Chapter 2 - Primary Market Issuing

Question 1

• first securities act passed by Congress
• governs the primary market, where new securities are created and first sold to the public
• this act was designed to provide purchasers of new securities with info regarding the issuer. It was also designed to prevent fraud in the sale of securities
• this act governs new issues of nonexempt securities
• referred to as the Paper Act, because it deals with the paper elements involving the issuance of securities
• this act also establishes which securities are exempt from registration and certain transactions that create an exemption from registration
• this act also contains Rule 144

Answer 1

Securities Act of 1933

Question 2

• this rule addresses resale in the secondary market of previously unregistered shares and also shares sold by insider or control persons of an issuing corporation

Answer 2

Rule 144

Question 3

• this statement is required to be filed by the issuer when it first moves to raise capital from the public by issuing securities
• this statement must provide the following information:

1. description of the issuer’s business
2. the shareholdings of issuer stock by officers, directors, and underwriters; and identification of all control persons - who are individuals holding at least 10% of the company’s securities
3. biographical data on officers and directors
4. the company’s capitalization, supported with certified financial statements
5. proposed usage of the issue’s proceeds

• if the 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

Answer 3

Registration (S-1) Statement

Question 4

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

Answer 4

Final Prospectus

Question 5

• this term refers to the b/d that is employed by the issuing corporation to assist with the SEC filing
• this entity usually assists from the point of submitting the SEC filings through the public offering
• the b/d will contract with the issuer using a document called the underwriting agreement
• the managing underwriter is also responsible for keeping the due diligence file and making sure that all proper disclosures have been made by the issuer

Answer 5

Investment Banker (Underwriter)

Question 6

• corporations issuing an add-on offering may qualify to file this abbreviated registration statement

Answer 6

S-3 Statement

Question 7

• this letter is used by the SEC to postpone the issue of a security when a registration statement has material deficiencies
• this letter requires the issuer to provide additional info

Answer 7

Deficiency Letter

Question 8

• this period begins when the issuer files the registration statement with the SEC

– this date is referred to as the Filing Date

• the underwriter prepares the Red Herring in this period
• neither offers nor sales may be made during this period
• in addition to SEC (federal) registration, new issues must be “blue-skied” in states where they are offered for sale meaning that they must be registered under state securities laws

– three methods to register at state level: notification, coordination, and qualification

• this period lasts a minimum of 20 days
• this period ends when the SEC releases the securities for sale to the public

– this date is referred to as the Effective Date

• at the end of this period, the corporation’s officers and directors, the underwriter, and syndicate members hold a due diligence meeting to review all aspects of the issue and determine if due diligence has been exercised in all areas concerning the issue

Answer 8

Cooling-Off Period

Question 9

• this preliminary prospectus is issued during the Cooling-Off Period
• it is not a complete prospectus and does not contain the following:

1. an offering price for the issue (however, it may contain a price range)
2. the effective date, or date when the securities will be publicly available

• this document is distributed to generate Indications of Interest (IOIs)

Answer 9

Red Herring

Question 10

• generated by distributing Red Herrings in the Cooling-Off Period
• this is not a binding sale
• it is simply an indication that the investor might have interest when the securities are available

Answer 10

Indications of Interest (IOI)

Question 11

• this is a very limited announcement that can be made by the issuer during the Cooling-Off Period
• this announcement shows important facts concerning the offering (i.e. the probable price range, description of the issue, and members of the syndicate)

Answer 11

Tombstone Announcement (Ad)

Question 12

• this period of time takes place during the pre-registration, cooling-off, and post-registration periods
• during this period, the offering participants may not in any way influence the price of the security

– this means that they cannot engage in secondary market trading of the security

Answer 12

Restricted Period

Question 13

• during this period, research may not be published on the offering company
• other prohibited activities in this period include public analyst appearances
• if the offering is an IPO, this period generally is 10 days after the Effective Date
• if the offering is an APO, this period is generally 3 days after the Effective Date for manager/co-manager

Answer 13

Quiet Period

Question 14

• a team of b/d’s who sell the securities to the public on behalf of the issuer
• team members share the risk of executing the underwriting
• team members sign an agreement among underwriters

– the agreement, referred to as the syndicate letter, specifies the duties, responsibilities and liabilities of each of the team members

• there are two types of underwriting agreements between the issuer and syndicate: Firm Commitment Underwriting and Best Efforts Underwriting

Answer 14

Syndicate

Question 15

• this is one of two kinds of underwriting agreements between the Issuer and the Syndicate
• in this kind of agreement, the syndicate buys the shares from the issuer and then re-offers the shares to the public
• the syndicate takes the risk for any unsold shares in this arrangement

– if unsuccessful in selling some shares of the new offering to the public, those unsold shares will be divided among each syndicate member based on its liability participation

Answer 15

Firm Commitment Underwriting

Question 16

• one of two kinds of underwriting agreements between the Issuer and the Syndicate
• in this agreement, the Syndicate applies its best effort to selling the shares on behalf of the issuer
• the issuer must keep any unsold shares meaning that the issuer takes on the risk for any unsold shares

Answer 16

Best Efforts Underwriting

Question 17

• the difference between what the public customer pays for each share of the new offering (public offering price/POP) and what the issuer receives
• this term is comprised of the following: the Manager’s Fee, the Syndicate Fee, and the Selling Concession

Answer 17

Underwriting Spreadh

Question 18

• this term is a component of the Underwriting Spread
• it is a fee that the Managing Underwriter receives for every share that is sold to the public

– it is usually the smallest portion of the spread

• the fee is meant to reimburse the Managing Underwriter for expenses and to compensate for the extra work it has done

– this extra work includes due diligence and acting as a liaison between the Issuer and Syndicate Members

Answer 18

Manager’s Fee

Question 19

• this fee is a component of the Underwriting Spread
• the fee is divided among Syndicate Members based on their liability participation in the offering

Answer 19

Syndicate Fee

Question 20

• this is a component of the Underwriting Spread

– it is the largest component of the three

• it is paid to the firm that actually sells the shares to the public

– this could be a Syndicate Member or a selling group member

Answer 20

Selling Concession

Question 21

• this event occurs when an issuers sells shares to the public for the first time
• this process begins when the issuer files an S-1 Registration Statement with the SEC. Filing this statement starts the Cooling-Off Period
• usually difficult for underwriters to price since there is no historical data on which to base the POP
• subject to FINRA Rule 5130, which states that b/d’s and registered persons are prohibited from buying this from the Syndicate
• shares must be offered to the public to avoid any misdealings by member firms and their associated persons
• the following categories of persons are restricted from purchasing:

1. Fiduciaries for the managing underwriter (i.e. accountants & attorneys)
2. Immediate family members of b/d personnel

– immediate family defined as spouse, siblings, children, parents, and in-laws. Does not include aunts, uncles, grandparents, or cousins

– an exception to the immediate family rule would apply if the issuer directed the sale to a registered person’s immediate family member

• if a restricted person(s) owns a portion of an established portfolio, the portfolio may still purchase this but only if the restricted person(s) do not own more than 10% of the portfolio

– a “carve-out” provision is available if restricted person(s) do own more than 10% of the portfolio. This would allow restricted person(s) to participate in the portfolio

• purchasers must sign a positive affirmation that they are not restricted persons and must reaffirm this every 12 months
• if an issuer wants to bring their own shares to market for the first time, they are required to hire a qualified independent underwriter to serve as an impartial third party to assist in objectively pricing the shares

Answer 21

Initial Public Offering (IPO)

Question 22

• this is a regulation that governs primary offerings
• this rule addresses possible conflicts of interest arising when an issuer brings its own shares to market

– a b/d conducting its own IPO would have difficulty objectively pricing its own shares

• this rule requires b/d’s to hire a qualified independent underwriter to serve as an impartial third party to assist in objectively pricing the IPO

– to be qualified, the underwriter must have done at least three offerings of at least 50% of this size in the last 3 years

• the issuing b/d is not required to hire a qualified independent underwriter for APO’s
• this rule also applies when the b/d is controlled by or controls the company whose shares are being offered

Answer 22

FINRA Rule 5121

Question 23

• this event occurs when a publicly traded issuer offers more shares to the public. This event is referred to as a “follow-on” offering
• this offering is done in the primary market
• issuers can usually file the abbreviated S-3 filing opposed to the longer, S-1 filing

Answer 23

Additional Public Offering (APO)

Question 24

• also referred to as a Shelf Registration, this process is authorized under SEC Rule 415
• allows firms to file one registration statement covering several issues of the same security prior to a public offering
• primarily used for primary offerings, but may be used for secondary offerings
• this process begins when the issuer files a registration statement with the SEC. Filing with the SEC creates a window of time in which the issuer may offer additional shares to the public

– the window may be 2 or 3 years, depending on the issuer’s size

• this type of offering process benefits the issuer because it does not have to file with the SEC each time it offers shares during the window
• usually sold at the current market price of the issuer’s outstanding shares in the secondary market. Often called “at-the-market” because the shares are issued at current market value

Answer 24

Shelf Offering

Question 25

• this type of issuer uses the Form S-3 to file a blanket registration statement with the SEC, for a 3-year shelf window
• this issuer must be public for at least 1 year prior to registration, be current in the SEC filings, and have a minimum public float of at least $75 million
• one of two types of issuers permitted to use Shelf Registration of primary offerings where the proceeds of the offering go to the issuer instead of selling shareholders

Answer 25

Seasoned Issuers (SI’s)

Question 26

• this type of issuer uses the Form S-3 to file a blanket registration statement with the SEC, for a 3-year shelf window
• defined as an issuer with at least $700 million of publicly held common equity or has issued at least $1 billion in non-common, non-convertible registered securities
• one of two types of issuers permitted to use Shelf Registration of primary offerings where the proceeds of the offering go to the issuer instead of selling shareholders
• typically issues a free-writing prospectus when distributing shares through an add-on offering

Answer 26

Well-Known Seasoned Issuer (WKSI’s)

Question 27

• this term occurs when a publicly traded company separates one of its divisions into its own entity
• the funding for this activity typically comes from the parent company through a debt or equity position
• can be sold to another entity

Answer 27

Spinoff

Question 28

• this term is a formal offer to the existing shareholders to purchase their stock at a price above current market value
• this type offer is usually a hostile takeover
• any stockholder that sells stock must deliver the shares net long to the tender
• in addition, an investor who owns options to buy the shares must exercise the options before the shares can be sold into the offer

Answer 28

Tender Offer

Question 29

• this prospectus is issued by a well-established company distributing shares through an add-on offering

– such companies are called WKSI’s. This means that they have not missed a debt or dividend payment in each of the last 3 years

• this prospectus can actually contain info that is not in the registration statement
• WKSI’s are allowed much more freedom in their communication with the public because there is ample public info concerning WKSI’s upon which investors can make informed investment decisions

Answer 29

Free-Writing Prospectus

Question 30

• this regulation addresses capital markets, M&A (mergers and acquisitions), and investment banking

– investment bankers and underwriters raise capital for new or existing corporate ventures from IPO’s, APO’s, and secondary offerings, both equity and debt

• this regulation places restrictions on market participants when associated with public offerings

– the participants are restricted from manipulating the offering price of the securities

– participants subject to this restriction include the Issuer, the Underwriting Syndicate, selling group members, market makers, and insiders of the issuing corporation

– an insider is a shareholder that owns 10% or more of the issuer’s stock

Answer 30

Regulation M

Question 31

• the period of time during which the offering participants are restricted from doing anything that may influence the price of the underwritten security
• corporations are classified by tiers: Tier 1, Tier 2, and Tier 3

Answer 31

Restricted Period (corporation)

Question 32

• average daily trade volume (ADTV) exceeds $1 million and the public float is valued at $150 million or more
• this tier of issuers has no restricted period because they are among the most actively traded companies

Answer 32

Tier 1 Corporation

Question 33

• ADTV is at least $100,000 and at least $25 million in public float
• the Restricted Period is one day prior to the Effective Date for this tier of issuers

Answer 33

Tier 2 Corporation

Question 34

• this tier of issuers is comprised of smaller businesses in terms of ADTV and public float
• the Restricted Period is 5 days prior to the Effective Date for this tier of issuers

Answer 34

Tier 3 Corporation

Question 35

• this activity occurs when a primary offering is partially sold with a set POP that is trading for a lower price in the Secondary Market
• shares are more attractive in the secondary market due to the fact that all primary offerings must be sold at the POP

– if the shares are not sold, the syndicate will be stuck with the remaining unsold offering

• the Managing Underwriter will purchase shares at POP or lower (stabilizing bid) in the secondary marketplace

– the bid is one-sided meaning that the underwriter is only purchasing, not selling, shares in the secondary market. This is done to stabilize the share price and facilitate the sale of the remaining primary offering by the syndicate

• this activity must be disclosed in the Prospectus if the syndicate has the privilege

Answer 35

Stabalization

Question 36

• this term is associated with the Stabilization Process
• it is charged to a syndicate or selling group member when its customer, who purchased the offering at POP, sells those shares back to the underwriter at the Stabilizing Bid

– in such cases, the syndicate or selling group member loses its selling concession

• when entering this term under stabilization procedures, the market maker must designate it as the term
• this must also be disclosed in the Prospectus

Answer 36

Penalty Bid

Question 37

• this rule states that, “members cannot trade securities in their own inventory ahead of research reports”
• in other words, members may not use nonpublic, advance knowledge of an upcoming research report or its content for its own benefit or that of another person
• members are required to establish, maintain and enforce policies and procedures to restrict or limit the flow of info between the research department and the trading department

Answer 37

FINRA Rule 5280

Question 38

• some securities are exempt under the 1933 Act from registration and prospectus requirements
• these securities are still subject to the anti-fraud provisions of the 1933 Act
• the following securities meet the exemption criteria:

1. US government and US government agency securities
2. Municipal securities
3. Issues of nonprofit organizations (i.e. Church Bonds)
4. Commercial paper
5. Issues of domestic banks and trust companies (BUT not bank holding companies)
6. Issues of small business investment companies

Answer 38

Exempt Securities

Question 39

• certain transactions allow an issuer to offer nonexempt, yet unregistered securities to the public
• the three following offerings qualify:

1. Intrastate Offerings
2. Regulation A Offerings
3. Regulation D Private Placements

Answer 39

Exempt Offerings

Question 40

• one of three types of Exempt Offerings
• securities sold within the borders of one state are allowed this type of exemption under Rule 147 of the 1933 Act, provided that one of the following conditions is met:

1. 80% of the corporation’s gross revenues are derived from operations within one state
2. 80% of the corporation’s assets are held in that state
3. 80% of the offering’s proceeds are used to expand operations within that state
4. A majority of the issuer’s employees must be based in the state

• in addition, 100% of the purchasers must be principal residents of that state and purchasers of the stock most hold it for 6 months before it can be sold to an out-of-state resident

Answer 40

Intrastate Offerings

Question 41

• this rule is an updated version of the rule that allows the exemption for Intrastate Offerings
• this Rule has all the same requirements of its original, with the exception of the following:

1. The issuer is not required to be organized in the state of issuance of the securities
2. The offering is not limited to in-state residents

Answer 41

Rule 147A

Question 42

• this Regulation in the Act of 1933, also known as the Small Issue or Small Dollar Exemption, is available for a new issue of less than $5 million during a 12-month period

– if the offering (new issue) is done by an affiliated person, the max that can be raised in any 12 consecutive months is $1.5 million

• issuers file an offering statement, called a Form 1-A, with the SEC and distribute an offering circular to prospective buyers

– the offering circular must be sent to the prospective purchaser either 48 hours prior to the purchase date, or at the time of purchase with a 5-day right to rescission that enables investors to get their money back if they change their minds

• sales under this Regulation must be reported to the SEC every 6 months
• advantages of this exemption are reduced legal fees and shorter preparation times for documents

Answer 42

Regulation A Offering

Question 43

• this new category of Regulation A was created by the JOBS Act
• there are two tiers under the new Reg: Tier 1 and Tier 2

– Tier 1 allows for offerings up to $20 million, including no more than $6 million on behalf of affiliates

– Tier 2 can raise up to $50 million with no more than $15 million on behalf of affiliates. The Offering Statement that is used is the Form 8-A

– both tiers require that no Bad Actors be associated with the offering

— A Bad Actor is the term that describes certain felons and other persons who are otherwise considered disqualified under the act

• this Reg also allows for additional types of solicitation, including “Testing the Waters”
• this expansion under a Reg A offering enables emerging companies to raise money without having to go through a full registration process

Answer 43

Reg A+

Question 44

• this type of solicitation is permitted under Reg A+, which was created by the 1933 Act and JOBS Act
• this type of solicitation takes place prior to filing the offering statements and is accompanied by a preliminary offering circular
• this enables the issuer to determine if there is marketability in their offering

– this expansion under a Reg A offering enables emerging companies to raise money without having to go through a full registration process

Answer 44

Testing the Waters

Question 45

• an issuer can avoid registration requirements by offering securities through a private placement under this Regulation of the 1933 Act, provided the following conditions are met:

1. The corporation must have adequate reason to believe the buyer is a sophisticated investor, meaning that the buyer has enough experience to evaluate the risks involved
2. The buyer must be provided with the same info that would be found in a Prospectus. This doc is referred to as the Offering Memorandum under this Regulation
3. The issuer must receive assurance, by obtaining an investment letter from the buyer, that the buyer does not intend to make a quick sale of the offering. For this reason, the stock in this Regulation is referred to as Letter Stock or Restricted Stock
4. The securities cannot be sold to more than 35 non-accredited investors. However, an unlimited number of Accredited Investors, director or officer of the issuer, or an individual with either a net worth of $1 million or an annual income of at least $200k for the past 2 years; if married, a joint income of at least $300k for the past 2 years. Non-accredited investors must designate a Purchaser Representative for each offering. The representative must not be associated with the issuer unless they are related to the purchaser by blood, marriage, or adoption

• these types of offerings cannot be advertised through the media to the general public
• an investment seminar is prohibited unless attendance is limited to potential purchasers who are represented by their Purchaser Representative

Answer 45

Regulation D Private Placements

Question 46

• this rule under Reg D allows for a private placement that can raise up to $5 million within 12 consecutive months
• limited disclosure documents are required as well as a signed subscription agreement

Answer 46

Rule 504 (Reg D)

Question 47

• this rule under Reg D states that there is a limit of 35 non-accredited investors in a Private Placement
• non-qualified investors must be sophisticated enough to understand the investment and its constraints
• NQ investors are allowed to use a purchaser’s representative as long as the rep is not associated with the issuer in ways other than blood, marriage, or adoption

Answer 47

Rule 506b (Reg D)

Question 48

• this rule under Reg D allows an unlimited amount of money can be raised by the issuer
• under the JOBS Act, the SEC created a new category of Reg D private placement called the 506c
• under a 506c, an unlimited amount of money can be raised, but the only persons eligible to purchase are Accredited Investors

– the issuer must verify that all investors are Accredited in order to qualify for this exemption

• the benefit of a 506c is that the issuer is allowed to advertise the offering, which under the other private placements is normally not allowed
• the issuer nor the placement agent is allowed to have any Bad Actors associated

Answer 48

Rule 506 (Reg D)

Question 49

• this rule under Reg D states that if there are any insignificant deviations from a term, condition or requirement under Rules 504 and 506 that are not directly intended to protect a particular person or entity, then the exemptions will still be valid as long as there was a reasonable attempt to comply

Answer 49

Rule 508 (Reg D)

Question 50

• this form is also referred to as a Notice of Sale
• this form is required when a private placement is being issued under Regulation D of the 1933 Act
• companies must file the Notice of Sale electronically with the SEC after they sell their securities
• this form includes the names and addresses of the company’s promoters, executive officers and directors, and some detail about the offering

– the form does not contain much info about the actual company

Answer 50

Form D

Question 51

• this Rule allows public resale of restricted and control securities under certain conditions, which are:

1. Holding Period: restricted securities must be held for a specified period of time before they may be sold in the marketplace. If a selling company is subject to SEC reporting requirements, the securities must be held for at least 6 months; otherwise, at least 1 year. The Holding Period begins when the securities are bought and fully paid for
2. Adequate Current Info: prior to sale, there must be adequate current info about the issuer of the securities, and the issuer must comply with the periodic reporting requirements of the Exchange Act
3. Trading Volume Formula: the volume limit is either 1% of the outstanding shares or trading volume for the last four weeks, whichever is greater
4. Ordinary Brokerage Transactions: the sale must be handled as a routine trading transaction, with the broker receiving a standard commission. Neither the seller nor broker is allowed to solicit orders to buy the securities
5. Filing a Notice of Proposed Sale with SEC: if the sale involved more than 5,000 shares or if the aggregate dollar amount is greater than $50k in any 90-day period, affiliates must file a notice with the SEC no later than the date of sale. The affiliate must file an amended notice if the security is not sold within 90 days of filing the Form

Answer 51

Rule 144 (Reg D)

Question 52

• this rule allows Qualified Institutional Buyers to purchase restricted (unregistered) stock
• it allows a Qualified Institutional Buyer to purchase unregistered securities outside of the US and import them if they buy from b/d’s

– a Qualified Institutional Buyer has at least $100 million in assets under discretionary management

Answer 52

Rule 144A Portal System

Question 53

• this Regulation addresses off-shore sales of previously unregistered securities
• the investor must reside outside of the US in order to qualify for the purchase of this Regulation’s offering
• an issuer likes to do offerings under this Reg because they are less expensive because no registration is required with the SEC
• the limitation on the resale to US residents is 1 year for equities and 40 days for debt offerings

Answer 53

Regulation S