Section 7.2: Underwriting & the Issuance Process

  • When an issuer hires an underwriter, there are two main types of agreements:

    • Best Efforts Agreement

    • Firm Commitment Agreement

1. Best Efforts Agreement:

  • The underwriter acts as an agent (a go-between for issuer and investors).

  • The underwriter does not purchase or hold the securities.

  • Investor funds are kept in an escrow account until the deal closes.

  • If few shares are sold, the issuer receives less money.

  1. Two types of Best Efforts Underwriting:

    • All-or-None (AON):

      • The underwriter must sell all securities or cancel the deal.

      • All investor funds held in escrow until all shares are sold.

    • Mini–Max:

      • The underwriter must sell a minimum number of securities.

      • If the minimum is not met, the deal is canceled.

      • Funds held in escrow until the minimum is reached.

2. Firm Commitment Agreement:

  • The underwriter acts as a principal, not an agent.

  • The underwriter purchases the entire issue from the issuer and resells it to the public.

  • The underwriter takes on financial risk — if they cannot sell all shares, they may lose money.

  • Syndicates are often formed to share the risk and profits.

  1. Key Terms:

    • Discount: Price paid by the underwriter to the issuer (lower than public price).

    • Public Offering Price (POP): Price at which securities are sold to investors.

    • Spread: The underwriter’s profit — difference between POP and the discount.

    • Syndicate: Group of underwriters working together in large offerings.

    • Managing Underwriter: Lead member of the syndicate.

    • Selling Group:

      • Assists in selling the securities but does not commit capital or hold shares.

      • No liability for unsold securities.

⚖️ Securities Act of 1933 — “Truth in Securities” Act:

  • Purpose: To ensure investors receive full and fair disclosure before purchasing new issues.

  • It protects investors by:

    1. Requiring registration of new issues.

    2. Requiring issuers to provide full disclosure of material information.

    3. Requiring distribution and underwriting of primary issues.

    4. Providing criminal penalties for fraud.

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📝 Registration Process

1. Filing the Registration Statement (Form S-1):

  • Filed with the SEC for all non-exempt securities.

  • Includes material information about the issuer and the issue, such as:

    • Business description

    • Financial condition

    • Management and ownership

    • Legal proceedings

    • Use of proceeds

  • Responsibility for accuracy lies with the issuer and its officers.

2. Cooling-Off Period:

  • Begins after filing Form S-1.

  • Lasts a minimum of 20 calendar days (may be longer).

  • SEC reviews the registration statement.

  • If changes are needed, SEC issues a deficiency letter — the review pauses until corrections are made.

  • Once corrected, the 20-day clock resumes (not restarts).

3. Effective Date:

  • Marks the end of the cooling-off period.

  • The SEC “releases” the issue for sale.
    ⚠️ The SEC never “approves” or “endorses” a security — only allows it to be sold.

  • The Final Prospectus becomes available at this time.

📘 Prospectuses

  • Preliminary Prospectus (Red Herring):

    • Distributed during the cooling-off period.

    • Missing only the final POP (Public Offering Price).

    • Used to gauge investor interest.

    Final Prospectus:

    • Includes all final information: issue details, POP, release date, and SEC disclaimer.

    • Must be delivered to investors who purchase in the primary market.

    • May be provided electronically (e.g., SEC website).

    • Includes the SEC disclaimer:

      “The SEC does not approve or disapprove of these securities.”

📰 Tombstone Advertisements

  • The only advertisement allowed during the cooling-off period.

  • Basic announcement containing:

    • Name of the issuer

    • Type and amount of security offered

    • Name of underwriters

    • POP (when available)

    • Disclaimer stating:

      “This announcement is neither an offer to sell nor a solicitation of an offer to buy these securities.”

🚫 During the Cooling-Off Period:

  • ✅ Allowed:

    • Tombstone ads

    • Preliminary prospectus (Red Herring)

    • Indications of interest

    • Due diligence

    • State registration (Blue Sky laws)

    ❌ Not Allowed:

    • No offers to sell

    • No money accepted

    • No binding agreements or promises

💼 Private Investment in Public Equity (PIPE):

  • A public company sells additional shares to institutional or accredited investors privately.

  • Exempt from SEC registration, making it faster and cheaper than a public offering.

🧊 Shelf Registration:

  • Used by companies that are already publicly traded.

  • Allows them to register securities now and sell later (up to 2 years).

  • Issuer can sell portions of the offering when needed.

  • Must file a supplemental prospectus before each sale.

  • Can be for an IPO or APO.

📄 Prospectus Delivery After Market Release

  • After the release date, investors may still be entitled to a prospectus for a limited time depending on the type of security:

Type of Offering / Security Type / Prospectus Delivery Period

  • IPO / NMS (exchange or NASDAQ) / 25 days

  • APO / NMS / 0 days (no requirement)

  • IPO / Non-NMS / (OTC/unlisted) 90 days

  • APO / Non-NMS / 40 days

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✺ Review questions ✺

  • Principal — buying the entire issue and reselling it to investors.

  • The spread (difference between POP and the discount).

  • Form S-1 Registration Statement.

  • a) Accepting money from investors
    b) Publishing a tombstone ad
    c) Promising to sell securities
    ✅ Answer: b) Publishing a tombstone ad

  • 20 calendar days

  • Allows a public company to register securities now and sell them later (up to 2 years).

  • Institutional and Accredited Investors

  • The underwriter must sell at least a minimum amount or cancel the offering