Several rules and regulations apply only to certain types of primary market offerings. This section covers the most common exceptions and special situations.
Earlier, we covered the typical securities registration process, including the 20-day cooling off period. But issuers don’t always want to wait that long. Sometimes they want registration in place now, so they can sell quickly later if market conditions improve.
For example, an issuer may want to raise capital through a bond offering, but wait until interest rates decline. Once rates fall to a target level, the issuer wants to move fast and lock in a lower borrowing cost.
To do this, issuers can use the shelf registration rule, formally SEC Rule 415. In this process, the issuer files a registration statement with the Securities and Exchange Commission (SEC) (typically SEC Form S-3). Some details are left blank, such as the bond’s coupon (interest rate) and maturity, because those terms will be set later based on market conditions. Even with blanks, the issuer must still provide the required disclosures that will ultimately be delivered to investors in a prospectus.
The SEC reviews the filing for completeness (other than the permitted blanks). If the required disclosures are included, the SEC declares the registration statement effective. The issuer can then wait, with the registration effectively sitting on a “shelf.”
At any point during the next three years, the issuer can take the registration “off the shelf,” complete the missing terms, and offer the securities quickly.
Continuing the example: if interest rates drop a year later, the issuer files the missing information (coupon, maturity, and other final terms). The securities can then be offered 48 hours (two days) after that filing. This avoids the 20-day cooling-off period, saving about 18 days.
In certain situations, changes to a company’s stock or corporate structure require SEC registration. Rule 145 identifies the events that trigger registration. These are the three instances:
Reclassifications
Transfers of assets
These events require both:
Other corporate actions can create new shares without requiring SEC registration. Stock splits (forward and reverse) and stock dividends create new shares but do not require registration. As a reminder, stock splits require shareholder approval, but stock dividends do not.
Rule 433 provides the legal basis and conditions for using free writing prospectuses (FWPs). An FWP is a written communication used in conjunction with a shelf offering, and it can be almost any written material about a new issue.
FWPs are flexible and may include emails, term sheets, websites, or PowerPoints that provide additional information to potential investors. Rule 433 allows WKSIs (Well-Known Seasoned Issuers) to use FWPs.
Generally, the FWP must be filed with the SEC by the date of first use. There are exceptions for immaterial or unintentional failures to file, as long as reasonable efforts are made to comply. An FWP may include information not in the registration statement, but it cannot conflict with the registration statement or any incorporated SEC reports.
U.S. issuers sometimes sell securities outside the United States. Regulation S explains when these offshore offerings can avoid SEC registration.
In most cases, registration isn’t required if the offering meets these conditions:
Non-U.S. residents who buy Regulation S securities may resell them at any time outside the U.S. However, they can’t resell the securities in the U.S. for the following periods after the offering closes:
Estimating demand for a new issue is difficult. Underwriters use tools such as indications of interest and internet search queries to gauge investor interest, but pricing and sizing an offering perfectly is still challenging. If demand is misjudged, the underwriting agreement may include tools to manage the imbalance.
If demand is higher than expected, the underwriter can use the green shoe clause, named after the Green Shoe Manufacturing Company (now known as Stride Rite Corporation). This clause allows the underwriter to request up to 15% more shares from the issuer to help meet excess demand. Green Shoe Manufacturing Company was the first to include this provision in its underwriting agreement.
During Facebook’s IPO in 2012, Morgan Stanley (the lead underwriter) considered instituting the green shoe clause. Facebook initially planned to sell 421 million shares, but Morgan Stanley increased the offering to 484 million shares (15% more) after seeing signs of increased demand. Morgan Stanley sold short the additional 63 million shares, which left 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 used when an issue is “sticky,” meaning the stock begins trading in the secondary market below its POP. This is what happened to Facebook during its IPO (continuing the example above). Shares were sold at $38 in the IPO, but they fell below $38 once secondary trading began. To help support the price, Morgan Stanley bought shares at $38 through a stabilizing bid.
Stabilizing bids are the only legal form of market manipulation. The lead underwriter places buy orders in the secondary market to increase demand and support the stock price. In the Facebook example, Morgan Stanley could have covered its 63 million share short position by buying shares from Facebook at $38 through the green shoe clause, but instead chose to buy in the market. This both covered the short position and helped stabilize the price.
The SEC permits stabilizing bids only if certain requirements are met:
Sometimes, customers who bought shares from the syndicate in the IPO sell those shares back to the syndicate during stabilization. In effect, the investor buys IPO shares and then immediately resells them to the syndicate.
If this happens, the syndicate member that originally sold the shares is assessed a penalty bid. A penalty bid requires the syndicate member to give up the selling concession earned on that sale. The logic is straightforward: the syndicate member shouldn’t be compensated for a sale that quickly reverses back to the syndicate. To reduce this behavior, syndicate members often stress long-term ownership to customers.
Regulation crowdfunding (Reg CF) allows companies to raise up to $5 million in a 12-month period, but this must be done through a FINRA approved crowdfunding platform. Both accredited and non-accredited investors can participate in Reg CF offerings.
Non-accredited investors are limited to how much they can buy based on their net worth or annual income:
Certain companies are not eligible to use the Regulation Crowdfunding exemption. These include:
While some exceptions apply, securities purchased through Reg CF cannot be resold for a period of one year.
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