An issuer that raises money from the public hires broker-dealers to price and sell its securities. Bringing a registered issue to market follows this order:
- The issuer chooses a managing underwriter to run the deal.
- It signs a nonbinding letter of intent. The binding underwriting agreement comes later, usually at pricing.
- It files the registration statement with the Securities and Exchange Commission (SEC).
- The syndicate and selling group form under their own agreements.
- The issue is registered in each state where it will be sold.
The underwriting agreement decides who is stuck with unsold shares and what the underwriters earn for that risk, through three terms:
- Firm commitment or best efforts: In a firm commitment, the underwriters buy the whole issue and absorb any unsold shares.
- Spread: This is the public offering price minus the amount the issuer receives per share. It splits into the manager's fee, the underwriting fee and the selling concession, and the...
- Market-out clause: It lets underwriters cancel a firm commitment if a material adverse event makes the issue unmarketable. Weak demand alone does not qualify.
Common mistakes
- Using a 40-day aftermarket delivery period for an issuer that was already reporting before filing. That issuer usually needs no aftermarket prospectus at all.
- Treating 25 days as the whole Rule 15c2-12 request period. It is only the minimum.
- Assuming every relative of industry personnel is restricted. A sibling living elsewhere, with no material support either way, can often buy.
Bottom line
- Firm commitment underwriters own unsold shares, best efforts underwriters are agents, and a market-out clause needs a material adverse event.
- A registration statement becomes effective 20 days after filing unless accelerated or delayed, and effectiveness is never SEC approval.
- Pre-filing allows nothing, cooling-off allows offers and indications of interest but no sales, and sales wait for effectiveness.
- The preliminary prospectus reaches buyers 48 hours before confirmations in a non-reporting issuer's IPO, and aftermarket delivery runs none, 25, 40 or 90 days.
Exam shortcut
Place every stem in a registration period before you read the choices. Words like "check," "deposit" or "confirm" before effectiveness signal a violation. For prospectus timing, first ask whether the issuer was reporting before it filed, then ask whether the stock is listed. For Rule 5130, add up only the restricted owners' percentages.
The full lesson (about 3,239 words, 22 min read) adds 2 worked examples, a self-check, free in the app.
Learning objectives
- A3
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