Several rules and regulations exist that don’t apply to every primary market offering. We’ll discuss these various topics in this section.
Throughout this unit, we’ve discussed the typical securities registration process, which involves the 20-day cooling off period. But what if an issuer wanted to register a security in the future but wanted to take advantage of market conditions quickly? For example, an issuer wants to raise capital through a bond issuance, but wants to wait until interest rates decline. When interest rates fall below a certain threshold, the issuer intends to offer security quickly to take advantage of the new lower cost of borrowing.
Issuers can bypass the normal rules and obtain quick security registration through the shelf registration rule, formally known as SEC Rule 415. Continuing with our example above, the issuer would file registration paperwork for the debt security with the Securities and Exchange Commission (SEC) (technically SEC Form S-3). Some of the form is left blank, including the security’s coupon (interest rate) and maturity, among other characteristics. As we stated above, the issuer is waiting until interest rates decline to offer the security, so some of the security’s features are yet to be determined. Regardless, the issuer still must make significant disclosures that will eventually be provided to investors by prospectus.
The SEC reviews the registration form for completeness, except for the blank sections not required to be filled out yet. If all the necessary disclosures are provided, the regulator grants the security effective registration. The issuer will now wait to offer the security to investors as the registration form is placed on a metaphorical “shelf” at the SEC. At any point in the next three years, the issuer can take the registration form off the “shelf,” fill out the missing parts, and offer the security quickly to investors.
Let’s assume interest rates decline far enough a year later. The issuer will now provide the SEC with the information left blank on the initial form (e.g., coupon, maturity, etc.). The security can then be offered to investors 48 hours (two days) after the new SEC filing. Registering a security this way allows the issuer to avoid the 20 day cooling off period, saving 18 days of waiting time.
In some circumstances, changes to stock or corporate structures require registration with the SEC. Rule 145 establishes what events or changes require registration. These are the three instances:
Reclassifications
Transfers of assets
Not only do these events require registration with the SEC, but they also require shareholder approval. There are other scenarios where new shares of stock are created but don’t require registration with the SEC. Stock splits (forward and reverse) and stock dividends result in new shares being created, but do not require registration. As a reminder, stock splits require shareholder approval, but stock dividends do not.
Issuers from the United States sell securities outside of the country on occasion. Regulation S establishes when these issuers avoid registering securities sold outside the United States. In most cases, there are no registration requirements if the offering meets these conditions:
Non-US residents purchasing Regulation S securities can sell the security at any time outside of the US. However, these investors are barred from selling the securities in the US for these time periods (after the offering closes):
Judging the demand for a new issue is a difficult task. There are many resources underwriters use to forecast demand for a new issue. For example, indications of interest and internet search queries are utilized to measure investor interest. Even with these tools, finding the perfect price for a new issue is near impossible. Regardless, the underwriter can utilize certain tools if they misjudge demand.
If there’s more demand than the underwriter expected, they can initiate the green shoe clause, which was named after the Green Shoe Manufacturing Company (now known as Stride Rite Corporation). The rule allows the underwriter to request up to 15% more shares from the issuer, which helps meet the extra demand for shares. The Green Shoe Manufacturing Company was the first company to institute this rule in its underwriting agreement.
During Facebook’s IPO in 2012, Morgan Stanley (the lead underwriter) considered instituting the green shoe clause. 421 million Facebook shares were initially set to be sold, but Morgan Stanley increased the offering to 484 million shares (15% more) after they saw signs of increased demand. This is where things get interesting. Morgan Stanley sold short the additional 63 million shares, which left them with two choices.
Option 1: to cover the short position, they could institute the green shoe clause and buy the additional 63 million shares from Facebook. They would pursue this action if the IPO was successful, which is measured by Facebook’s trading price in the secondary market. Facebook’s POP (public offering price) was $38. If the stock began trading in the secondary market above $38, Morgan Stanley would institute the clause and purchase the shares (to close the short position) directly from Facebook at $38 (minus fees).
Option 2: they could institute a stabilizing bid.
Stabilizing bids are utilized by underwriters when they have a “sticky” issue, which occurs when the stock begins trading in the secondary market below its POP. This is what happened to Facebook during its IPO (continuing the story from above). The shares were sold at $38 in the IPO, but they fell well below $38 once they began trading in the secondary market. To help influence the price of the stock back upwards, Morgan Stanley bought back shares at $38 through a stabilizing bid.
Stabilizing bids are the only legal form of market manipulation. Essentially, the lead underwriter floods the secondary market with requests to purchase the stock, driving demand and the stock price upward. From Morgan Stanley’s perspective, they could’ve bought the shares from Facebook at $38 (to close its 63 million share short position), but they chose to go to the market instead. By doing so, they closed the short position and “stabilized” Facebook’s stock price.
The SEC allows stabilizing bids to occur as long as certain requirements are met. First, the bid must be at or below the POP. It can never be above; in the Facebook example, Morgan Stanley stabilized exactly at the POP ($38). Second, there can only be one bid placed at a time, meaning other syndicate members cannot stabilize at different prices separate from the lead underwriter. Last, the possibility of stabilization must be disclosed in the prospectus.
On some occasions, customers that purchased shares from the syndicate during the IPO will sell their shares back to the syndicate during stabilization. Essentially, the investor bought IPO shares only to resell them immediately back to the syndicate. If this occurs, the syndicate member that sold those shares is assessed a penalty bid. A penalty bid results in the syndicate member relinquishing the selling concession they earned when selling the shares. This should make sense - why should the syndicate member be compensated for a sale when the shares were sold back immediately to the syndicate? To avoid this from happening, many syndicate members emphasize the importance of long-term ownership to their customers.
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