Other rules

Other rules and regulations exist that don’t apply to every primary market offering. We’ll cover a few of those topics here.

Shelf registration

Throughout this unit, we’ve discussed the typical securities registration process, which includes the 20-day cooling off period. But what if an issuer wants to register a security now and still be able to take advantage of favorable market conditions later?

For example, an issuer wants to raise capital through a bond issuance, but plans to wait until interest rates decline. Once rates fall below a certain level, the issuer wants to move quickly to lock in a lower cost of borrowing.

Issuers can do this through the shelf registration rule, formally known as SEC Rule 415. In this approach, the issuer files registration paperwork with the Securities and Exchange Commission (SEC) (typically SEC Form S-3). Parts of the form may be left blank, including details such as the security’s coupon (interest rate) and maturity. Those terms may not be known yet because the issuer is waiting for the right market conditions.

Even with some blanks, the issuer still must provide the required disclosures that will ultimately be delivered to investors through a prospectus.

The SEC reviews the registration statement for completeness, except for the sections that are permitted to remain blank at this stage. If the required disclosures are included, the SEC declares the registration effective. The issuer then waits to sell the securities - often described as placing the registration “on the shelf.”

For up to the next three years, the issuer can take the registration “off the shelf,” complete the missing information, and offer the security to investors on short notice.

Suppose interest rates decline enough a year later. The issuer files the previously omitted details with the SEC (for example, coupon and maturity). The security can then be offered to investors 48 hours (two days) after that filing. This process avoids the 20-day cooling off period, saving 18 days.

Stabilizing bids

Stabilizing bids are used by underwriters when they have a “sticky” issue - meaning 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 push the price back up, Morgan Stanley bought shares at $38 through a stabilizing bid.

Stabilizing bids are the only legal form of market manipulation. In practice, the lead underwriter enters bids to buy the stock in the secondary market, which can increase demand and support the stock price.

In the Facebook example, Morgan Stanley could’ve bought shares directly from Facebook at $38 to close its 63 million share short position, but instead chose to buy in the market. By doing so, it both closed the short position and helped “stabilize” the stock price.

The SEC allows stabilizing bids as long as certain requirements are met:

• The bid must be at or below the POP. It can never be above the POP. (In the Facebook example, Morgan Stanley stabilized exactly at the POP of $38.)
• Only one stabilizing bid may be in place at a time. Other syndicate members can’t stabilize at different prices separate from the lead underwriter.
• The prospectus must disclose that stabilization may occur.

Sometimes, customers who bought shares from the syndicate during the IPO sell those shares back into the market during stabilization, and the syndicate ends up repurchasing them. In effect, the investor bought IPO shares and then immediately resold them back to the syndicate.

When this happens, the syndicate member that originally sold those shares may be 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 if the shares were quickly sold back to the syndicate.

To reduce this behavior, many syndicate members stress long-term ownership to their customers.