The Securities Act of 1933
The Securities Act of 1933 is the first of the big 4 securities acts, and like the other 3, its name tells you what it does: it regulates the issuance of securities. The Securities Act of 1933 is also known as the paper act, since it focuses on the prospectus and other paper requirements involved in issuing securities. The act regulates the primary market, the issuer market, where the majority of the proceeds from a sale go to the issuer of the security.
The Securities Act of 1933 did not create the SEC. The SEC, and the Federal Reserve Board’s control of Regulation T, came from the next act, the Securities Exchange Act of 1934, covered in the next chapter.
Registering an offering under the 1933 act is separate from an issuer’s “reporting company” status under the 1934 act, which requires ongoing SEC filings regardless of whether the issuer is doing a new offering at the time. Whenever an issuer wants to sell securities to the public, it must register that specific offering with the SEC under the 1933 act, by filing a registration statement and prospectus, regardless of whether it is already a reporting company. Reporting companies, their insiders, insider trading and the information barriers firms use to prevent it are Securities Exchange Act topics, taught in the next chapter, The Securities Exchange Act of 1934.
Registering an offering
Before an issuer can sell securities to the public, it must register the offering with the SEC by filing a registration statement and prospectus.
Tombstone ads, basic announcements that name the security and its underwriters, are also allowed during the cooling-off period, but no sales can be finalized until the registration is effective.
Trust Indenture Act of 1939
The Trust Indenture Act of 1939 (TIA) is a federal law that adds to the Securities Act of 1933 with more specifics regarding the issuance of debt securities, bonds, in the US.
There are many parts of this act, only some of which are likely to be seen.
There must be an independent and qualified trustee to act for the benefit of holders of the securities, and must follow the provisions of the indenture. The indenture is a legal document that all notes, bonds, and debentures must have, an indenture that is qualified under the TIA, in order to be lawfully sold in interstate commerce, unless exempt. Smaller offerings are exempt: debt issued without an indenture is exempt up to $50 million in any 12 months, so a larger offering needs a qualified indenture. A separate exemption covers debt issued under an indenture that limits it to $10 million, counted over 36 months.
In the indenture there are 2 primary parts. The first is the promises, also called covenants: legally enforceable rules and conditions that the issuer agrees to follow in order to protect the interests of the bondholders. Covenants can be positive or negative. Negative covenants are restrictions that prevent the firm from taking certain actions that would increase the risk of default; an example is a limit on how much additional debt the issuer can take on. Positive covenants are promises to take specific actions, such as making interest payments on time and in full and following applicable rules and regulations. If covenants are broken, the debt could become immediately due.
The second are the processes that would be followed in the event of default.
Underwritings
There are several underwritings that get used, with best efforts and firm commitment being the most common. Underwritings are when an investment bank, those companies that know how to issue securities, how to raise capital, the filing requirements, and all of those details, and use that to assist companies trying to raise capital through the issuance of securities. They work by contract with the issuer, where they are getting some type of share of the proceeds raised in the offering. Best efforts are where the underwriter will do “their best effort” to sell the securities, but if they can’t sell all of the securities, then the unsold shares get returned to the issuer. In best efforts, the underwriters have little risk, and the issuer has the majority of the risk. Firm commitment is when the underwriter simply pays the issuer for all of the shares, and then the underwriters, and their teams, are required to sell it. In firm commitments, the underwriters have all of the risk as they need to sell them now, and the issuer doesn’t have the risk, as they raised all the money they needed.
All-or-none underwriting is when the issuer says that if they don’t sell the entire issuance, just cancel it, and return the money to the investors. If 100% of the issuance isn’t bought, the entire issuance is canceled. Mini-max is another underwriting that is similar, except that instead of 0 or 100%, there is some minimum the issuer will accept. Maybe it’s a $100m issuance; in the case of all-or-none, if they don’t sell all $100m, then the entire issuance is canceled. In the case of mini max, the issuer may say $100m is what they want to issue, but if at least $70m gets issued, continue. In this case if less than $70m of the issuance is sold, the issuance is canceled, but if at least $70m is purchased, then the issuance goes forward.
Syndicates
Underwriters often form groups of underwriters in order to spread the risk around to multiple companies in the case of larger issuings. There will be a syndicate manager, the “head” underwriter of the syndicate. There will be documents that show how the shares will be distributed, and we discuss that in their own section.
Selling group
Underwriters, investment banks, will work with broker-dealers to assist them in actually selling the securities to customers. These broker-dealers are then part of the selling group. There are additional filings, and requirements for selling groups, and they are discussed in their own section as well.
Overallotment (green shoe) option
The syndicate may sell more shares than it has committed to buy from the issuer. Selling these extra shares is called overallotting, and it leaves the syndicate with a short position. An overallotment option, nicknamed the green shoe, is an option the issuer grants the underwriters to buy additional shares from it to cover that short position. In a firm commitment offering, the option can’t cover more than 15% of the shares being offered, counted without the option shares themselves (FINRA Rule 5110).
If the stock trades above the offering price, the syndicate typically exercises the option and buys the extra shares from the issuer. If it trades below, the syndicate typically buys them in the market instead. Those purchases are syndicate covering transactions (Regulation M, Rule 104), and they also support the stock’s price.
Example: Sizing an overallotment option
An issuer sells 8 million shares in a firm commitment offering. The largest overallotment option it can grant covers more shares, for 9.2 million shares in total.
State registrations
State securities laws, known as blue-sky laws, are only lightly tested on FINRA exams. Many states based theirs on the Uniform Securities Act (USA), a model law written by the Uniform Law Commission that isn’t itself the law of any state. The state securities administrators, along with those of the Canadian provinces and Mexico, work together through NASAA, the North American Securities Administrators Association.
With state law, effectively everything needs to register; issuers, broker-dealers, their representatives (known as agents at the state level), investment advisors, and similar persons.
The 3 types of state securities registration, the most testable part of this topic, are:
- Notice filing - for federal covered securities, such as registered investment companies. Securities listed on the NYSE or Nasdaq are also federal covered securities, but states can’t require any filing or fee for them at all. It isn’t technically a registration: the issuer files a notice with the state, which can require copies of what was filed with the SEC and a fee.
- Coordination - For an offering that is also being registered with the SEC under the Securities Act of 1933; the state registration can become effective at the same time as the federal one.
- Qualification - For an offering with no federal registration, such as an intrastate offering, or one that can’t use another method.