Initial Public Offering
An initial public offering (IPO) or stock market launch, is the first sale of stock by a private company to the public. It can be used by either small or large companies to raise expansion capital and become publicly traded enterprises. Many companies that undertake an IPO also request the assistance of an investment banking firm acting in the capacity of an underwriter to help them correctly assess the value of their shares, that is, the share price (IPO Initial Public Offerings, 2011).
Reasons for listing
When a company lists its securities on a public exchange, the money paid by investors for the newly issued shares goes directly to the company (in contrast to a later trade of shares on the exchange, where the money passes between investors). An IPO, therefore, allows a company to tap a wide pool of investors to provide itself with capital for future growth, repayment of debt or working capital. A company selling common shares is never required to repay the capital to investors.
Once a company is listed, it is able to issue additional common shares via a secondary offering, thereby again providing itself with capital for expansion without incurring any debt. This ability to quickly raise large amounts of capital from the market is a key reason many companies seek to go public.
There are several benefits to being a public company, namely:
- Bolstering and diversifying equity base
- Enabling cheaper access to capital
- Exposure, prestige and public image
- Attracting and retaining better management and employees through liquid equity participation
- Facilitating acquisitions
- Creating multiple financing opportunities: equity, convertible debt, cheaper bank loans, etc.
- Increased liquidity for equity holder
Disadvantages of an IPO
There are several disadvantages to completing an initial public offering, namely:
- Significant legal, accounting and marketing costs
- Ongoing requirement to disclose financial and business information
- Meaningful time, effort and attention required of senior management
- Risk that required funding will not be raised
- Public dissemination of information which may be useful to competitors, suppliers and customers
Procedure
IPOs generally involve one or more investment banks known as “underwriters“. The company offering its shares, called the “issuer”, enters a contract with a lead underwriter to sell its shares to the public. The underwriter then approaches investors with offers to sell these shares.
The sale (allocation and pricing) of shares in an IPO may take several forms. Common methods include:
A large IPO is usually underwritten by a “syndicate” of investment banks led by one or more major investment banks (lead underwriter). Upon selling the shares, the underwriters keep a commission based on a percentage of the value of the shares sold (called the gross spread). Usually, the lead underwriters, i.e. the underwriters selling the largest proportions of the IPO, take the highest commissions—up to 8% in some cases.
Multinational IPOs may have many syndicates to deal with differing legal requirements in both the issuer’s domestic market and other regions. For example, an issuer based in the E.U. may be represented by the main selling syndicate in its domestic market, Europe, in addition to separate syndicates or selling groups for US/Canada and for Asia. Usually, the lead underwriter in the main selling group is also the lead bank in the other selling groups.
Because of the wide array of legal requirements and because it is an expensive process, IPOs typically involve one or more law firms with major practices in securities law, such as the Magic Circle firms of London and the white shoe firms of New York City.
Public offerings are sold to both institutional investors and retail clients of underwriters. A licensed securities salesperson ( Registered Representative in the USA and Canada ) selling shares of a public offering to his clients is paid a commission from their dealer rather than their client. In cases where the salesperson is the client’s advisor it is notable that the financial incentives of the advisor and client are not aligned.
In the US sales can only be made through a final prospectus cleared by the Securities and Exchange Commission.
Investment dealers will often initiate research coverage on companies so their Corporate Finance departments and retail divisions can attract and market new issues.
The issuer usually allows the underwriters an option to increase the size of the offering by up to 15% under certain circumstance known as the greenshoe or overallotment option.
Auction
A venture capitalist named Bill Hambrecht has attempted to devise a method that can reduce the inefficient process. He devised a way to issue shares through a Dutch auction as an attempt to minimize the extreme underpricing that underwriters were nurturing. Underwriters, however, have not taken to this strategy very well which is understandable given that auctions are threatening large fees otherwise payable. Though not the first company to use Dutch auction, Google is one established company that went public through the use of auction. Google’s share price rose 17% in its first day of trading despite the auction method. Brokers close to the IPO report that the underwriters actively discouraged institutional investors from buying to reduce demand and send the initial price down. The resulting low share price was then used to “illustrate” that auctions generally don’t work.
Perception of IPOs can be controversial. For those who view a successful IPO to be one that raises as much money as possible, the IPO was a total failure. For those who view a successful IPO from the kind of investors that eventually gained from the underpricing, the IPO was a complete success. It’s important to note that different sets of investors bid in auctions versus the open market—more institutions bid, fewer private individuals bid. Google may be a special case, however, as many individual investors bought the stock based on long-term valuation shortly after it launched its IPO, driving it beyond institutional valuation.
Pricing
The underpricing of initial public offerings (IPO) has been well documented in different markets (Ibbotson, 1975; Ritter 1984; Levis, 1990; McGuinness, 1992; Drucker and Puri, 2007). While issuers always try to maximize their issue proceeds, the underpricing of IPOs has constituted a serious anomaly in the literature of financial economics. Many financial economists have developed different models to explain the underpricing of IPOs. Some of the models explained it as a consequences of deliberate underpricing by issuers or their agents. In general, smaller issues are observed to be underpriced more than large issue (Ritter, 1984; Ritter, 1991; Levis, 1990).
Historically, some of IPOs both globally and in the United States have been underpriced. The effect of “initial underpricing” an IPO is to generate additional interest in the stock when it first becomes publicly traded. Through flipping, this can lead to significant gains for investors who have been allocated shares of the IPO at the offering price. However, underpricing an IPO results in “money left on the table”—lost capital that could have been raised for the company had the stock been offered at a higher price. One great example of all these factors at play was seen with theglobe.com IPO which helped fuel the IPO mania of the late 90′s internet era. Underwritten by Bear Stearns on November 13, 1998, the stock had been priced at $9 per share, and famously jumped 1000% at the opening of trading all the way up to $97, before deflating and closing at $63 after large sell offs from institutions flipping the stock. Although the company did raise about $30 million from the offering it is estimated that with the level of demand for the offering and the volume of trading that took place the company might have left upwards of $200 million on the table.
The danger of overpricing is also an important consideration. If a stock is offered to the public at a higher price than the market will pay, the underwriters may have trouble meeting their commitments to sell shares. Even if they sell all of the issued shares, if the stock falls in value on the first day of trading, it may lose its marketability and hence even more of its value.
Underwriters, therefore, take many factors into consideration when pricing an IPO, and attempt to reach an offering price that is low enough to stimulate interest in the stock, but high enough to raise an adequate amount of capital for the company. The process of determining an optimal price usually involves the underwriters (“syndicate”) arranging share purchase commitments from leading institutional investors.
On the other hand, some researchers (e.g. Geoffrey C., and C. Swift, 2009) believe that IPOs are not being under-priced deliberately by issuers and/or underwriters, but the price-rocketing phenomena on issuance days are due to investors’ over-reaction (Friesen & Swift, 2009).
Some algorithms to determine underpricing: IPO Underpricing Algorithms
Issue price
A company that is planning an IPO appoints lead managers to help it decide on an appropriate price at which the shares should be issued. There are two ways in which the price of an IPO can be determined: either the company, with the help of its lead managers, fixes a price (fixed price method) or the price is arrived at through the process of book building.
Note: Not all IPOs are eligible for delivery settlement through the DTC system, which would then either require the physical delivery of the stock certificates to the clearing agent bank’s custodian, or a delivery versus payment (DVP) arrangement with the selling group brokerage firm.
Quiet period
There are two time windows commonly referred to as “quiet periods” during an IPO’s history. The first and the one linked above is the period of time following the filing of the company’s S-1 but before SEC staff declare the registration statement effective. During this time, issuers, company insiders, analysts, and other parties are legally restricted in their ability to discuss or promote the upcoming IPO (U.S. Securities and Exchange Commission, 2005).
The other “quiet period” refers to a period of 40 calendar days following an IPO’s first day of public trading. During this time, insiders and any underwriters involved in the IPO are restricted from issuing any earnings forecasts or research reports for the company. Regulatory changes enacted by the SEC as part of the Global Settlement enlarged the “quiet period” from 25 days to 40 days on July 9, 2002. When the quiet period is over, generally the underwriters will initiate research coverage on the firm. Additionally, the NASD and NYSE have approved a rule mandating a 10-day quiet period after a Secondary Offering and a 15-day quiet period both before and after expiration of a “lock-up agreement” for a securities offering.
Stag profit
Stag profit is a stock market term used to describe a situation before and immediately after a company’s Initial public offering (or any new issue of shares). A stag is a party or individual who subscribes to the new issue expecting the price of the stock to rise immediately upon the start of trading. Thus, stag profit is the financial gain accumulated by the party or individual resulting from the value of the shares rising.
For example, one might expect a certain I.T. company to do particularly well and purchase a large volume of their stock or shares before flotation on the stock market. Once the price of the shares has risen to a satisfactory level the person will choose to sell their shares and make a stag profit.
Largest IPOs
- Agricultural Bank of China $22.1 billion (2010)[1]
- Industrial and Commercial Bank of China $21.9 billion (2006)[2]
- American International Assurance $20.5 billion (2010)[3]
- Visa Inc. $19.7 billion (2008)[4]
- General Motors $18.1 billion (2010)[5]
IPOs value
The US last topped the IPO league tables in 2008 and then east took over west with China (Shanghai, Shenzhen and Hong Kong) raised $73 billion or almost double the amount of money raised on the New York Stock Exchange and Nasdaq combined up to end of November 2011. Hong Kong Stock Exchange raised 30.9 billion this year as the top bourse for the third year in a row, while New York raised 30.7 billion.[6]
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PINK SHEETS
OTC Markets Group, Inc., informally known as “Pink Sheets“, is a private company that provides services to the U.S. over-the-counter (OTC) securities market including electronic quotations, trading, messaging, and information platforms. According to the U.S. Securities and Exchange Commission, OTC Markets Group, Inc. is not a stock exchange. The company simply facilitates the exchange of securities between qualified independent brokers.
History
The company was first established in 1913 as The National Quotation Bureau (NQB). For decades, the NQB reported quotations for both stocks and bonds, publishing the quotations in the paper-based Pink Sheets and Yellow Sheets respectively. The publications got their names from the color of paper they were printed on.
Regulatory status
Pink Sheets is not a stock exchange. To be quoted via Pink Sheets, companies do not need to fulfill any requirements (e.g. filing financial statements with the SEC). With the exception of foreign issuers, mostly represented by ADRs, the companies quoted in the Pink Sheets tend to be closely held, extremely small, thinly traded, or bankrupt. Most do not meet the minimum U.S. listing requirements for trading on a stock exchange such as the New York Stock Exchange. Many of these companies do not file periodic reports or audited financial statements with the SEC, making it very difficult for investors to find reliable, unbiased information about those companies.
For these reasons the SEC views companies listed on Pink Sheets as “among the most risky investments“[1] and advises potential investors to heavily research the companies in which they plan to invest.
Pink Sheets market tiers
Pink Sheets established a categorization system to indicate the level of financial and corporate disclosure provided by the companies using its quotation system. The disclosure categories do not signify issuer quality or merit of any security. Categorization is based on the level and timeliness of a company’s disclosure and any category can include speculative, distressed, or questionable companies. Investors are encouraged to use caution when considering these companies for investment.[2]
OTCQX
OTCQX is the top tier of the OTC market. Exclusively for companies that meet financial standards and undergo a qualitative review. Investor focused companies use the quality-controlled OTCQX platform to offer investors transparent trading, superior information, and easy access through their regulated U.S. broker-dealers. OTCQX is a market tier is for domestic (U.S.) companies registered with and reporting to the Securities and Exchange Commission or a banking or insurance regulator.
OTCQB
The OTCQB tier designates OTC-traded companies that have operating businesses and provide substantial disclosure to the marketplace. Although OTCQBX companies are not SEC reporting entities, they must provide audited financials and certain disclosures to Pink OTC Markets. OTCQB is the middle tier of the OTC market. OTCQB companies are reporting with the SEC or a U.S. banking regulator, making it easy for investors to identify companies that are current in their reporting obligations. There are no financial or qualitative standards to be in this tier.
OTC Pink — The Speculative Trading Marketplace
OTC Pink is the third tier of the OTC market. OTC Pink is the speculative trading marketplace that has no financial standards or reporting requirements. OTC Pink companies choose the level of information they provide to investors and may have current, limited or no public disclosure.
Current Information
The Current Information tier indicates companies that have submitted information no older than six months to the Pink Sheets News Service or have made a filing on the SEC’s EDGAR system in the previous six months. This category includes shell companies or development stage companies with little or no operations as well as companies without audited financial statements and as such should be considered extremely speculative by investors.
Limited Information
The Limited Information tier is designed for companies that are unwilling or unable to meet Pink Sheets’ Guidelines for Providing Adequate Current Information. Companies in this tier have submitted some but not all of current information required. These are often companies with financial reporting problems, economic distress, or in bankruptcy.
No Information
This tier indicates companies that are unwilling or unable to provide disclosure to the public markets – either to a regulator, a stock exchange or Pink Sheets. Companies in this category do not make Current Information available via Pink Sheets News Service, or if they do, the available information is older than six months. This category includes defunct companies that have ceased operations as well as ‘dark’ companies with questionable management and market disclosure practices. Publicly traded companies that are not willing to provide information to investors should be treated with suspicion and their securities should be considered highly risky.
Caveat Emptor – Buyer Beware
There is a public interest concern associated with the company. This may include a spam campaign, stock promotion or known investigation of fraudulent activity committed by the company or insiders. During a spam campaign, any stock that is not in the Current Information category will also have its quotes blocked on pinksheets.com.
Other OTC markets
OTCBB
The OTC Bulletin Board (OTCBB) is a listing of securities that are also traded “over the counter” similar to the Pink Sheets, but unlike Pink Sheet companies, OTCBB companies are required to file timely reports with the U.S. Securities and Exchange Commission. Many OTCBB companies are also quoted via Pink Sheets’ electronic quotation system.
Grey Market
Securities that are not listed on any stock exchange nor formally quoted via the OTCBB or Pink Sheets are considered to be in the Grey Market. Unsolicited transactions are processed independently and not centrally listed or quoted. Trades are reported to a self-regulatory organization (SRO), which then passes the data on to market data companies.
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INVESTMENT TERMS YOU MUST KNOW
What is a Corporation?
A corporation is a fictitious person. It consists of several natural persons, who in the name of the corporation, are authorized by law to transact a business. The instrument which defines the rights and duties of the corporation is called a charter. It is issued by state governments under seal.
What is meant by Capital Structure?
The plan adopted by a corporation for securing capital necessary for its activities is called the capital structure.
What is a joint Stock Company?
A joint stock company is a partnership in which the affairs of the business are conducted by officers chosen by the stockholders.
What is Stock?
In a general term, it is applied to the shares in the capital stocks of banks, insurance, industrial, railroad and other incorporated or joint stock companies.
What is Capital Stock?
The capital stock of a company is the sum total of all the shares issued at their par value.
What is Treasury Stock?
Treasury stock is the stock of a corporation which has been issued once, and has either been bought back or donated to the treasury. The law provides that no corporation can sell its capital stock under its par value. However, once the stock has been issued and acquired back by the treasury, they can sell it at any price the board of directors see fit. Capital or unissued stock is often and erroneously referred to as treasury stock. When buying stock in new enterprises, determine whether it is capital stock or treasury stock. If the latter, why?
What is a Share?
A share represents a component part of the capital stock. It is commonly issued in denominations of $1, $5, $10, $25, or $100. The stock certificate represents the number of shares.
What is a Stock Certificate?
A stock certificate is a written or printed instrument of a corporation or joint stock company issued to the stockholder, certifying the value of each share and the number of shares the certificate represents.
What is a Common Stock?
As a rule the common stock has the voting power of the corporation, although there are exceptions. When the interest has been paid on the corporation’s bonds, debentures and preferred stock, the remainder of the earnings are available for dividends. The amount payable is determined and declared by the board of directors and may vary from time to time. Such earnings might be, and often are, sufficient to make the common stock yield a higher income than preferred. Extra dividends, stock split-ups, etc., as a rule are divided among common stock-holders. Common stock can be said to represent the basic owner-ship of the company.
What is a Preferred Stock?
A preferred stock is one which, after the interest on bonds and debentures has been paid, takes preference over common stock on earnings. Preferred stock usually carries a specific dividend yield, and when the dividend is not earned, it can, at the discretion of the directors, be paid in whole or in part out of surplus. If not paid, the dividend accumulates and must be paid before any payment is made to the common stockholders, providing it carries a cumulative clause which most preferred stocks do. Some preferred stocks have voting power. Others do not, except in the case of defaulted dividends. Preferred usually takes preference over assets in dissolution, although there are in-stances where no such provision is made.
What is a Participating Preferred?
A participating preferred stock is the same as preferred, with the added feature that it participates with common. After it has received its specific dividend and an equal amount has been received by common, then both preferred and common participate alike. In other cases a limit is placed upon its participation. Determine from the certificate as to what extent it participates.
What is a Convertible Stock?
This usually applies to a preferred stock, which may at some designated time and at some designated price be converted into the common stock of the same company.
Are There Any Advantages in a Convertible Stock?
At times, yes. A preferred stock may be selling at par, and the common stock considerably above. The conversion privilege at such times becomes valuable.
What is the Purpose of Issuing Convertible Stocks?
They are usually issued to stimulate distribution of the preferred stock, and make the offering more attractive.
What is a Stock Assessment?
A stock assessment is the sum levied pro rata upon the stock-holders of a corporation to cover losses, etc. Many stocks are non-assessable and so state the fact on the face of their certificate. Practically all bank stocks, however, are assessable in the event of failure.
What is a Street Certificate?
A Street Certificate is a stock certificate used for negotiable purposes, the assignment being made in blank on the back of the certificate, and the signature or endorsement thereto being guaranteed by a bank, or some reliable stock house, as being authentic and genuine.
What is a Bond?
A bond is written or printed obligation under seal, issued by a company or corporation, municipal or state government, or by the federal government. Bonds of business corporations are usually secured by mortgages on their real estate or plant and equipment. Municipal bonds are issued by the vote of the people or their representatives, and for their payment a sinking fund is accumulated by a yearly tax rate being levied on all the real property within the limits of the municipality. Government bonds are bonds issued by the federal government. Their names are usually derived from the interest they bear, and the time when due. Thus United States 4′s 1945, is understood to mean United States bonds bearing four percent interest and due in 1945. The same parlance is used in describing corporate bonds.
What is a Coupon Bond?
A coupon bond has coupons or certificates of interest attached to them. When the interest becomes due these coupons are detached and surrendered, upon receipt of the interest represented by them. The interest coupons on government coupon bonds are payable to the bearer, and will be cashed by any bank or banker in the United States.
What are Registered Bonds?
A registered bond is one payable to the owner as registered in the books of the corporation or government issuing it. Registered bonds can be transferred only by assignment and registry on the books of its issuer. The interest on registered bonds is paid by checks, payable to the registered owner and sent to him.
What is a Convertible Bond?
A convertible bond is one which may be converted into preferred or common stock, as may be specified in its indenture, within a certain period of time.
What is the Advantage of a Convertible Bond, if any?
At times a bond may be selling at par, and the company’s stock considerably above. The conversion privilege at such a time becomes valuable.
What is the Par Value of a Bond?
The par value of a bond is the face value, or the denomination as expressed on the face of the bond.
What is the Market Value of a Bond?
The market value of a bond is the amount at which it is quoted in the market. Bonds that sell above par are at a premium when they are worth more than their face value. Below par, or at a discount, when they are worth less than their face value.
What are Bond Quotations?
Bond quotations are the market price or rates that bonds sell for. Bonds are usually quoted flat, that is, the quoted price is for the bond as it is at the time of the quotation, which includes accrued interest. After the closing of the books, however, registered bonds are quoted less the interest.
What is a Bond Price Flat? See bond quotations.
What is a Debenture?
A debenture is a direct obligation of the company, but not secured by a mortgage. (See text matter.)
What Precaution is Used Against Counterfeiting?
Few counterfeit efforts are successful. Elaborate precautions are taken by engraving companies, who are approved by various stock exchanges, together with their use of a steel over-lapping process which prevents the successful photographing, duplication and counterfeiting of stocks and bonds. Another protective feature is the registrar and transfer.
What is a Registrar and Transfer?
All stocks listed on stock exchanges are required to have a registrar and transfer office. The entire stock of the corporation is registered at the registrar’s office and then deposited with the transfer agent. The registrar acts as a check on the transfer office, and combined with the fact that no corporation whose stock is listed can act as its own transfer agent, eliminates the danger of over-issuance, as well as counterfeiting. Such offices also enable a holder of a stock to have it transferred quickly and efficiently.
What is a Cash Sale?
Whenever a sale is made which calls for the delivery of the securities the same day, the transaction is said to be a cash sale.
What is a Regular Sale?
A regular sale, or the regular way, is the delivering of the securities by the seller upon the business day following the day upon which the contract of sale was made.
What is an Asked Price?
The asked price is the price which is asked by the seller of the security. Somewhere between the bid and asked price, an actual price is agreed upon.
What is a Bid Price?
A bid price is the price offered for a security by a prospective buyer.
What is a Market Price?
A market price is the actual price at which a security is selling in the open market.
What is a Firm Price?
A price which is quoted and held to for a definite period of time is called a firm price.
What is a Nominal Price?
When there are no actual transactions or trades the probable value of a security as a basis for trading is estimated, and is called a nominal price.
What is a Put and Call?
A Put and Call is an option given to a purchaser, whereby he may either sell or buy a designated stock, at a certain price, within a fixed period of time.
How Does a Put Work?
B makes an agreement with X, whereby X agrees to buy from B 100 shares of stock at a price, say of $50.00 per share, at anytime during the duration or life of the Put. If B was buying stock in anticipation of a rise in the market and the market should decline to say $40.00 per share, he can deliver the 100 shares to X at the Put price of $50.00 per share. “Puts” are usually used as insurance when buying or going “long” of the market.
How Does a Call Work?
B makes an agreement with X, whereby X agrees to sell to B 100 shares of stock at a price, say of $70.00 per share, at any-time during the duration or life of the call. If B was selling in anticipation of the market declining, and the market should rise to $80.00 per share, he could call on X during the life of the Call to deliver him 100 shares at $70.00 per share. Calls are usually used as insurance when selling or going “short” of the market.
What is a Straddle?
A straddle is a combination of both the Put and Call, and gives the purchaser the option of acting either way, within the time limit.
What Does a Put and Call Cost?
The usual cost of a Put or a Call on 100 shares is $137.50, for one month and gives the purchaser the option of acting either way, within the time limit.
What Obligation is There to a Put and Call?
There is no obligation on the part of the purchaser of a Put and Call to exercise it. It is simply an option to either buy or sell a stock at a certain price, and if the market moves against him, he has no reason to exercise his option. His loss is confined to the cost of the option.
Why are Puts and Calls Used?
Many traders deal in Puts and Calls rather than the actual buying and selling of stocks. For example, a trader who believes the market is going up buys a Call on 1000 shares of Compass Motor for thirty days. On the day he purchased the Call the market may have been, say $50.00 per share. It is unlikely that any one will sell him a Call permitting him to call the stock at $50.00 per share thirty days later. They may sell him the option, however, three points above the market, that permits him to call the stock at $53.00 per share. If the market goes merely to $53.00 during the thirty days there is no reason to exercise his option, but if it went to say $55.00 per share, he has two points in his favor or $2,000 profit. The Call cost him $137.50 per 100 shares, or $1,375.00 plus tax and commission for his 1000 shares. The opposite is employed when purchasing a Put.
What is Meant by Hedging with Puts and Calls?
Puts and Calls are used in two ways. A Call may be purchased by a large “short-seller” to protect himself against an advancing market. In other words, if he was going short ten thousand shares of stock at the current market price of $50.00 per share, he buys a Call for hedging purposes. If the market ran away and went to $70.00 per share, and his Call permits him to buy the stock at $53.00 per share, his loss is thus confined to 3 points plus the price of the Call. On the other hand, consider a bull operator. He believes the market is going to advance and buys ten thousand shares of Compass Motor Company at $75.00 per share. To protect himself he buys a 30 day Put at $72.00 per share, which permits him to deliver to the seller of the Put ten thousand shares of stock at $72.00 per share, anytime during the thirty day period. Instead of the market advancing as he had anticipated, it breaks to $65.00 per share. Nevertheless the ten thousand shares he purchased at $75.00 per share can be delivered to the seller of the Put at $72.00 per share, and he thus confines his loss to 3 points, plus tax and commission and the price of the Put, irrespective of how low the market sinks. You will also find the small trader using Puts and Calls for speculative purposes with no intention of actually buying or selling the stock. For instance, Jones buys a Call for 100 shares of stock at $52.00 per share for a period of a week or a month. In his transaction he is hoping that the market will go up. If it goes to 55, he delivers his Call to some Stock Ex-change house. They in turn sell 100 shares of stock in the market at 55, and call on the person who issued the Call to deliver them 100 shares at 52. They deliver Jones a difference check between 52 and 55, less their commission and tax. Thus you find the large “short-seller” buying Calls to protect himself against a rising market, and the small trader buying Calls hoping that the market will rise. You reverse the modus operandi on a Put.
What is Meant by Rights?
A right is the privilege given to old stockholders to participate in the issuance of new stock at a definite price, usually lower than the prevailing market price.
Can Rights be Sold?
Rights can usually be sold for the difference in price of the new stock and the prevailing price of the old.
What is Meant by Ex-Rights?
When the rights to subscribe have expired, in accordance with the date indicated by a corporation, the stock then sells Ex-Rights, the privilege of subscription to the new stock having expired.
What are Dividends?
Dividends are all or a portion of the earnings that a corporation distributes among those holding its stock.
What is Meant by Ex-Dividend?
When a stock sells Ex-Dividend, it means the transfer books are closed to the new purchaser during that particular dividend period.
What is Negotiable Paper?
Negotiable paper is any document which may be transferred from one owner to another by indorsement or delivery, or both, as promissory notes, drafts, bills of exchange, etc.
What is a Draft?
A draft is a written order by one person on another, for the payment of a specified sum of money to a third person, or to his order.
What is a Sight Draft?
A sight draft is a draft drawn and payable “at sight,” that is, when it is presented to the drawee for payment.
What is a Time Draft?
A time draft is a draft payable on a specified date; or a certain time after date; or a certain time after sight.
What is a Letter of Credit?
A letter of credit is a letter issued by a banking house to a person who desires to travel abroad. The letter is usually ad-dressed to the foreign correspondents of the bank issuing it, requesting them to furnish the traveller with such funds as he may require, up to the aggregate amount named in the letter.
What are Travellers Cheques?
Travellers cheques are substitutes for letters of credit and bills of exchange. They are similiar in form to bank bills. They are issued for fixed printed amounts, with the equivalent of each denomination in the money of the principal European countries, and are payable to order, after being signed and countersigned by the purchaser or holder. They are cashed without discount or commission by an extended list of banks and bankers, and are received in settlement of hotel bills by the principal hotels in Europe.
What are Bills of Exchange?
Bills of Exchange are written orders, such as letters of credit, express money orders, telegraphic money orders, and other instruments which permits making payments at distant places without the transmission of money. Such methods, which avoids the risk and expense of sending the money itself, are called Bills of Exchange.
What is Exchange?
Exchange is the method of making payments at distant places without the transmission of money.
What is an Exchange Center?
An exchange center is some recognized money center.
Where are the Principal Money Centers?
In the United States they are located in New York, Boston, Philadelphia, Chicago, St. Louis, Baltimore, Cincinnati and San Francisco. In Europe they are located in London, Paris, Antwerp, Geneva, Amsterdam, Hamburg, Frankfort, Berlin and Vienna.
What are the Different Kinds of Exchange?
Exchange consists of two kinds; domestic and foreign.
What is Domestic Exchange?
Domestic exchange is exchange payable in the country in which it is drawn. The domestic bills of exchange are commonly called drafts.
What is Foreign Exchange?
Foreign exchange is exchange payable in another country, other than that in which it is drawn. It is by means of the system of foreign exchange that the people of the various nations pay their debts to one another.
What is the Par of Exchange?
The par of exchange is the established value of the standard unit of one country expressed in that of another. It is of two kinds, intrinsic and commercial.
What is the Intrinsic?
Using the former gold standard of America as an example, the pound sterling of Great Britain contained 113 grains of pure gold, and the dollar of the United States 23.22 grains of pure gold. Since 113 grains is 4.8665 times greater than 23.22 grains, the pound sterling was worth $4.86 65/100. The par value of the intrinsic gold pound sterling is now $8.2397. The new dollar contains only 15 5/21 grains. (See text on money.)
What is the Commercial?
The commercial exchange, commonly called the course of ex-change, is the market value of the standard unit of money of one country expressed in the currency of another. (See text on foreign exchange.)
What is Arbitrage of Exchange?
The calculation of the relative value of exchange at the same time in two or more places, with the purpose of taking advantage of the difference in price. It is conducted largely and most profitably by cable, buying in the cheaper and selling in the dearer market.
What is Interest?
Interest is that which is paid for the use of money. The essential elements of interest are the principal, the time, the rate, the interest, and the amount. The sum upon which interest is charged is termed the principal; the period for which the principal bears interest is the time; the annual rate charged for the use of the principal is the rate of interest; the product of the rate of interest and the time is the percent of interest; the result obtained by taking a percent of interest of the principal is the interest; the sum of the principal and interest is the amount.
What is Legal Interest?
Legal interest is computed at the rate established by law, when no specific agreement is made. The legal rate of interest, being established by State statutes, varies in different states.
What is Usury?
Usury is any rate of interest in excess of the legal rate.
What is Simple Interest?
Simple interest is the interest allowed for the use of the principal only. The term, interest, is always understood to mean simple interest. If other forms of interest are meant they are specifically designated, as compound interest, periodic interest, etc.
What is Periodic Interest?
Periodic interest is simple interest on the principal and on any interest remaining unpaid.
What is Compound Interest?
Compound interest is the interest paid on the principal and on the principal increased by the interest, at the expiration of regular intervals.
What is a Business Cycle?
A business cycle can be said to be a complete change and cycle of business activity. The cycle starts with the very beginning of a general depression and continues throughout the falling period, into the beginning of improvement, on through the rising period, into very prosperous times, and ends in a reaction that marks the beginning of another period of depression. While prices are falling, purchasers hold off for lower prices, and producers curtail production, which in turn increases unemployment. When prices reach bottom and the spread between production and consumption begin to close, we enter the improvement period and from there on business activity begins to resume its normal function.Whenever the financial and business structure becomes top-heavy as the result of. strained credit and inflated conditions, a crisis occurs which starts a period of deflation. This constitutes the first phase of the cycle, which is followed by the selling of securities and commodities at greatly reduced prices throughout the falling period. At the end of the second phase you find stock prices low, speculation inactive, dividends, if not abandoned altogether are very low, and unemployment acute. The third phase, which is the beginning of improvement, finds stocks of goods reduced, debts paid off, and an increased volume of trade manifested first in retail trade. This period of revival eventually ends in another period of prosperity which constitutes the complete business cycle. We have passed through fourteen such major cycles in the past one hundred and twenty years.
What is a Crisis and Panic?
A crisis can be said to be the turning point of a cycle of prosperity, which sometimes results in a temporary business or financial panic. At such times conditions are often intensified out of all proportion to actual conditions. Prices become so unstable, commodities and purchasing power alike fluctuate to such an extent, that tens of thousands of manufacturers through-out the country find themselves competing with each other. However, after deflation has run its course equilibrium sets in.
What are Business Barometers?
Business barometers are graphs or charts which furnish an index to forecast future trends by comparing them with business trends of the past. Such barometers afford an accurate picture of past performances of various lines of industry, measured against the present date. Commodity prices, construction figures, railroad loadings, average price of stocks, bank statements, and other numerous indices, are used as business barometers.
What are Stock Market Forecasts?
Predictions as to the future trend of the market are known as stock market forecasts.
What is Meant by the Trend of the Market?
The movement of the market, either up or down, is spoken of as the trend. There are two types of trends, major and minor. A major trend, either upward or downward, is a sustained movement over a long period of time. The zigzag of a market up or down, over a few days or several weeks, is known as a minor trend. For instance, in a major bull movement with an upward trend, in which a temporary decline sets in, the market may be spoken of as having a minor downward trend. The opposite is true in a bear market.
What is a Bull Market?
When the general movement of prices is upward, it is said to be a bull market.
What is a Bear Market?
When the general movement of prices is downward, it is said to be a bear market.
What a Double-Top?
When a market has advanced over a long period of time, under bullish influence, and meets with a strong decline, recovers from this decline, reaches its former high again, and then starts to decline once more, it is regarded as a double-top, meaning the long bull movement has ended.
What is a Double-Bottom?
The opposite of a double-top.
What is the Price System?
The medium of exchange. (See text on money.)
What is the Price Level?
The general average of representative commodities is known as the price level. However, the drastic change in one commodity does not necessarily affect the general price level. For instance, the rise in the price of wheat might offset the decline in the price of corn. It is the average price of all commodities, which fit into our economic system, upward or downward, which raises or lowers the price level.
What is a Credit Structure?
Credit constitutes approximately 95 percent of all business activity. Actual money plays but little part in the gigantic economic scheme of things. This business, whether it be the functioning of banks, the erection of buildings, the building of railroads, the mining of raw material, the constant blazing of the furnace fires of industry, or the wide expanse of our wheat fields, as well as the issuance of billions in stocks and bonds, is all classified under the vast machine known as the credit structure.
What is Our Economic System?
The factors which contribute to the national income is known as the economic system. Water power, timber resources, vast mineral deposits, oil wells, agricultural lands and other natural resources, which combine with industry to turn these basic raw materials into consumable articles form the basis of practically all national income.
What is a Stock Broker?
Stock brokers, in the parlance of the Street, were known as anyone engaged in the buying, selling and distribution of stocks and bonds. The Security Exchange Commission has ruled, however, that any one who effects transactions in securities other than for his own account is a broker.
What are Broker’s Loans?
There are two different kinds of loans known as brokers loans, namely, call money and time money. Call money can be called, or the loan terminated, at anytime simply by calling for it. Unless otherwise specified it is payable the same day called, but it is seldom that any loan is called after 12.15; P.M. for the current day. The rate of interest fluctuates constantly, especially in an active market, hence call loans are made and renewable from day to day. Time money, on the other hand, is what the name implies. Loans are made for a definite period of time, running from thirty days to six months, and occasionally longer. Such loans are secured by stocks and bonds.
Who Supplies the Money for Broker’s Loans?
As has been previously discussed in the text, hundreds of banks, corporations, insurance companies, and others, forward their surplus funds to their New York correspondents, to be used either at their discretion or in call loans. The latter insures them immediate liquidity, practically any hour of the day. The sources from which broker’s loans originate can be said to include the small bank, far back in the Rocky Mountains, to the various foreign capitals of the world. The aggregate of these loans run into billions of dollars.
What Security is There for Broker’s Loans?
If there could be such a thing as perfect security, then money which is advanced for broker loans would occupy the foremost place in such a category. Call loans, which constitute possibly eighty or ninety percent of broker’s loans, are callable on demand from day to day, and thus enjoy a liquidity unattainable in any other endeavour. Banks which loan money to brokers, take as collateral only the soundest securities, and, on a declining market, brokers must constantly keep their marginal accounts up to the standard proportion required by the banks which make these loans. In other words, if any bank loans $75 against a stock which has a market value of $100, and the stock dropped to $50 per share, the bank would insist that the broker reduce the loan to $37.50, or else put up two shares of stock as col-lateral instead of one. The broker in turn calls his customers for more margin, and their failure to provide it necessitates selling them out. It should be stated here that when a broker calls for margin, and the failure of the customer to provide it necessitates the closing of the account, the broker should not be blamed. It should be remembered that the difference between the margin on the stock, and its cost, is borrowed from the bank by the broker, and when markets decline they demand more margin from him. Failure to provide the additional margin will result in the bank selling his account out, which is in effect your own.
It may seem a harsh rule, nevertheless, it is the only one under which banks, insurance companies, and hundreds of corporations, will permit their surplus to come to market. They demand and obtain ironclad collateral and quick liquidity.
What is the Highest Rate Paid for a
New York Stock Exchange Seat?
Seats on the New York Stock Exchange reached an all-time high in 1929 when they sold for $625,000. The lowest price recorded in the past 50 years was in 1890 when a seat sold for $17,000.
High and Low for Curb Seats?
The high for Curb seats was $254,000 in 1929, and, the low was $3,900 in 1923.
What is a Short Sale?
The short-seller in the stock market simply sells stock that he does not own at the moment, but which he expects to be able to acquire later, at a price lower than at which he sold. Every sale calls for a delivery, hence the short-seller must borrow the stock he sells short, and repay it when he buys back to cover.
Does a Short Sale Ever Help the Market?
The short-sale is the governor which keeps markets from running away. If it were not for the “bears” or short-sellers, who exercise restraint in a bull market, stocks would reach an impossible stage of inflation. The short-seller also exercises an-other beneficial influence on the market. When markets are breaking and every one is selling, the short-seller is then buying to cover his short position. In such markets the short-seller in covering his position, is the real cushion which keeps markets from breaking wide open.
What Interest is Charged the Customer on a Short Sale?
Unlike the long sale, the short-seller pays no interest on the marginal difference when he sells short. The broker borrows the stock from some one who has it on hand, and puts up cash with the lender, in the amount of the market value of the security. The man who lends the stock receives the cash equivalent of it, so instead of making a charge for the lending of stocks, he pays interest to the broker on the money. This interest the broker keeps for himself for having negotiated the loan of the stock for his customer.
What is the Function of the Stock Clearing House?
The stock clearing house consists of two branches, day and night. The day branch handles stocks and bonds that are cleared for money, and the night branch handles those which are cleared for stocks. Its purpose is to minimize the number of steps involved in trading in stocks, and to reduce as far as possible the broker requirements of bank credit and money. To illustrate: X sells 100 shares to Y at 90 and Y sells them to broker Z at 93. Usually X would in this case know nothing about the deal between Y and Z. In the night clearing house, where stocks are cleared, the three transactions are brought together and X is directed to deliver the 100 shares of stock directly to Z. This automatically settles Y’s contract to buy and sell, which in effect cancel one another. This makes it unnecessary for him to compare records and receive and deliver the shares himself, and avoids the need for arranging loans to handle the transaction.
To simplify its operation the night branch arbitrarily fixes, at the end of each business day, a delivery or settlement price for the day. For purposes of delivery the closing bid price for the day is usually selected. Payment for delivered stock balances is based, not upon the actual prices at which X. Y. and Z. bought and sold the stocks, but the selected price. Any inequalities that may exist between the delivery price for a stock, and the actual price at which it may have been bought or sold, are adjusted with the night clearing branch by check or draft as the case may require.
What is Investment Banking?
Investment banking or the banker is one who buys and sells securities for his own account. His duties consist primarily of underwriting or distributing new issues of securities. Many organizations find it more profitable when issuing new stocks to sell them outright to investment bankers, rather than to attempt distribution themselves.
What are Investment Trusts?
An Investment Trust is an organization which combines the funds of a multitude of small or large investors and invests such funds in a diversified list of stocks. A man who possesses only a few hundred dollars might feel more secure in having his funds in diversified lines of industry. This he cannot accomplish very well with limited capital. He thus seeks to achieve his aim through Investment Trusts. The shares of such organizations are issued against their assets which consists of a portfolio of diversified stocks, subject to constant change in the discretion of the management. The management’s object is to enhance the value of their holdings or assets from time to time, either by trading in the market, or through the appreciation of stocks they hold in their portfolio. Dividends collected from their holdings are distributed as dividends to the holders of their own shares. These organizations should not be confused with holding companies, or other forms of trust, such as fixed trusts, etc.
What is a Fixed Trust?
A group of stocks are selected for a portfolio and deposited with some bank or custodian. Shares are then sold in this port-folio or fixed trust. All dividends accruing to the portfolio are distributed pro rata to the shareholders, and in the event any security goes to default, it is elimated, and sold for what it will bring and the proceeds divided among the holders of the Fixed Trust’s shares. Usually such a trust is set up for twenty years, after which time all stocks in the portfolio are sold and the proceeds divided up.
What is a Financial Statement?
A statement giving the financial set-up, the value of the assets, the earnings, liabilities, etc. It also gives some indication of the managerial policy and abilities.
What is a Balance Sheet?
A balance sheet is a statement of the financial condition of a business at a given time.
What is a Floor Trader?
A floor trader is one who deals in active stocks, buying and selling for his own account, usually on quick turnovers, and for small and sure profits. They will change their positions in the market very quickly, and may be bulls one hour and bears the next.
What is a Specialist?
The specialists are a group of dealers who specialize in one or a limited number of securities, making their headquarters at a post at the part of the floor where the securities are dealt in. They are ready under all conditions of the market, to buy or sell the securities that they devote their attention to. In doing this, like a floor trader, they help to create a continuous market, and render the commission brokers business of executing orders for the public much easier. Without the specialist, fluctuations between sales of certain stocks would be much greater, and at times bids to buy or offers to sell the less active stocks would be lacking entirely.
What are Odd Lot Dealers?
The odd lot dealers specialize in the handling of orders for less than 100 shares, the Stock Exchange unit of trading. These dealers have developed a continuous market to meet the rapidly growing demands of investors limited to trading in less than 100 share units. These dealers buy 100 share lots on the floor and split them up as required to fill the small orders that they have accumulated. Or they will buy small lots, and, combining them, sell in 100 share lots on the floor.
What are Arbitragers?
Arbitragers are a group of traders who buy in one market and sell quickly in another. Arbitraging means taking quick ad-vantage of a temporary price difference in a stock between two markets. Most arbitraging takes place between New York and London, though you often find small differentials in price on the various domestic exchanges. Such operations are usually carried out from brokers offices which have direct wires.
What is a Stop-Loss Order?
It is an order used when the customer desires, after having purchased stock, to limit his possible losses to a few points. For example, if after buying a stock on margin, the trend of the market is downward, the customer may specify to the broker a price below the market quotation on his stock, at which it is to be sold.
Is a Stop-Loss Order Always Effective?
The answer is no. The market may drop very rapidly and the customer fails to get out at his stop price. For instance, he may buy a stock at 150 and place a stop loss at 147. The broker puts this order in, but if there are others ahead of it and it does not sell at 147, it then becomes an “at the market order” and the broker is obliged to sell the security even though he may sincerely anticipate an immediate rally. If the customer desires to stop a loss, and at the same time does not want to sell at less than the stop price, he can make use of a “stop and limit” order, as follows. “Sell 100 U. S. Steel common at 147, stop limit 146. In the first instance the broker cannot sell for less than 147, and in the latter he must sell at 147 if possible, and not less than 146.
What is a Market Corner?
When one or more operators have accumulated the majority of the available stock of a corporation, and the short interest finds no stock available when they go to cover, it is then said that a corner exists. At such times those who possess the stock can demand their own price. (See text, Hill and Harriman.)
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BELOW PLEASE FIND A COMPLETE WALL STREET GLOSSARY (A-Z) AT THE LINK BELOW:
http://www.wallstreetglossary.com/
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FINALLY THIS IS HOW TO TAKE YOUR COMPANY PUBLIC:
Q&A: Small Business and the SEC
A guide to help you understand how to raise capital and comply with the federal securities laws
Table of Contents
- What Are the Federal Securities Laws?
- How Can I Get Answers to My Questions?
- Should My Company “Go Public”?
- How Does My Small Business Register a Public Offering?
- If My Company Becomes Public, What Disclosures Must I Regularly Make?
- Are there legal ways to offer and Sell Securities Without Registering With the SEC?
- Intrastate Offering Exemption
- Private Offering Exemption
- Regulation A
- Regulation D
- Accredited Investor Exemption – Section 4(6)
- California Limited Offering Exemption – Rule 1001
- Exemption for sales of securities through employee benefit plans – Rule 701
- Are There State Law Requirements in Addition to Federal Ones?
- What Resources Are Available Through the U.S. Small Business Administration?
- Where Can I Go for More Information?
- How Can We Improve This Guide?
I. What Are the Federal Securities Laws?
In the chaotic securities markets of the 1920s, companies often sold stocks and bonds on the basis of glittering promises of fantastic profits – without disclosing any meaningful information to investors. These conditions contributed to the disastrous Stock Market Crash of 1929. In response, the U.S. Congress enacted the federal securities laws and created the Securities and Exchange Commission (SEC) to administer them.
There are two primary sets of federal laws that come into play when a company wants to offer and sell its securities to the public. They are:
- the Securities Act of 1933 (Securities Act), and
- the Securities Exchange Act of 1934 (Exchange Act).
Securities Act
The Securities Act generally requires companies to give investors “full disclosure” of all “material facts,” the facts investors would find important in making an investment decision. This Act also requires companies to file a registration statement with the SEC that includes information for investors. The SEC does not evaluate the merits of offerings, or determine if the securities offered are “good” investments. The SEC staff reviews registration statements and declares them “effective” if companies satisfy our disclosure rules. We describe this process in more detail beginning on page 7.
Exchange Act
The Exchange Act requires publicly held companies to disclose information continually about their business operations, financial conditions, and managements. These companies, and in many cases their officers, directors and significant shareholders, must file periodic reports or other disclosure documents with the SEC. In some cases, the company must deliver the information directly to investors. We discuss these obligations more fully beginning on page 11.
Exemptions
Your company may be exempt from these registration and reporting requirements. We discuss exemptions beginning on page 16.
II. How Can I Get Answers to My Questions?
The SEC tries to meet the needs of small business through its rules and regulations. It also offers informal guidance by answering your questions over the phone, through the mail or by e-mail. The SEC offers you a number of ways to express your views and get help from the staff. Of course, you should always retain competent counsel before engaging in any securities offering.
Special Ombudsman to Serve You
In 1996, we appointed a Special Ombudsman for Small Business to serve you and to represent the concerns of smaller companies within the SEC. You can tell the Ombudsman your concerns about any SEC proposal or rule. The Ombudsman also can answer your general questions or help you find the answers to your specific questions. The Ombudsman’s telephone number is (202) 551-3460.
The Office of Small Business
The Division of Corporation Finance’s Office of Small Business directs the SEC’s small business rulemaking initiatives and comments on SEC rule proposals affecting small companies. Its staff works with Congressional committees, government agencies, and other groups concerned with small business. The Office also specializes in the review of filings from small companies. Its telephone number is (202) 551-3460.
Town Hall Meetings
The Office of Small Business also sponsors small business town hall meetings across the country. These meetings help the SEC convey basic information to small businesses and learn more about the problems small businesses face in raising capital. These meetings help the SEC design programs that meet small businesses’ needs while protecting investors.
Government-Business Forum on Small Business Capital Formation
In addition to the town hall meetings, the SEC sponsors the Government-Business Forum on Small Business Capital Formation. This annual meeting provides the only national forum for small businesses to let government officials from different parts of the federal government know how the laws, rules and regulations impact the ability of small companies to raise capital. You can get more information about this forum from the Office of Small Business.
Internet Web Site
We also maintain a home page on the World Wide Web at http://www.sec.gov. Our site includes recent SEC releases and other updating information of interest to small companies. Through our Web site, small companies and investors can also find documents publicly filed on the SEC’s Electronic Data Gathering, Analysis, and Retrieval, or EDGAR, system. Most registration statements and other documents must now be filed electronically via that system.
III. Should My Company “Go Public”?
When your company needs additional capital, “going public” may be the right choice, but you should weigh your options carefully. If your company is in the very early stages of development, it may be better to seek loans from financial institutions or the Small Business Administration. Other alternatives include raising money by selling securities in transactions that are exempt from the registration process. We discuss these alternatives later.
There are benefits and new obligations that come from raising capital through a public offering registered with the SEC. While the benefits are attractive, be sure you are ready to assume these new obligations:
Benefits
- Your access to capital will increase, since you can contact more potential investors.
- Your company may become more widely known.
- You may obtain financing more easily in the future if investor interest in your company grows enough to sustain a secondary trading market in your securities.
- Controlling shareholders, such as the company’s officers or directors, may have a ready market for their shares, which means that they can more easily sell their interests at retirement, for diversification, or for some other reason.
- Your company may be able to attract and retain more highly qualified personnel if it can offer stock options, bonuses, or other incentives with a known market value.
- The image of your company may be improved.
New Obligations
- You must continue to keep shareholders informed about the company’s business operations, financial condition, and management, incurring additional costs and new legal obligations.
- You may be liable if you do not fulfill these new legal obligations.
- You may lose some flexibility in managing your company’s affairs, particularly when shareholders must approve your actions.
- Your public offering will take time and money to accomplish.
IV. How Does My Small Business Register a Public Offering?
If you decide on a registered public offering, the Securities Act requires your company to file a registration statement with the SEC before the company can offer its securities for sale. You cannot actually sell the securities covered by the registration statement until the SEC staff declares it “effective,” even though registration statements become public immediately upon filing.
Registration statements have two principal parts:
- Part I is the prospectus, the legal offering or “selling” document. Your company – the “issuer” of the securities – must describe in the prospectus the important facts about its business operations, financial condition, and management. Everyone who buys the new issue, as well as anyone who is made an offer to purchase the securities, must have access to the prospectus.
- Part II contains additional information that the company does not have to deliver to investors. Anyone can see this information by requesting it from one of the SEC’s public reference rooms or by looking it up on the SEC Web site.
The Basic Registration Form – Form S-1
All companies can use Form S-1 to register their securities offerings. You should not prepare a registration statement as a fill-in-the-blank form, like a tax return. It should be similar to a brochure, providing readable information. If you file this form, your company must describe each of the following in the prospectus:
- its business;
- its properties;
- its competition;
- the identity of its officers and directors and their compensation;
- material transactions between the company and its officers and directors;
- material legal proceedings involving the company or its officers and directors;
- the plan for distributing the securities; and the intended use of the proceeds of the offering.
Information about how to describe these items is set out in SEC rules. Registration statements also must include financial statements audited by an independent certified public accountant.
In addition to the information expressly required by the form, your company must also provide any other information that is necessary to make your disclosure complete and not misleading. You also must clearly describe any risks prominently in the prospectus, usually at the beginning. Examples of these risk factors are:
- lack of business operating history;
- adverse economic conditions in a particular industry;
- lack of a market for the securities offered; and
- dependence upon key personnel.
Alternative Registration Forms for Small Business Issuers
If your company qualifies as a “small business issuer,” it can choose to file its registration statement using one of the simplified small business forms. A small business issuer is a United States or Canadian issuer:
- that had less than $25 million in revenues in its last fiscal year, and
- whose outstanding publicly-held stock is worth no more than $25 million.
Form SB-1 – To Raise $10 Million or Less
Small business issuers offering up to $10 million worth of securities in any 12-month period may use Form SB1. This form allows you to provide information in a question and answer format, similar to that used in Regulation A offerings, a type of exempt offering discussed on page 19. Unlike Regulation A filings, Form SB-1 requires audited financial statements.
Form SB-2 – To Raise Capital in Any Amount
If your company is a “small business issuer,” it may register an unlimited dollar amount of securities using Form SB-2, and may use this form again and again so long as it satisfies the “small business issuer” definition.
One advantage of Form SB-2 is that all its disclosure requirements are in Regulation S-B, a set of rules written in simple, non-legalistic terminology. Form SB-2 also permits the company to:
- Provide audited financial statements, prepared according to generally accepted accounting principles, for two fiscal years. In contrast, Form S-1 requires the issuer to provide audited financial statements, prepared according to more detailed SEC regulations, for three fiscal years; and
- Include less extensive narrative disclosure than Form S-1 requires, particularly in the description of your business, and executive compensation.
Staff Review of Registration Statements
SEC staff examines registration statements for compliance with disclosure requirements. If a filing appears incomplete or inaccurate, the staff usually informs the company by letter. The company may file correcting or clarifying amendments. Once the company has satisfied the disclosure requirements, the staff declares the registration statement effective. The company may then begin to sell its securities. The SEC can refuse or suspend the effectiveness of any registration statement if it concludes that the document is misleading, inaccurate, or incomplete.
V. If My Company Becomes Public, What Disclosures Must I Regularly Make?
Your company can become “public” in one of two ways – by issuing securities in an offering registered under the Securities Act or by registering the company’s outstanding securities under Exchange Act requirements. Both types of registration trigger ongoing reporting obligations for your company. In some cases, the Exchange Act also subjects your company’s officers, directors and significant shareholders to reporting requirements. Let’s discuss these requirements individually.
Reporting obligations because of Securities Act registration
Once the staff declares your company’s Securities Act registration statement effective, the Exchange Act requires you to file reports with the SEC. The obligation to file reports continues at least through the end of the fiscal year in which your registration statement becomes effective. After that, you are required to continue reporting unless you satisfy the following “thresholds,” in which case your filing obligations are suspended:
- your company has fewer than 300 shareholders of the class of securities offered; or
- your company has fewer than 500 shareholders of the class of securities offered and less than $10 million in total assets for each of its last three fiscal years.
If your company is subject to the reporting requirements, it must file information with the SEC about:
- its operations;
- its officers, directors, and certain shareholders, including salary, various fringe benefits, and transactions between the company and management;
- the financial condition of the business, including financial statements audited by an independent certified public accountant; and
- its competitive position and material terms of contracts or lease agreements.
All of this information becomes publicly available when you file your reports with the SEC. As is true with Securities Act filings, small business issuers may choose to use small business alternative forms and Regulation S-B for registration and reporting under the Exchange Act.
Obligations because of Exchange Act registration
Even if your company has not registered a securities offering, it must file an Exchange Act registration statement if:
- it has more than $10 million total assets and a class of equity securities, like common stock, with 500 or more shareholders; or
- it lists its securities on an exchange or on Nasdaq.
If a class of your company’s securities is registered under the Exchange Act, the company, as well as its shareholders and management, are subject to various reporting requirements, explained below.
Ongoing Exchange Act periodic reporting
If your company registers a class of securities under the Exchange Act, it must file the same annual, periodic, and current reports that are required as a result of Securities Act registration, as explained above. This obligation continues for as long as the company exceeds the reporting thresholds previously outlined on page 11. If your company’s securities are traded on an exchange or on Nasdaq, the company must continue filing these reports as long as the securities trade on those markets, even if your company falls below the thresholds.
Proxy rules
A company with Exchange Act registered securities must comply with the SEC’s proxy rules whenever it seeks a shareholder vote on corporate matters. These rules require the company to provide a proxy statement to its shareholders, together with a proxy card when soliciting proxies. Proxy statements discuss management and executive compensation, along with descriptions of the matters up for a vote. If the company is not soliciting proxies but will take a vote on a matter, the company must provide to its shareholders an information statement that is similar to a proxy statement. The proxy rules also require your company to send an annual report to shareholders if there will be an election of directors. These reports contain much of the same information found in the Exchange Act annual reports that a company must file with the SEC, including audited financial statements. The proxy rules also govern when your company must provide shareholder lists to investors and when it must include a shareholder proposal in the proxy statement.
Beneficial ownership reports
If your company has registered a class of its equity securities under the Exchange Act, persons who acquire more than five percent of the outstanding shares of that class must file beneficial owner reports until their holdings drop below five percent. These filings contain background information about the beneficial owners as well as their investment intentions, providing investors and the company with information about accumulations of securities that may potentially change or influence company management and policies.
Tender offers
A public company with Exchange Act registered securities that faces a takeover attempt, or third party tender offer, should be aware that the SEC’s tender offer rules will apply to the transaction. The same is true if the company makes a tender offer for its own Exchange Act registered securities. The filings required by these rules provide information to the public about the person making the tender offer. The company that is the subject of the takeover must file with the SEC its responses to the tender offer. The rules also set time limits for the tender offer and provide other protections to shareholders.
Transaction reporting by officers, directors and ten percent shareholders
Section 16 of the Exchange Act applies to your company’s directors and officers, as well as shareholders who own more than 10% of a class of your company’s equity securities registered under the Exchange Act. It requires these persons to report their transactions involving the company’s equity securities to the SEC. Section 16 also establishes mechanisms for a company to recover “short swing” profits, those profits an insider realizes from a purchase and sale of a company security within a six-month period. In addition, Section 16 prohibits short selling by these persons of any class of the company’s securities, whether or not that class is registered under the Exchange Act.
VI. Are There Legal Ways To Offer and Sell Securities Without Registering With the SEC?
Yes! Your company’s securities offering may qualify for one of several exemptions from the registration requirements. We explain the most common ones below. You must remember, however, that all securities transactions, even exempt transactions, are subject to the antifraud provisions of the federal securities laws. This means that you and your company will be responsible for false or misleading statements, whether oral or written. The government enforces the federal securities laws through criminal, civil and administrative proceedings. Some enforcement proceedings are brought through private law suits. Also, if all conditions of the exemptions are not met, purchasers may be able to obtain refunds of their purchase price. In addition, offerings that are exempt from provisions of the federal securities laws may still be subject to the notice and filing obligations of various state laws. Make sure you check with the appropriate state securities administrator before proceeding with your offering.
A. Intrastate Offering Exemption
Section 3(a)(11) of the Securities Act is generally known as the “intrastate offering exemption.” This exemption facilitates the financing of local business operations. To qualify for the intrastate offering exemption, your company must:
- be incorporated in the state where it is offering the securities;
- carry out a significant amount of its business in that state; and
- make offers and sales only to residents of that state.
There is no fixed limit on the size of the offering or the number of purchasers. Your company must determine the residence of each purchaser. If any of the securities are offered or sold to even one out-of-state person, the exemption may be lost. Without the exemption, the company could be in violation of the Securities Act registration requirements. If a purchaser resells any of the securities to a person who resides outside the state within a short period of time after the company’s offering is complete (the usual test is nine months), the entire transaction, including the original sales, might violate the Securities Act. Since secondary markets for these securities rarely develop, companies often must sell securities in these offerings at a discount.
It will be difficult for your company to rely on the intrastate exemption unless you know the purchasers and the sale is directly negotiated with them. If your company holds some of its assets outside the state, or derives a substantial portion of its revenues outside the state where it proposes to offer its securities, it will probably have a difficult time qualifying for the exemption.
You may follow Rule 147, a “safe harbor” rule, to ensure that you meet the requirements for this exemption. It is possible, however, that transactions not meeting all requirements of Rule 147 may still qualify for the exemption.
B. Private Offering Exemption
Section 4(2) of the Securities Act exempts from registration “transactions by an issuer not involving any public offering.” To qualify for this exemption, the purchasers of the securities must:
- have enough knowledge and experience in finance and business matters to evaluate the risks and merits of the investment (the “sophisticated investor”), or be able to bear the investment’s economic risk;
- have access to the type of information normally provided in a prospectus; and
- agree not to resell or distribute the securities to the public.
In addition, you may not use any form of public solicitation or general advertising in connection with the offering.
The precise limits of this private offering exemption are uncertain. As the number of purchasers increases and their relationship to the company and its management becomes more remote, it is more difficult to show that the transaction qualifies for the exemption. You should know that if you offer securities to even one person who does not meet the necessary conditions, the entire offering may be in violation of the Securities Act.
Rule 506, another “safe harbor” rule, provides objective standards that you can rely on to meet the requirements of this exemption. Rule 506 is a part of Regulation D, which we describe more fully on page 24.
C. Regulation A
Section 3(b) of the Securities Act authorizes the SEC to exempt from registration small securities offerings. By this authority, we created Regulation A, an exemption for public offerings not exceeding $5 million in any 12-month period. If you choose to rely on this exemption, your company must file an offering statement, consisting of a notification, offering circular, and exhibits, with the SEC for review.
Regulation A offerings share many characteristics with registered offerings. For example, you must provide purchasers with an offering circular that is similar in content to a prospectus. Like registered offerings, the securities can be offered publicly and are not “restricted,” meaning they are freely tradeable in the secondary market after the offering. The principal advantages of Regulation A offerings, as opposed to full registration, are:
- The financial statements are simpler and don’t need to be audited;
- There are no Exchange Act reporting obligations after the offering unless the company has more than $10 million in total assets and more than 500 shareholders;
- Companies may choose among three formats to prepare the offering circular, one of which is a simplified question-and-answer document; and
- You may “test the waters” to determine if there is adequate interest in your securities before going through the expense of filing with the SEC.
All types of companies which do not report under the Exchange Act may use Regulation A, except “blank check” companies, those with an unspecified business, and investment companies registered or required to be registered under the Investment Company Act of 1940. In most cases, shareholders may use Regulation A to resell up to $1.5 million of securities.
If you “test the waters,” you can use general solicitation and advertising prior to filing an offering statement with the SEC, giving you the advantage of determining whether there is enough market interest in your securities before you incur the full range of legal, accounting, and other costs associated with filing an offering statement. You may not, however, solicit or accept money until the SEC staff completes its review of the filed offering statement and you deliver prescribed offering materials to investors.
D. Regulation D
Regulation D establishes three exemptions from Securities Act registration. Let’s address each one separately.
Rule 504
Rule 504 provides an exemption for the offer and sale of up to $1,000,000 of securities in a 12-month period. Your company may use this exemption so long as it is not a blank check company and is not subject to Exchange Act reporting requirements. Like the other Regulation D exemptions, in general you may not use public solicitation or advertising to market the securities and purchasers receive “restricted” securities, meaning that they may not sell the securities without registration or an applicable exemption. However, you can use this exemption for a public offering of your securities and investors will receive freely tradable securities under the following circumstances:
- You register the offering exclusively in one or more states that require a publicly filed registration statement and delivery of a substantive disclosure document to investors;
- You register and sell in a state that requires registration and disclosure delivery and also sell in a state without those requirements, so long as you deliver the disclosure documents mandated by the state in which you registered to all purchasers; or,
- You sell exclusively according to state law exemptions that permit general solicitation and advertising, so long as you sell only to “accredited investors,” a term we describe in more detail below in connection with Rule 505 and Rule 506 offerings.
Even if you make a private sale where there are no specific disclosure delivery requirements, you should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws. This means that any information you provide to investors must be free from false or misleading statements. Similarly, you should not exclude any information if the omission makes what you do provide investors false or misleading.
Rule 505
Rule 505 provides an exemption for offers and sales of securities totaling up to $5 million in any 12-month period. Under this exemption, you may sell to an unlimited number of “accredited investors” and up to 35 other persons who do not need to satisfy the sophistication or wealth standards associated with other exemptions. Purchasers must buy for investment only, and not for resale. The issued securities are “restricted.” Consequently, you must inform investors that they may not sell for at least a year without registering the transaction. You may not use general solicitation or advertising to sell the securities.
An “accredited investor” is:
- a bank, insurance company, registered investment company, business development company, or small business investment company;
- an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
- a charitable organization, corporation or partnership with assets exceeding $5 million;
- a director, executive officer, or general partner of the company selling the securities;
- a business in which all the equity owners are accredited investors;
- a natural person with a net worth of at least $1 million;
- a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
- a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.
It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well. You must also be available to answer questions by prospective purchasers.
Here are some specifics about the financial statement requirements applicable to this type of offering:
- Financial statements need to be certified by an independent public accountant;
- If a company other than a limited partnership cannot obtain audited financial statements without unreasonable effort or expense, only the company’s balance sheet, to be dated within 120 days of the start of the offering, must be audited; and
- Limited partnerships unable to obtain required financial statements without unreasonable effort or expense may furnish audited financial statements prepared under the federal income tax laws.
Rule 506
As we discussed earlier, Rule 506 is a “safe harbor” for the private offering exemption. If your company satisfies the following standards, you can be assured that you are within the Section 4(2) exemption:
- You can raise an unlimited amount of capital;
- You cannot use general solicitation or advertising to market the securities;
- You can sell securities to an unlimited number of accredited investors (the same group we identified in the Rule 505 discussion) and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment;
- It is up to you to decide what information you give to accredited investors, so long as it does not violate the antifraud prohibitions. But you must give non-accredited investors disclosure documents that generally are the same as those used in registered offerings. If you provide information to accredited investors, you must make this information available to the non-accredited investors as well;
- You must be available to answer questions by prospective purchasers;
- Financial statement requirements are the same as for Rule 505; and
- Purchasers receive “restricted” securities. Consequently, purchasers may not freely trade the securities in the secondary market after the offering.
E. Accredited Investor Exemption – Section 4(6)
Section 4(6) of the Securities Act exempts from registration offers and sales of securities to accredited investors when the total offering price is less than $5 million.
The definition of accredited investors is the same as that used in Regulation D. Like the exemptions in Rule 505 and 506, this exemption does not permit any form of advertising or public solicitation. There are no document delivery requirements. Of course, all transactions are subject to the antifraud provisions of the securities laws.
F. California Limited Offering Exemption – Rule 1001
SEC Rule 1001 provides an exemption from the registration requirements of the Securities Act for offers and sales of securities, in amounts of up to $5 million, that satisfy the conditions of §25102(n) of the California Corporations Code. This California law exempts from California state law registration offerings made by California companies to “qualified purchasers” whose characteristics are similar to, but not the same as, accredited investors under Regulation D. This exemption allows some methods of general solicitation prior to sales.
G. Exemption for Sales of Securities through Employee Benefit Plans – Rule 701
The SEC’s Rule 701 exempts sales of securities if made to compensate employees. This exemption is available only to companies that are not subject to Exchange Act reporting requirements. You can sell at least $1,000,000 of securities under this exemption, no matter how small your company is. You can sell even more if you satisfy certain formulas based on your company’s assets or on the number of its outstanding securities. If you sell more than $5 million in securities in a 12-month period, you need to provide limited disclosure documents to your employees. Employees receive “restricted securities” in these transactions and may not freely offer or sell them to the public.
VII. Are There State Law Requirements in Addition to Federal Ones?
The federal government and state governments each have their own securities laws and regulations. If your company is selling securities, it must comply with federal and state securities laws. If a particular offering is exempt under the federal securities laws, that does not necessarily mean that it is exempt from any of the state laws.
Historically, most state legislatures have followed one of two approaches in regulating public offerings of securities, or a combination of the two approaches. Some states review small businesses’ securities offerings to ensure that companies disclose to investors all information needed to make an informed investment decision. Other states also analyze public offerings using substantive standards to assure that the terms and structure of the offerings are fair to investors, in addition to the focus on disclosure.
To facilitate small business capital formation, the North American Securities Administrators Association, or NASAA, in conjunction with the American Bar Association, developed the Small Company Offering Registration, also known as SCOR. SCOR is a simplified “question and answer” registration form that companies also can use as the disclosure document for investors. SCOR was primarily designed for state registration of small business securities offerings conducted under the SEC’s Rule 504, for sale of securities up to $1,000,000, discussed on page 20. Currently, over 45 states recognize SCOR. To assist small business issuers in completing the SCOR Form, NASAA has developed a detailed “Issuer’s Manual.” This manual is available through NASAA’s Web site at http://www.nasaa.org.
In addition, a small company can use the SCOR Form, called Form U-7, to satisfy many of the filing requirements of the SEC’s Regulation A exemption, for sales of securities of up to $5,000,000 (discussed on page 19), since the company may file it with the SEC as part of the Regulation A offering statement.
To assist small businesses offering in several states, many states coordinate SCOR or Regulation A filings through a program called regional review. Regional reviews are available in the New England, Mid-Atlantic, Midwest and Western regions.
Companies seeking additional information on SCOR, regional reviews or the “Issuer’s Manual” should contact NASAA.
VIII. What Resources Are Available Through the U.S. Small Business Administration?
When assessing your capital needs, you should consider programs offered through the U.S. Small Business Administration (SBA). Congress established the SBA in 1953 to aid, counsel, and protect the interests of the Nation’s small business community. The SBA accomplishes this in part by working with intermediaries, banks, and other lending institutions to provide loans and venture capital financing to small businesses unable to secure financing through normal lending channels. The SBA offers financing through the programs listed below.
7(a) Loan Guaranty Program:
This is the SBA’s primary lending program and was designed to meet the majority of the small business lending community’s financing needs. In addition to general financing, the 7(a) program also encompasses a number of specialized loan programs. The following are a few of the many specialized loan programs:
Low Doc
This program is designed to increase the availability of funds under $100,000 and streamline or expedite the loan review process.
CAPLines
An umbrella program to help small businesses meet their short-term and cyclical working-capital needs with five separate programs.
International Trade
If your business is preparing to engage in or is already engaged in international trade, or is adversely affected by competition from imports, the International Trade Loan Program is for you; and
DELTA
Defense Loan and Technical Assistance is a joint SBA and Department of Defense effort to provide financial and technical assistance to defense-dependent small firms adversely affected by cutbacks in defense.
Microloan Program
This program works through intermediaries to provide small loans from as little as $100 up to $25,000.
Certified Development Company (504 Loan) Program
This program, commonly referred to as the 504 program, makes long term loans available for purchasing land, buildings, machinery and equipment, and for building, modernizing or renovating existing facilities and sites.
Small Business Investment Company Program
Small Business Investment Companies (SBICs), which the SBA licenses and regulates, are privately-owned and managed investment firms that provide venture capital and start-up financing to small businesses.
To find additional information on these and other financial programs please contact your local SBA District Office (call 1-800-8-ASK-SBA for the nearest office) or look on SBA’s Web site (http://www.sba.gov).
Additional Financial Resources and Information from the SBA’s Office of Advocacy
Angel Capital Electronic Network (ACE-Net)
The Office of Advocacy of SBA has established an Internet site where small companies may list their Regulation A and Regulation D 504/SCOR stock offerings. ACE-Net is a cooperative effort between SBA and nine universities, state-based entities, and other non-profit organizations to provide a listing service where small companies may list their stock offering for review by high net worth investors (accredited investors). In addition, ACE-Net anticipates providing mentoring and educational services for small companies needing business planning and securities information. You can find the ACE-Net Internet site at the following URLs: http://www.sba.gov/ADVO/ or http://www.ace-net.org.
Small Business Lending in the United States
The Office of Advocacy of SBA has ranked the nearly 10,000 banks in the country on a state-by-state basis to determine which banks are “small business friendly.” The state-by-state directory helps small businesses locate which banks in their area are more likely to lend to small business. The directory is available over the Internet at: http://www.sba.gov/ADVO/stats/.
IX. Where Can I Go for More Information?
The staff of the SEC’s Office of Small Business and the SEC’s Small Business Ombudsman will be glad to assist you with any questions you may have regarding federal securities laws. For information about state securities laws, contact NASAA or your state’s securities administrator, whose office is usually located in your capital city.
The entire text of the SEC’s rules and regulations is available through the U.S. Government Printing Office or from several private publishers of legal information. In addition, numerous books on this subject have been published, and some are available at public libraries. As of this writing, the following volumes of Title 17 of the Code of Federal Regulations (the SEC’s rules and regulations) were available from the Government Printing Office:
- Vol. II – Parts 200 to 239. SEC Organization; Conduct and Ethics; Information and Requests; Rules of Practice; Regulation S-X and Securities Act of 1933.
- Vol III – Parts 240 to End. Securities Exchange Act of 1934; Public Utility Holding Company, Trust Indenture, Investment Company, Investment Advisers, and Securities Investor Protection Corporation Acts.
For additional information about how to obtain official publications of Commission rules and regulations, contact:
Superintendent of Documents
Government Printing Office
Washington DC 20402-9325
For copies of SEC forms and recent SEC releases:
Publications Section
U.S. Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0019
Telephone: (202)942-4046
Other useful addresses, telephone numbers, web sites and e-mail:
SEC’s World Wide Web site: http://www.sec.gov
SEC Office of Small Business
SEC Small Business Ombudsman
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0304
Telephone: (202) 551-3460
E-mail address and form:
smallbusiness@sec.gov
https://tts.sec.gov/oiea/Complaint.html
North American Securities Administrators Association
10 “G” Street, N.E., Suite 710
Washington, D.C. 20002
(202) 737-0900
NASAA’s World Wide Web site: http://www.nasaa.org
SBA’s World Wide Web site: http://www.sba.gov
ACE-Net World Wide Web site: http://www.ace-net.org
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What some e-cigarettes look like. There is no suggestion this type was the one involved in the explosion.
