Selling Securities To The Public The Basic Procedure

There are many rules and regulations surrounding the process of selling securities. The Securities Act of 1933 is the origin of federal regulations for all new interstate securities issues. The Securities Exchange Act of 1934 is the basis for regulating securities already outstanding. The Securities and Exchange Commission, or SEC, administers both acts.

There is a series of steps involved in issuing securities to the public. In general terms, the basic procedure is as follows:

1. Management's first step in issuing any securities to the public is to obtain approval from the board of directors. In some cases, the number of authorized shares of common stock must be increased. This requires a vote of the shareholders.

2. The firm must prepare a registration statement and file it with the SEC. The registration statement is required for all public, interstate issues of securities, with two exceptions:

a. Loans that mature within nine months b. Issues that involve less than $5 million

The second exception is known as the small-issues exemption. In such a case, simplified procedures are used. Under the basic small-issues exemption, issues of less than $5 million are governed by Regulation A, for which only a brief offering statement is needed. Normally, however, a registration statement contains many pages (50 or more) of financial information, including a financial history, details of the existing business, proposed financing, and plans for the future.

3. The SEC examines the registration statement during a waiting period. During this time, the firm may distribute copies of a preliminary prospectus. The prospectus contains much of the information put into the registration statement, and it is given to potential investors by the firm. The preliminary prospectus is sometimes called a red herring, in part because bold red letters are printed on the cover.

A registration statement becomes effective on the 20th day after its filing unless the SEC sends a letter of comment suggesting changes. In that case, after the changes are made, the 20-day waiting period starts again. It is important to note that the SEC does not consider the economic merits of the proposed sale; it merely makes sure that various rules and regulations are followed. Also, the SEC generally does not check the accuracy or truthfulness of information in the prospectus.

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VI. Cost of Capital and Long-Term Financial Policy

16. Raising Capital

© The McGraw-Hill Companies, 2002

CHAPTER 16 Raising Capital

The registration statement does not initially contain the price of the new issue. Usually, a price amendment is filed at or near the end of the waiting period, and the registration becomes effective.

4. The company cannot sell these securities during the waiting period. However, oral offers can be made.

5. On the effective date of the registration statement, a price is determined and a full-fledged selling effort gets under way. A final prospectus must accompany the delivery of securities or confirmation of sale, whichever comes first.

Tombstone advertisements (or, simply, tombstones) are used by underwriters during and after the waiting period. An example is reproduced in Figure 16.1. The tombstone contains the name of the issuer (the World Wrestling Federation, or WWF, in this case). It provides some information about the issue, and it lists the investment banks (the underwriters) that are involved with selling the issue. The role of the investment banks in selling securities is discussed more fully in the following pages.

The investment banks on the tombstone are divided into groups called brackets based on their participation in the issue, and the names of the banks are listed alphabetically within each bracket. The brackets are often viewed as a kind of pecking order. In general, the higher the bracket, the greater is the underwriter's prestige.

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