Chapter 20 Notes

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Published on 10 Oct 2011
Chapter 20 Issuing Equity Securities to the Public Notes
20.1 The Public Issue
a firm issuing securities must satisfy a number of requirements set out by provincial regulations and statutes and enforced by
provincial securities commissions; such as in Canada where regulation is carried out by provincial commissions
regulators’ goal is to promote the efficient flow of information about securities and the smooth functioning of securities markets
all companies listed on the TSX come under the jurisdiction of the Ontario Securities Commission (OSC)
in general terms, the OSC rules seek to ensure that investors receive all material information on new issues
the OSC’s responsibility for efficient information flow goes beyond new issues
it continues to regulate the trading of securities after they have been issued to ensure adequate disclosure of information
informational role is gathering and publishing insider reports filed by major shareholders, officers, and directors of TSX firms
20.2 The Basic Procedure for a New Issue
in general terms, the basic procedure is as follows:
1) Management’s first step in issuing any securities is to obtain approval from BOD. The firm must engage an underwriter.
2) The firm must prepare and distribute copies of a preliminary prospectus to the OSC and to potential investors. The
preliminary prospectus contains some of the financial information that will be contained in the final prospectus; it does
not contain the price at which the security will be offered. The preliminary prospectus is sometimes called a red herring,
in part because bold red letters are printed on the cover warning that the OSC has neither approved nor disapproved of the
securities. The OSC studies the preliminary prospectus and notifies the company of any changes required. This process is
usually completed within about two weeks.
3) Once the revised, final prospectus meets with the OSC’s approval, a price is determined and a full-fledged selling effort
gets underway. A final prospectus must accompany delivery of securities or confirmation of sale, whichever comes first.
red herring first document released by an underwriter of a new issue to prospective investors
tombstone an advertisement that announces a public offering of securities; it identifies the issuer, the type of security, the
underwriters, and where additional information is available
The POP System
the POP (Prompt Offering Prospectus) system, accessible only by large companies, lets issuers file annual and interim financial
statements regardless of whether they issue securities in a given year
to use the system, issuers must have been reporting for 36 months and have complied with continuous disclosure requirements
20.3 The Cash Offer
if the public issue of securities is a cash offer, underwriters are usually involved
underwriters perform the following services for corporate issuers—(1) formulating the method used to issue the securities; (2)
pricing the new securities; and (3) selling the new securities
typically, the underwriter buys the securities for less than the offering price and accepts the risk of not being able to sell them
syndicate (banking group) a group of investment banking companies that agree to cooperate in a joint venture to underwrite
an offering of securities for resale to the public, since underwriting involves risk
spread the gap between the interest rate a bank pays on deposits and the interest rate it charges on loans
Types of Underwriting
two basic types of underwriting are involved in a cash offer: regular underwriting and a bought deal
regular underwriting the purchase of securities from the issuing company by an investment banker for resale to the public
regular underwriting includes an “out clause”, which gives the banking group the option to decline the issue if the price drops
firm-commitment underwriting an underwriting in which an investment banking firm commits to buy the entire issue and
assumes all financial responsibility for any unsold shares; like regular underwriting without the out clause
best-efforts underwriting an offering in which an underwriter agrees to distribute as much of the offering as possible and to
return any unsold shares to the issuer; close counterpart to regular underwriting
bought deal one underwriter buys securities from an issuing firm and sells them directly to a small number of investors
Investment Dealers
investment banks are at the heart of new security issues; they provide advice, market the securities (after investigating the
market’s receptiveness to the issue), and underwrite the proceeds
they accept the risk that the market price may fall between the date the offering price is set and the time the issue is sold
in addition, investment banks have the responsibility of pricing fairly
while the underwriter has a short-run incentive to price high, investment banks have a long-run incentive to make sure that its
customers do not pay too much; they might desert the underwriter in future deals if they lose money on this one
thus, as long as investment banks plan to stay in business over time, it is in their self-interest to price fairly
The Offering Price and Underpricing
the issuing firm faces a potential cost if the offering price is set too high or too low
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