A share of stock can change hands thousands of times, but the company that created it is paid only once. Questions on market structure come down to two things: where a trade happened, and who received the money.
Companies and governments raise cash for plants, research or debt repayment by selling new securities. The primary market is where issuers sell new securities and receive the proceeds. Under Securities Act Section 2(a)(4), an issuer is anyone who issues or proposes to issue a security, such as a corporation selling stock or a city selling bonds.
A company's first sale of stock to the public is its initial public offering (IPO). A later sale of new shares by a company that is already public is a follow-on offering. Both are primary market sales, because new securities are created and the money flows to the issuer.
Securities Act Section 5 governs the primary market. It makes it unlawful to sell a security through the mail or interstate commerce unless a registration statement is in effect.
Common mistakes
- Calling unlisted trading third market. An unlisted stock traded between dealers is OTC trading. The third market requires an exchange-listed stock traded off its exchange.
- Filing Nasdaq under dealer markets. Nasdaq has been a national securities exchange since 2006, so its stocks are exchange-listed.
- Crediting the issuer with trading gains. If IPO shares sold at $20 later trade at $26, the $6 gain belongs to investors.
Bottom line
- The primary market is where issuers sell new securities and receive the proceeds, net of the underwriting spread; IPOs, follow-ons, Rule 506(b) private placements and Regulation A sales all count.
- Dealers deliver a prospectus for 40 days after a registered offering, or 90 days after an issuer's first one, unless SEC Rule 174 shortens the period.
- The secondary market is investors trading with investors on exchanges, OTC and electronic venues; the issuer receives nothing, and regular-way trades settle T+1.
- Exchanges, including the NYSE and Nasdaq (an exchange since 2006), are auction markets; the OTC market is a dealer market where market makers quote bids and asks and trade as principal.
Exam shortcut
Before you read the choices, find two facts in the stem: who is selling, and whether the security is exchange-listed. If the issuer sells new securities, answer primary market, whether the offering is registered or exempt, and the issuer gets the proceeds. Words like "institutions," "directly," "block," "ATS" or "dark pool" point to the fourth market.
The full lesson (about 3,993 words, 27 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- A3
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