Selling New Securities - SEC Rules

Shelf Registration — SEC Rule 415

If, after the IPO, a company wants to issue and sell more new securities, it would have to go through the same basic procedure as the IPO, but with some differences. First, the price of the new securities would be determined by the current market price of the securities that are already being bought and sold in the secondary market. Secondly, the new prospectus would not have to be as detailed, because the public company must publish financial reports continually, and file those reports with the SEC.


In the 1980's, the SEC adopted Rule 415, which allowed public companies to register new securities, but then shelve the public offering for up to 2 years. Thus, the company can make a public offering when the company needs the money, or market conditions are favorable, with a minimum of expense and effort.

 

SEC Rule 144 — Private Placement Market

Companies that are too small or risky for an IPO can get financing through private placements, which is also cheaper and faster than a public offering. SEC Rule 144

A private placement is the selling of unregistered securities, either stocks or bonds, to qualified institutional investors—investment companies, pension funds, and insurance companies, especially life insurance companies. The cost of a private placement is much less than a public offering, because the securities do not have to be registered with the SEC, the issuer does not have to comply with U.S. generally accepted accounting principles, and because there are usually only a few institutional investors involved, marketing costs are much less.

The SEC enacted Regulation D in 1982 which defines a qualified institutional investor as one who can understand, or can employ those who understand, the return and the risk of securities, and can bear the risks.

However, the purchaser of a private placement must sign a letter of intent, called an investment letter, which states that the securities are being bought for investment and not for resale. Thus, these securities are often called letter securities, or in the case of bonds, letter bonds. If the letter securities are stocks, then they may be called letter stocks, or 144 stocks.

lthough the issuer does not have to give a prospectus to buyers in a private placement, it still must furnish information that the SEC deems material in the form of a private placement memorandum to potential investors. Unlike a prospectus, though, the SEC does not review the memorandum. Because there are usually few investors in any given private placement, the investors can negotiate the characteristics of the issue, giving them more flexibility than they would have in a public offering.

Letter securities cannot be resold for 2 years (1 year if more onerous conditions are met), and when they are, it must be a regular brokerage transaction.

Most private placement bonds are not investment grade, and because they were privately placed, they can’t be resold to the public unless they are first registered with the SEC. Thus, they generally pay a higher interest rate compared to other securities of comparable terms.

An investment banker can tailor private placements for their institutional customers.governs private placement transactions.

SEC Rule 144A — Increasing Liquidity and Foreign Investment, and Domestic Issuance of Foreign Securities

Previously, investors who bought private-placement securities could not resell them for 2 years. This cost issuers more because they had to pay a higher yield to compensate investors for the illiquidity of their purchase. In April, 1990, the SEC enacted Rule 144A, which allowed institutional investors to trade the investments among themselves at any time, and without having to register the securities. This not only lowered the cost of raising funds by the issuer, but it also increased foreign investment, which increased the supply of money, and thereby reduced its cost een more. Rule 144A offerings are underwritten by investment bankers.

Rule 144A also enhanced the domestic issuance of securities for foreign issuers, primarily because it eliminated the need to register the securities, thereby saving time and expense.

Selling New Securities

Before a corporation can offer securities for sale to the public, it must register the offering with the Securities and Exchange Commission (SEC), the federal agency responsible to enforcing the nation’s securities laws. The primary law governing the public offering of securities is the Securities Act of 1933, also known as the Act of Full Disclosure. Generally, the investment bank that is handling the offering will register with the SEC for the corporation.

SEC Registration

For any new offering of securities, a corporation must file a registration statement with the SEC that contains the following information:

• A description of the corporation.
• A concise biography of the officers and directors of the corporation.
• Financial stakes of all insiders, the directors and officers (control persons) in the corporation, and a list of anyone holding more than 10% of the corporation’s securities.
• Complete financial statements.
• What securities are being offered for sale, and how will the money be used.
• Any legal proceedings that may have a material impact on the company.

The SEC will review the registration to be sure that everything is in compliance with the law, and that there is full disclosure. If it is, then the SEC will approve the registration, and allow the company to sell its securities on a specified date—the effective date. However, SEC approval is not an endorsement of the issue, but only that there has been proper disclosure.

If there is any problem with the registration, then the SEC will send a deficiency letter to remedy the problem. Generally, the underwriting manager handles the deficiency letters quickly, because deficiency letters delay the effective date. No securities can be sold or even offered for sale before the effective date.

The time between filing and the effective date is known as the cooling-off period. During this time, no reports, recommendations, or sales literature may be sent to anyone. The underwriters may, however, send a preliminary prospectus—often called a red herring, because of the red lettering on the title page—that provides potential investors with all the necessary information that an investor would need to make an intelligent decision, which includes a description of the company and its business, income statement and balance sheets, any pending events that could have an impact on the business, such as mergers or acquisitions, its competition, and the agencies that regulate it. What it does not contain, however, is the public offering price of the new securities and the effective date for the sale, since the effective date would not yet be known.

A preliminary prospectus is published to generate and gauge interest among investors in the new securities, but it cannot offer them for sale until the registration has been approved by the SEC. The indication of interest will be used by the investment bank to price the new securities.

SEC Rule 134 does permit 1 other type of publication during the cooling-off period—the tombstone ad. The tombstone ad must be clear that it is an announcement only, and not an offer to sell nor a solicitation to buy.

WHAT IS NAKED SHORT SELLING AND IS IT REALLY BAD AS THAY SAY?

As we have learned, selling a stock short is taking a negative position on a stock, it’s essentially a bet that the stock price will go down. You have to first borrow shares from a brokerage house, sell those, and then buy shares of the stock back at a later date to repay the borrowed ones, hopefully when the price has gone down.

Naked short selling is a practice of sale that is conducted before the seller has proper ownership or has been authorized to sell the security by the current owner. Naked short selling is conducted with the anticipation of being able to buy back the security at a lower price in short order, thus covering the original sale and managing to make a profit from the venture.

While the strategy of selling a stock short is considered ethical and legal in many parts of the world, naked short selling is considered to be highly unethical in most markets.

The SEC declared general naked shorting illegal in 1934. but they included a provision allowing market makers to employ the use of naked short selling when the anticipated result was to increase the liquidity of the investment market and help to restore some balance to an unstable situation.

Naked shorting to drive down share prices violates US law. Many companies have been accused of using naked shorts in order to make profits at the expense of share prices. To do this, the trader simply enters a naked short with no intention of ever delivering the shares. A large enough short sale could cause the price to fall, as is the case with any stock being sold, so as long as the trade is large enough to move the share price, the short is likely to be profitable. Normally this would be risky; if the price did move back up for other reasons, the trader would be driving the price up with every purchase, a condition known as a "short squeeze". But as long as the buyer turns around and shorts it back into the market, the price continues dropping, making the trades profitable even though no one actually holds any of the shares.

IS IT REALLY AS BAD AS THAY SAY?

You will hear from some people that naked short selling is not bad for a stock market. But it is. If you allow someone to sell stocks he doesn't own, if he does it in 1000 shares it’s not a problem. But what happens if he short a 100,000,000 shares of a company? The result is that naked short selling creates an increased supply of shares of a company and price of the stock eventually falls. So the fear is that, even if there is no reason for stock to fall, and the company is in great business like Coca-Cola Inc. someone could drive prices down and profit from it or by buying put options.

To help you understand this, I’ll give you an example: let’s say you bought a house for you your family for $100,000. You agreed to put a deposit of 30% ie $30,000. You pay your mortgage, and everything seams fine, until one day you realize that someone naked sold short your mortgages and several other in that area, increasing supply of houses like yours, and driving the prices down fast! As a result, the price of your house fall below $30.000 and you get a call from your bank (ie. a margin call) requesting to pay the difference or they will sell the house at the market. Next day, your house is sold a you had to move out. A week later, price of the house goes back up to $100.000.

That’s how feels every investor or Bear Stearns, or any other company which was under heavy naked short selling in the period of crash in 2008. Yes, prices fell anyway, but the question is did someone manipulated and fueled that fall?

CONCLUSION

Don't get me wrong, short selling has an important role in price discovery process, because short sellers are reality check and they try to exploit inefficiencies and  short sell companies that shouldn't have high valuations. That is OK. But allowing someone to sell something he doesn't own, in a way that each of his sale further depress and manipulate the price should be and is illegal.