Selling New Securities - Final Prospectus

The prospectus is a short form of the SEC registration, containing only those facts necessary for an investor to make an intelligent decision regarding the issue. It can only be distributed after the effective date of SEC registration. 

The final prospectus must be published and sent to each investor no later than the confirmation date of the purchase. The final prospectus will have the price of the new securities, the underwriters' discount, and any requirements specified by the SEC in approving the registration. The final prospectus will also contain the latest financial information about the company. 

The price of the new securities is decided when the registration is approved, but if market conditions or lack of interest lower the marketable price sufficiently, the underwriting may be postponed or even canceled. The SEC requires that any prospectus that is more than 9 months old must not have any financial information that is more than 16 months old. If there is any event during the distribution of the prospectus that could have a material impact on the company, then the prospectus must be amended to reflect the new developments. In the past, this has been done by stickering, actually pasting a new page on top of the obsolete material. Nowadays, however, with prospectuses in electronic format, the new material can be added, and the obsolete material can be amended or deleted directly.

When the new issue of securities is a first-time sale of stock by a company, it is called an initial public offering (IPO), or going public. This allows the founders and venture capitalists who invested in the company to profit from their investment.

90-Day Rule for IPOs:

Before a company goes public, most of its financial information is confidential and has not been published. Therefore, the SEC requires that a prospectus be available for at least 90 days after the effective date to provide financial information. After 90 days, the company will have posted its 1st required financial statements with the SEC, which any investor can examined for the latest financial information about the company.

40-Day Rule for New Issues:

A new issue is any offering of new issues of stock that is not an IPO. In this case, the company will have already filed periodic financial statements with the SEC, so the SEC requires that a prospectus for the new offering has to be available for at least 40 days after the effective date of the new issue.

25-Day Rule for Exchange traded Issues:

If the new issue is going to be traded on a public stock exchange, then a prospectus must be available for at least 25 days after the effective date.

Public Distribution of New Issues:

All members of the underwriting syndicate must make a bona fide public distribution of the new issue at the public offering price.
 

Overallotments:

Usually, the underwriting syndicate members will accept a small percentage of orders over their allotment, because they know that some clients will cancel their order before delivery. Therefore, the underwriting manager will distribute more new issues to each syndicate member than they are required to sell—an overallotment. If fewer clients cancel than expected, then either the issuer will issue more shares to cover the additional sales—and get more money—or the underwriting syndicate will have to go short to cover the additional sales, which is a risk to the underwriting members, and will have to buy it back, probably at a higher price, in the secondary market to cover their shorts.

Stabilization:

When a new issue doesn't sell as well as expected, then initial investors may sell their shares in the secondary market for less than the public offering price while the syndicate members still have shares to sell. However, the underwriting syndicate cannot sell the shares for less than the public offering price, so, in this situation, they would not be able to sell their remaining shares.

To prevent a drop in price before all shares have been distributed to the public, the underwriting manager stands ready to buy any issues offered in the secondary market at or slightly below—but never above—the public offering price as a way to stabilize (aka peg, fix) the price of the new offering until it has been fully distributed to the public. Price-fixing is generally illegal, but is allowable in the distribution of new issues by Rule 104 of the Securities Exchange Act of 1934, but only until all shares have been publicly distributed—pegging the price afterward is against the law.

Stabilization may not work. The underwriting syndicate may be unable to sell all of the shares at the public offering price, in which case, they will have to take the loss. 

Syndicate Penalty Bid:

To stabilize the new issue, the underwriting manager buys the stock back at or near the public offering price. If the manager buys the stock back from a client of a syndicate member, then the manager has already paid or credited the syndicate member its underwriter's allowance. The syndicate penalty bid takes this money back from the syndicate member during the stabilization period, because the underwriting manager will have to re-sell those shares.