Other rules

Other rules and regulations exist that don’t apply to every primary market offering. We’ll discuss some of these topics in this section.

Shelf registration

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 the 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 a 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.

Stabilizing bids

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. 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.