remaining 200,000 of their 30% share would be divided among the other portfolio investors.

Question 17

FINRA Rule 5121

Answer 17

States that broker-dealer conducting its own IPO must hire a qualified independent underwriter. To qualify, this underwriter must’ve done at least three offerings of at least 50% of the same size in the last three years.

APO’s do not require an independent underwriter. Broker/dealer may be it’s own managing underwriter for APO’s, price is current market price.

Question 18

APO application

Answer 18

IPOs require an S1 filing, which is a registration statement. APOs only need an abbreviated S3 filing, presuming eligibility requirements are met.

Question 19

Shelf offering

Answer 19

Authorized by SEC Rule 415.  Several issues of a security are covered under one registration statement within 2-3 years, depending on issuer’s size.

Usually sold at current market price in secondary market. 

Question 20

Seasoned issuer (SI)

Answer 20

Has been public for at least one year, be current in SEC filings, and has a minimum public float of $75 million.

WKSIs (well known seasoned issuers) are a type of SI.

Can use form S-3 to file a blanket registration statement with the SEC, for a three-year shelf window.

Question 21

Well-known seasoned issuers (WKSIs)

Answer 21

An issuer with at least $700 million of publicly held common equity, or has issued at least 1 billion in noncommon, non-convertible registered securities. Can file an S-3.

Question 22

FINRA Rule 145

Answer 22

Allows companies to sell certain securities without first having to register the securities with the SEC.

Addresses mergers and acquisitions, substituting one security for another and/or transferring assets from one person to another.

Exempts stock splits, changes in par value and stock dividends from the filing of registration statement.

Question 23

Tender offer

Answer 23

A formal offer to the existing shareholders to purchase their stock above current market value. Usually a hostile takeover.

Must remain open for 20+ days.  if the price of the tender offer changes,  must remain open for another 10 days.

May include a minimum number of shares to be tendered for the offer to be binding.

(There’s nothing tender about it).

Question 24

Free-writing prospectus

Answer 24

Disclosure document issued by well-known, seasoned investors distributing shares through an add-on offering or subsequent primary offering. Cannot have missed a debt or dividend payment in the last three years.

Can contain more information than registration statement. These companies have great latitude because there’s a lot of public information about them.

Question 25

Regulation M

Answer 25

Intent: Prevent manipulation of share prices by people who could benefit from that manipulation. Participants cannot manipulate offer prices. Cannot buy, bid or purchase during the restricted period.

Affects the issuer, syndicate, sellers, market makers, and issuing corporation insiders ( those with 10+% of stock)

RESTRICTED AVG. DAILY PUBLIC PERIOD/TIER TRADE VOL. FLOAT

T1 0 days. $1M. $150M
T2 1 day $100,000 $25M
T3 5 days <$100,000 <$25M

There is less concern about manipulating the price on large, well-established companies. Example: imagine trying to manipulate Microsoft.

Question 26

 Rule 101 – regulation M

Answer 26

Covers activities of underwriters, broker dealers, and others participating in the DISTRIBUTION.

Question 27

Rule 102 - regulation M

Answer 27

Governs the activities of issuers and SELLING security holders

Question 28

Rule 103 – regulation M

Answer 28

Pertains to NASDAQ passive MARKET MAKING.

Question 29

Rule 104 – regulation M

Answer 29

Governs STABILIZATION transactions and certain post-offering activities by the underwriters.

The right to make stabilization purchases must be disclosed in the prospectus.

Question 30

Rule 105 - regulation M

Answer 30

Governs SHORT SELLING in anticipation of a public offering

Question 31

Stabilization – Regulation M

Answer 31

Occurs when a managing underwriter or designee will purchase shares of a primary offering on the secondary market at a price that prevents the security from falling lower. Having this privilege must be disclosed in a prospectus.

The syndicate or selling group sacrifices their concession (or other penalty) for participating in the stabilization bid. If the syndicate has this privilege, it must be disclosed in the prospectus.

Question 32

Analyst and research reports - restrictions

Answer 32

Analysts may not participate in roadshows for the offering or publishing research on the security during the offering.

One exception is if the analyst already follows the issue or on a regular basis, and produces research on the issue or securities in conjunction with other companies on a regular basis. Analyst may not change the current recommendation from past recommendations, or highlight the issuer when releasing the research.

Analyst may publish research on the issuer’s bonds during a stock offering, unless they are convertible bonds

Any written communication between analysts and investment banking department must include copy to legal or compliance.

Question 33

FINRA rule 5280

Answer 33

FINRA members cannot trade securities in their own inventory ahead of research reports. May not use non-public information to benefit themselves or others.

Must establish, maintain and enforce policies to restrict flow of information between research and trading departments.

Question 34

Exemptions from registration – exempt Securities

Answer 34

– US government agency securities.
– Municipal securities
– issues of nonprofit organizations such as churches.
– commercial paper.
– issues of domestic banks and trust companies.
– issues of small business investment companies.

Question 35

Exemptions from registration – exempt offerings

Answer 35

– Rule 147 – intrastate offerings.
– Regulation A – small issue, with two offering tiers
– Regulation D - private placement.
– Regulation crowdfunding.

Question 36

Rule 147: Exempt offerings – intrastate offerings

Answer 36

Exemptions under rule 147 of 1933 Act: Issue is exempt if one of the following is met:

– 80% of company’s gross revenues are from within one state.
– 80% of assets are in that state
– 80% of offerings proceeds are used to expand operations in that state.
– majority of employees are based in a state.
– All purchasers must be principal residents of that state and must hold it for six months before it can be sold to an out-of-state resident

Question 37

Rule 147 versus rule 147A

Answer 37

Rule 147A:
- Issuer is not required to be organized in the state of issuance.
– offering is not limited to in-state residents.

Question 38

Exempt offerings – regulation A

Answer 38

From 1933 act, a.k.a. a small issue or small dollar exemption. Allows small companies to raise capital without full registration, which saves them money.

Question 39

Exempt offerings - regulation A+

Answer 39

Amendment to regulation A; increases amount of money that can be raised.

– Tier 1 - allows up to $20 million in a 12 month period, with no more than $6m on behalf of affiliates.

– Tier 2 - allows $75 million in a 12 month period, with no more than $22.5m on behalf of affiliates. Tier 2 issuers must file Form 8-A, which is a shortened registration statement.

Issuers file an offering statement on Form 1-A with the SEC and distribute an offering circular to prospective buyers.

Allows for “testing the waters” solicitation prior to filing the offer statement via preliminary offering circular, enabling issuer to determine if the offering is marketable.

Bad actor provision disqualifies participants convicted of fraud, or similar violations

Question 40

Regulation D private placements

Answer 40

Intent is to help small businesses develop offerings without the expense of registration. Avoid registration by offering securities through a private placement if all are met:

– must be sophisticated investors.
- issue an offering memorandum, contains same information as a prospectus.
– buyer commits not to sell for six months, thus is considered “restricted stock”
– maximum of 35 non-accredited investors, each must designate a purchaser representative. Note: These Representatives may not be associated with the issuer unless related to the purchaser by blood, marriage or adoption (Rule 506B)
– Unlimited accredited investors may invest
– cannot be advertised through media to general public. An investment seminar is only allowed if attendance is potential purchasers who are represented by their purchaser representatives.

Question 41

Regulation D, Rule 504

Answer 41

Private placement can raise up to $10 million within 12 consecutive months, requires disclosure statements, and subscription agreements

Question 42

Regulation D, rule 506 - Revenue allowance

Answer 42

Unlimited amount of money can be raised to be a private placement

Question 43

Regulation D, rule 506(b)

Answer 43

Allows
1) unlimited, accredited investors and
2) up to 35 sophisticated, non-accredited investors in a 90-day period.

Question 44

Regulation D, rule 506(c)

Answer 44

A 506(c) offering requires all investors to be accredited investors and issuer takes steps to verify they are accredited to qualify for 506(c) exemption.

Allows the issuer to advertise the offering, which is normally not permitted under other private placements.

Created under JOBS Act

Question 45

Regulation D, rule 506(d)

Answer 45

Bad actors provision, disqualifies associated persons if they had a disqualifying event. Includes criminal conviction, or regulatory/court action.

Question 46

Form D, or notice of sale

Answer 46

Must be filed by companies that meet Regulation D requirements and do not have to register with the SEC.

Contains names and addresses of company employees (companies, promoters, executive officers, directors) and some details about the offering, but little about the company.

Question 47

Accredited investor

Answer 47

May buy unregistered securities.

-I know the individual requirements –

Requirements for entities:
– Bank, insurance company, registered investment company, business development, company, or small business investment company.
– ERISA-compliant benefit plan with more than $5m
– Charity, corporation, trust, or partnership with more than $5m
- A Director, executive officer, or general partner of the company selling the securities
– A business in which all owners are accredited investors
– one who holds a series 7 or a series 82 license
-Knowledgeable employee of a private fund

Question 48

Accredited investor – special equivalent

Answer 48

A cohabitant with a relationship generally equivalent to having a spouse.

– Joint net worth exceeds $1 million
– income exceeds $300,000 for two years.

Question 49

Accredited investor – 2020 expanded definitions for individuals

Answer 49

– Include an individual who holds a series 7, series 65 series 82 or other educational/professional certifications the SEC may choose in the future.

• An individual who is a knowledgeable employee of a private fund, solely with respect to an investment in the fund. Directors, certain executive officers, affiliated investment manager, employees in the investment activities, or investment companies managed by the affiliated manager.

Question 50

Accredited investor - 2020 expended definition for entities or institutions

Answer 50

– Confirmed LLCs with $5 million in assets
– SEC-registered and state-registered investment advisors, exempt reporting advisors, and RBICs
– Any entity with $5 million not formed for a specific purpose of investing in the securities offered. Includes Indian tribes, government bodies and foreign entities.
– family offices with at least $5 million under management and their family clients

Question 51

Accredited investors – purchaser definitions

Answer 51

– A corporation counts as one purchaser. However, if that entity is not an accredited investor and organized for the specific purpose of acquiring the securities, then each beneficial owner of the securities is counted as a separate purchaser.

– non-contributory employee benefit plan with one investment trustee counts as one purchaser.

– clients of an investment advisor, or customers of a broker/dealer are considered purchasers.

– any accredited investor is a purchaser.

Question 52

Regulation crowdfunding (Reg CF)

Answer 52

Allow small businesses to raise capital from a large number of investors via the Internet.

– Maximum offering amount over 12 months may not exceed $5 million.

• Non-accredited investors may rely on the greater of their annual income or net worth for calculating investment limits:

1) If income or net worth is less than $107,000, the greater of either $2200 or 5% of income/worth of the investor

2) If income or net worth is equal to or more than $107,000, the greater of 10% of annual income or 10% of net worth, not to exceed $107,000

-Must take place through online, SEC-registered intermediary

– Security is purchased via crowdfunding cannot be sold for a year, creating liquidity risk.

Question 53

Entities not eligible for regulation crowdfunding exemption

Answer 53

– non-American companies.
– those subject to reporting requirements of act of 1934
– certain investment companies.
– those disqualified under the regulations rules.
– those failed to comply with regulations annual reporting requirements x two years.
– Companies without a business plan
– companies whose business plan involves merger or acquisition with an unknown company

Question 54

Crowdfunding portal

Answer 54

A broker acting as an intermediary in a transaction involving the offer or sale of securities, that does not:

– offer advice or recommendations.
– solicit purchases, sales or offers to buy securities on the platform.
– compensate employees, agents or other persons for such solicitation.
– hold, manage, possess or otherwise handle, investor funds or securities.

FINRA members must notify FINRA:
1) of a transaction involving the offer or sale of securities for the first time, or
2) within 30 days of directly or indirectly controlling, or being controlled by or under common control with, a funding portal.

Question 55

Form C

Answer 55

Must be filed for crowdfunding.

Includes name, address, website, business description, business plan, financial condition and leadership members. May require financial statements or auditing.

Question 56

Rule 144

Answer 56

Covers resale (a.k.a. secondary market) sale) of restricted/control securities

• 6 to 12 month holding before can be sold
  – must be adequate current info prior to sale.
  – volume limited to 1% of outstanding shares or average trading volume for last four weeks, whichever is greater
  – handled as an ordinary transaction with a standard commission
  – if more than 5000 shares or $50,000 in 90 days, must file SEC notice by date of sale. If not sold in 90 days, must file an amended notice.

Question 57

Rule 144A

Answer 57

Allows purchase of restricted stock by QIBs.

These are entities with at least $100 million in assets under discretionary management

Question 58

Regulation S

Answer 58

Covers offshore sales of unregistered securities. Investor must reside outside the US for purchase of regulation S offering.

Limitation on the resale to US residents is one year for equities, and 40 days for debt offerings.

Is less expensive because there’s no registration with the SEC.

Question 59

Other crowdfunding rules

Answer 59

• Crowdfunding issuers can test the waters prior to filing an offering document to the SEC, to gauge investor interest in advance.
• Issuers are required to provide disclosures about the business in Form C, filed with the SEC. INCLUDE NAME, ADDRESS, AND WEBSITE OF BUSINESS, DESCRIPTION OF BUSINESS, BUSINESS PLAN, FINANCIAL CONDITION, AND INFORMATION ABOUT DIRECTORS, OFFERS SERVERS AND BENEFICIAL OWNERS ( those with 20%+ ownership)
• Subject to bad actor provisions that can disqualify an offering

– Cannot be sold for one year, creating potential liquidity risk

Question 60

Tender offer conditions

Answer 60

• The company making the tender offer may have a stipulation of minimum shares to be tendered. For example, if a company has 1 million shares, offering company may require 90% of them are tendered to complete the transaction.
• Any stockholder selling into the tender must deliver the shares “net long” to the tender. “Net long” means the investor has the ability to deliver the shares.

For example, if the investor just owns a warrant to purchase the shares, the warrant must be exercised first, and then the shares can be sold into the tender offer. Same for options.