Chapter 3 - Issuing Corporate Securities

Question 1

Securities Act of 1933

Answer 1

• Regulates the primary market.
• Full and fair disclosure
• Known as
  
  • the Paper Act
  • Truth in Securities Act
• SEC no approval clause

Question 2

Registration statement

Answer 2

Filed with the SEC. Must contain detailed information including:

• Balance sheet dated with 90 days of registration
• Profit & loss statements for last 3 years
• Company’s capitalization
• Use of proceeds
• Shareholders holding more than 10%
• Biographical information of officers & directors.

Question 3

Registration process

Answer 3

Upon submitting, under SEC review for 20 days - known as the cooling-off period. No sales of the securities may take place during this time.

During the cooling-off period:

• May solicit/receive an indication of interest
• Preliminary prospectus (hard copy) - red herring
• Roadshows
• Due diligence meetings

SEC will issue an effective date - when sales can take place.

Note for the exam: the SEC never approves the issue, so anything that indicates that the sales may take place after the SEC approves it is a wrong answer.

Question 4

Deficiency letter

Answer 4

The SEC will issue a deficiency letter asking for clarification or further information regarding certain points relating to the registration statement and therefore extend the cooling-off period beyond the 20 days.

Question 5

Providing the prospectus to after-market purchasers

Answer 5

The aftermarket prospectus delivery requirements may be met electronically.

For IPOs:

• 90 days after being issued on OTCBB (Pink OTC)
• 25 days for NASDAQ securities

For Additional offerings:

• 40 days after being issued on OTCBB
• No requirement for listed or NASDAQ securities

Question 6

Tombstone Ads

Answer 6

A tombstone ad is an announcement and description of the securities to be offered. Tombstone ads are traditionally run to announce the new issue, but they are not required and do not need to be filed with the SEC.

Question 7

FINRA rule 5130

Answer 7

A broker-dealer underwriting a new issue must make a complete and bona fide offering of all securities being issued to the public and may not withhold any of the securities.

FINRA rule 5130 covers initial offerings of common stock only.

Question 8

Rules relating to Hot Issues

Answer 8

• Free riding and withholding
• Restricted persons (anyone with series 7, or spouse)
• Contingently approved persons (may be allowed)
• Directed stock (typically allocated to employees) is OK
• Greenshoe provision (over-allotment) limited to 15% of the original offering.

Question 9

Carve-out Procedure

Answer 9

Rules related IPO purchases for restricted persons.

Question 10

Prospectus

Answer 10

Preliminary prospectus (hard copy) - red herring. Can be provided during the 20-day cooling-off period with no markups. Does not include:

• An offering price (may have a range)
• Proceeds to the issuer
• Underwriters discount

Final prospectus - also known as a statutory prospectus

• Can be delivered electronically.
• Access = Delivery. If it can be viewed on the SEC website, it is deemed to be delivered.

Freewriting prospectus - any form of written communication published or broadcast by an issue or which contains information about the securities offered for sale that does not meet the definition of a statutory prospectus.

Question 11

Underwriting Corporate Securities

Answer 11

Various fees and charges are deducted from each share.

• Management fee - goes to lead underwriter. The person or company that brought the deal in. The fee is charged regardless of who sells it.
• Underwriting fee - legal & expenses
• Selling concession - whoever sells the shares

Underwriting: $2.50
Proceeds to the issuer are $22.50

The underwriting spread is the difference between what the investor pays on the public offering and what the issuer receives upon the sale of those new security

Question 12

Firm Commitment

Answer 12

In a firm commitment underwriting, the underwriter guarantees to purchase all of the securities being offered for sale by the issuer regardless of whether it can sell them to investors.

Note: typically they will have a market out clause if a material item is discovered impacting the underwriting.

Question 13

Contingent underwriting

Answer 13

All or None (AON) - the issuer has determined that it must receive the proceeds from the sale of all the securities. If all the securities are sold, the proceeds will be released to the issuer. If all the securities are not sold, the issue is canceled and the investors’ funds will be returned to them.

Mini-Maxi - does not become effective until a minimum amount of the securities have been sold. Once the minimum has been met, the underwriter may then sell the securities up to the maximum amount specified under the terms of the offering. All funds collected from the investors will be held in escrow until the underwriting is completed.

Standby - used in conjunction with a preemptive rights offering. Done on a firm commitment basis. The standby underwriter agrees to purchase any shares the current shareholders do not purchase. The standby underwriter will then resell the securities to the Public.

Question 14

Types of Offerings

Answer 14

IPO - First-time issue. Company was previously private.

Subsequent primary - Additional shares issued. Proceeds go to the issuer or to the company.

Secondary offering - selling shareholders receive the proceeds from the sale minus the underwriters’ compensation.

Combined/Split offering - some of the proceeds go to the shareholders and some of the proceeds go to the issuer or the company.

Question 15

Stabilization

Answer 15

Question 16

Private Placement Reg D

Answer 16

Accredited investors: $200k/yr (single) or $300k/yr (joint) or $1MM net worth (minus home). Think 1-2-3.

Non-accredited investors:

• National: 35 people
• State: 10 people
• 12 month period

Question 17

Rule 144

Answer 17

Regulates how control or restricted securities may be sold. The rule designates:

• The holding paired for the security
• The amount of the security that may be sold
• Filing procedures
• Method of sale

The maximum that can be sold is the greater of 1% of the outstanding stock or average weekly trading volume during the most recent four weeks.

Form 144 must be filed at the time the order is placed to sell the security. If selling <5,000 shares and

Stock sold under rule 144 becomes part of the public float.

The broker-dealer may execute the order with a market maker or may inquire with customer service expressed an unsolicited interest in the securities in the last 10 days or with a broker-dealer who has expressed interest in the securities in the last 60 days.

Question 18

PIPE transactions

Answer 18

Private investment in a public equity.

Public companies that wish to obtain additional financing without selling securities to the general public may sell securities to a group of accredited investors through a private placement.

Question 19

Rule 144a

Answer 19

Permits the resale of restricted stock to qualified institutional buyers (QIB)

QIB = $100MM

May not use information on new account card

Question 20

Rule 145

Answer 20

Requires that shareholders approve any merger or re-organization of the companies ownership. Any merger or acquisition will be reported to the SEC on form S-4.

Question 21

Rule 147 / 147a

Answer 21

Allows an issue were to raise an unlimited amount of capital within one state. Because the offering is being made only in one state, it is exempt from registration with the SEC and is subject to the jurisdiction of the state securities administrator.

Must meet at least one of the following:

• 80% of the issue was income must be received in that state
• 80% of the offerings proceeds must be used in that state
• 80% of the issue were assets must be located in that state
• A majority of the issue is employees are based in-state

No resale out of state for six months.

Rule 147a allows out-of-state residents to purchase.

Question 22

Regulation S

Answer 22

Domestic issuers who make a distribution of securities exclusively to offshore investors do not have to file a registration statement for the securities under the Securities Act of 1933.

Securities distributed are subject to a compliance period:

• 40 days for debt
• 6 months for securities

Issuers must report the sale of securities under Regulation S by filing form 8K.

Question 23

Regulation A

Answer 23

Allows issuers to raise up to $50 million in any 12 month period as amended by the Jobs Act of 2012.

• Tier 1 - up to $20MM
• Tier 2 - up to $50MM

Regulation A provides issuers with an exemption from the standard registration process. This exemption from full registration allows smaller companies access to the capital markets without having to go through the expense of filing a full registration statement with the SEC.

Must file an abbreviated notice of sale or offering circular known as an S1-A.

Question 24

Crowdfunding

Answer 24

Provides the ability to raise capital from small investors through a broker-dealer or a registered crowdfunding portal. The portal must be registered with the SEC and must also be a FINRA member firm.

Limits on crowdfunding:

• 12 month limit
• Income or net worth < $100,000 can invest greater of $2,000 or 5% of income or net worth
• Income or net worth > $100,000 can invest lesser of 10% of income or net worth or maximum of $100,000.

Question 25

Rules regarding issuing research reports during distribution

Answer 25

Rule 137: Non-participants. Not part of the underwriting syndicate.

Rule 138: Non-equivalent securities. Example: Non-convertible bond is different than the security.

Rule 139: If part of normal business is to issue a report, it can continue under certain parameters (e.g. cannot change rating, etc.)

Question 26

Blackout for issuing research

Answer 26

Question 27

Rule 415 Shelf Registration

Answer 27

Allows an issuer to register securities that may be sold for its own benefit, or the benefit of a subsidiary, or in connection with business plans in an amount that may be reasonably sold by the issuer within a two-year period.

Question 28

Additional communication rules

Answer 28

A forward-looking statement is NOT a fact.

Road shows:

• An analyst may not attend unless the company is an emerging growth company (EGC)
• Electronic roadshows must be recorded and filed with SEC

Question 29

Direct Participation Program (DPP) rollup transaction

Answer 29

Traditionally used for oil & gas or real estate.

• Max fee = 2% of total value
• Must be paid regardless in equal installments
• Failing to disclose negative opinion is fraud

Question 30

Alternate Public Offering / Reverse Merger

Answer 30

Can be used by a private company as a cost-effective alternative to a traditional public offering. In an APO transaction, a private company acquires or merges with a company that is already public as a means of taking itself public.

The transaction is reported on 8K.