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192 Cards in this Set
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Introductory Class Describe the differences between a primary offering and a secondary offering. |
A primary offering is a sale, or issuance, of securities by the company itself (the issuer). A secondary offering is the sale of the company’s securities by an individual who already holds them. Secondary offerings are usually made by insiders, for example the CEO,CFO, or a director. |
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Introductory Class What is the green shoe? |
The green shoe, or over-allotment option, is a right held by the underwriter of an offering to purchase additional shares from the issuer at the same price as the initial shares when the demand for the offering exceeds the quantity of initial shares. This option is written into the underwriting agreement between the issuer and the underwriter (i.e., the investment bank that has (under § 2(a) of the ’33 Act) either (1) purchased shares from the issuer with a view toward distributing them, or (2) is offering or selling securities on behalf of the issuer). Underwriters will often intentionally aim to produce this excess demand, because it makes it look like a hot offering (especially if the demand exceeds the number of shares by 4 or 5 times). As with all shares, the issuer must register the green shoe with the SEC and pay the appropriate fees. |
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Laws relating to Securities Offerings Perform the 40 Act back of the envelope test using the following information (show your work), and state whether the company is a 40 Act company: Cash items $250 million Government securities 0 Investment securities $300 million Other $800 million |
To determine whether this is a ’40 Act company, we must determine whether the proportion of (Investment Securities) / (Investment Securities + Other) is less than 40%. If the proportion is less than 40%, the corporation is not a ’40 Act company and does not have to worry about registering under the ’40 Act or selling shares to avoid such registration requirements. Here, ($300mil) / ($300mil + $800mil) = ~ 27%, so the company is not a ’40 Act company. |
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Laws relating to Securities Offerings What is “materiality” and how does it apply to the IPO prospectus? |
The concept of materiality helps define what information must be included in the IPO prospectus. The prospectus must disclose all material information, in addition to information that would be necessary to make that material required information not misleading. Information is material if a reasonable investor would consider the information important in making an investment decision. Stated differently, material information would alter the total mix of information available to the investor in a way that could influence his decision. See TSC Industries. |
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Laws relating to Securities Offerings In IPOs for companies offering and listing common stock on a national securities exchange, these companies register ______________ under the Securities Act of 1933 and __________ under the Securities Exchange Act of 1934. |
(1) Transactions; (2) Classes of securities |
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NYSE Listing How is a “specialist” selected? |
The Issuer may select a DMM directly or delegate the authority to the NYSE to select a DMM on its behalf. If the Issuer chooses to select a DMM itself, it must choose a minimum of four DMMs to interview from a pool of DMMs eligible to participate in the allocation process. Within two business days of the interview, it must select a DMM. If the Issuer delegates the authority to choose a DMM to the NYSE, then three members of the NYSE’s senior management will select a DMM based on a review of all information that would be available to the Issuer. |
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NYSE Listing Tell me three things that the company will need to provide to the NYSE during their confidential review of eligibility. |
Issuer’s charter and by-laws; Specimens stock certificates; Annual reports to shareholders for the last five years; The latest available prospectus covering an offering under the Securities Act of 1933 (where available) and latest Form 10-K filed with the SEC; The proxy statement for the most recent annual meeting; and Supplementary data to assist the NYSE in determining the character of the share distribution and the number of publicly-held shares. |
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Publicity Issues Related to the Offering Explain the differences between a Rule 134 notice and Rule 135 notice |
Both rules allow the issuer to publish very limited information (sometimes referred to as a tombstone ad) while it is contemplating an offering, without it constituting an illegal offer – either prior to the filing of an RS, or without the use of a ’33 Act § 10 compliant prospectus during the waiting period. Rule 135 applies during the pre-filing period, meaning the period before the issuer files a registration statement (RS) with a preliminary prospectus with the SEC. It can include the issuer’s name, its intention to make an offering, and some details about that offering, but it cannot include the name of the underwriter. Moreover, it must include a legend stating that it is not an offer of securities (which cannot be made before the RS is filed per ’33 Act § 5(c)). Rule 134 applies during the waiting period, after the RS has been filed with the SEC but before it becomes effective. Again, it can only include very limited information about the offering, but this time it can include the names of the underwriters. |
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Publicity Issues Related to the Offering Is “conditioning the market” advisable from a legal perspective in an IPO? Why or why not? |
No, conditioning the market is not advisable. One of the basic philosophies underlying the ’33 Act is that the preliminary prospectus should be the main document relied upon by the investor in making the investment decision. The reason for this emphasis is that the preliminary prospectus is supposed to include the good, the bad, and the ugly, enabling the investor to make a fully informed, unhurried decision. Conditioning the market is altering the total mix of information available to the investor outside that prospectus, perhaps influencing their decision without disclosing all material facts. If an issuer is found to have conditioned the market in a way that constitutes a "gun-jumping" violation of § 5, there could be various consequences, including delaying the offering for a "cooling off" period to allow the improper information to become stale, giving future shareholders a cause of action to rescind their sales if the price goes down, and requiring the issuer to include this potential liability as a risk factor in its prospectus. |
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Publicity Issues Related to the Offering Please explain the differences in the publicity allowed under the federal securities laws in the pre-filing period versus the waiting period for an IPO. |
Some rules are the same for both the pre-filing period and the waiting period. For example, throughout, the issuer can respond to reasonable press requests received in the ordinary course of its business. It can also disclose factual information that it has a history of disclosing in its ordinary course of business, in the same manner and form that it usually discloses the information, to non-investors under Rule 169. However, there are important differences. First, the issuer is allowed to use the slightly more expansive Rule 134 disclosure during the waiting period in place of the Rule 135 disclosure, which means it can disclose the name of the underwriter. Second, because an RS is filed, the issuer is no longer prevented under § 5(c) from making offers in an appropriate manner. It can therefore publicize the offering itself a bit more by distributing a § 10 compliant preliminary prospectus and talking to potential investors via a road show (which, as long as it’s live, constitutes an oral offer and thus does not violate § 10) about information contained in that preliminary prospectus. Moreover, the issuer can distribute other writings (free writing prospectus) as long as they’re accompanied or preceded by a § 10 compliant prospectus (including the price range). Rule 405. |
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Underwriters and Liabilities Thinking back to the in Re Worldcom, Inc. Securities Litigation (U.S. District CourtSouthern District of New York) and underwriter liability in that case, why are underwriters, who can make huge amounts of money in fees (up to 7% of the total offering price), so concerned about their potential liability? |
As in Worldcom, if there is a material misstatement or omission in the registration statement (§ 11), or a violation of § 5 or a material misstatement or omission in a prospectus or oral communication (§ 12), the purchasing shareholders can sue for rescission of the sale. In other words, they will receive the difference between the price they purchased at and the price the stock falls to after the misstatement or omission comes to light. In Worldcom, the discovery that the issuer had, inter alia, improperly capitalized substantial costs brought the stock price crashing down, virtually obliterated the underwriters’ earnings through the gross spread. |
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Underwriters and Liabilities Why doesn’t the issuer have a due diligence defense? |
The issuer does not have a due diligence defense because it is presumed to know everything about itself. Because the issuer is in the best position to give complete and accurate information about itself, it is generally incentivized to ensure that this information is properly cultivated and shared, for example through all the provisions requiring disclosure of internal controls (ex: SOX 302). |
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Underwriters and Liabilities Regulation M deals with the concept of “stabilization.” Please briefly describe thisconcept. |
Stabilization involves activities undertaken to influence the market for the issuer’s securities, for example by creating the impression that there is a high demand and limited supply to stir up interest in the stock. Such actions are generally prohibited, except in some cases to prevent a precipitous decline in the price, and generally even when they are allowed they must be disclosed. |
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Underwriting Agreements and The Agreement Among Underwriters What is the material adverse change clause (MAC clause) and what purpose does it serve? |
This provision allows for termination of the Underwriting Agreement and is intended to protect the Underwriters from having to purchase the securities if external events occur between the time of offering and pricing. Any material adverse change (aka a “MAC”) or any development involving a prospective material adverse change in or affecting the earnings, business, management, properties, assets, rights, operations, condition (financial or otherwise) or prospects of the Issuer. Events include things like wars, national emergencies, suspension of trading on the NYSE or NASDAQ, banking moratorium, or downgrade of issuer's debt securities. |
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Underwriting Agreements and The Agreement Among Underwriters Why several and not joint liability in the underwriting agreement? |
If the purchase obligation was “joint”, then this would have important effects on the net capital requirements of each underwriter participating in the offering. Therefore, to minimize the amount charged against an underwriter’s net capital, the commitments are several. Section 11(e) of the 33 Act – Liability is limited to the price at which the securities underwritten by each underwriter were distributed to the public. If each underwriter was jointly liable for the entire offering amount, then the underwriters would not get the protection of this hold-down provision. |
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The Financials (F-pages) For each financial statement line item, place an X in either the balance sheet or income statement column to indicate the financial statement that such line item appears. For example, “cash” appears on the balance sheet. On your answer sheet, please reproduce the following table with your answers or write “Balance Sheet” or “Income Statement” next to each line item. Cash - Balance sheet Accounts Receivable Cost of Goods Sold Additional Paid in Capital Accumulated Depreciation Goodwill Operating Income |
Accounts Receivable - Balance Sheet Cost of Goods Sold - Income Statement Additional Paid in Capital - Balance sheet Accumulated Depreciation - Balance Sheet Goodwill - Balance Sheet Operating Income - Income Statement |
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The Financials (F-pages) Per the FASB, the financial statements must be relevant and reliable. Which is more reliable, the historical value of land on the balance sheet or the value of a derivative security marked-to-market as of the date of the balance sheet? Why? |
The historical value of land is more reliable. Reliable means that the information faithfully reflects the financial position, results of operation, and cash flow of the business. In accounting, whether information is "faithfully" presented usually relies on whether it is compliant with GAAP. The GAAP principle of historical cost requires that the value of assets be marked at the price they were acquired, rather than marked to present value (unless there has been a permanent change that results in a decline in the value of the asset). This often reflects the broader accounting principle of conservatism: we are certain what we paid for the asset originally, but we may not be certain of the true current value of a security (especially a derivative, under today’s transforming derivative markets), so we should rely only on what we know rather than overestimating the value of an asset. |
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The Financials (F-pages) Regulation S-X – Fill in the table with the appropriate number of years of required financial statements in the IPO prospectus: Balance Sheet __ years Income Statement __ years Stockholders’ Equity __ years Cash Flow __ years |
Balance Sheet 2 years Income Statement 3 years Stockholders’ Equity 3 years Cash Flow 3 years |
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Accounting Issues and Comfort Letters What is “channel stuffing?” |
Channel stuffing is an accounting trick whereby the company provides incentives for a purchaser of its products to acquire more than it needs in a particular accounting period. A company may do this to improve its revenues during a bad time, thus smoothing its income over the course of market fluctuations. |
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Accounting Issues and Comfort Letters Explain the concept of revenue recognition. |
The basic concept in revenue recognition is that revenue should not be recognized until it is realized or realizable and earned by a company. Under GAAP, the earnings process must be substantially complete in order for a company to recognize revenues from a transaction. Staff Accounting Bulletin 104 (“SAB 104”) states that: “The staff believes that revenue generally is realized or realizable and earned when all of the following criteria are met: (1) Persuasive evidence of an arrangement exists; (2) Delivery has occurred or services have been rendered; (3) The seller’s price to the buyer is fixed or determinable; and (4) Collectibility is reasonably assured.” If significant contingencies to the receipt of income exist, then income should not be recognized. |
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Accounting Issues and Comfort Letters Explain the concept of “conservatism” and why this is important with respect to a company’s financial statements. |
The tendency for accountants to understate rather than overvalue. For example, recording losses once a company believes they will occur, not later when in fact the loss does occur. Additionally, gains are not recorded until they actually occur, not when anticipated. In effect, accountants are more likely to want revenues understated and expenses overstated, particularly true since the enactment of Sarbanes-Oxley. |
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Risk Factors (1) Discuss the “bespeaks caution” doctrine and how it relates to risk factors. |
Under the bespeaks caution doctrine, an issuer may use forward-looking statements (for example projections, predictions, and future value opinions) as long as they include meaningful cautionary language that such statements are the product of speculation and not certain. The cautionary language must be tailored. The doctrine is relevant to risk factors because such risks often involve future developments in the market, for example a predicted decline in housing prices or a trend toward less expensive homes in the case of a home construction company, and thus necessarily involve forward-looking statements of anticipated trends. |
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Risk Factors (1) Once a company has completed its IPO, does a company have to include risk factors in Securities Exchange Act of 1934 filings? If so, which filings? |
Yes, the company has to include its risk factors in the 10K and 10Q. |
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Law Firm Opinions and Letters What is a Rule 10b-5 “negative assurance” legal opinion and who gives that legal opinion to whom in IPO? |
The issuer's counsel gives the Rule 10b-5 negative assurance legal opinion to the underwriter, usually as a closing condition of the UW agreement (and perhaps again as a bring-down disclosure right before the effective date). The Rule 10b-5 negative assurance opinion provides that nothing has come to counsel's attention that leads them to believe that the Registration Statement (except as to the financial statements, financial data, supporting schedules, and statistical data included therein, as to which we have not been requested to comment), contains any untrue statement of a material fact or omits to state a material fact required to be stated therein or necessary to make statements therein not misleading. It helps the Underwriters to establish their due diligence defense under sections 11 and 12 of the 33 Act. |
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act What does Regulation S-K contain and what is the relationship between Regulation S-K and Form S-1? |
The Form S-1 is used for registration under the 33 Act of securities of all registrants for which no other form is authorized or prescribed, except that it is not used for securities of foreign governments. Form S-1 itself is only a few pages long because the detailed disclosure it requires is found in Regulation S-K, to which Form S-1 references. Reg S-K contains the requirements for the non-financial parts of the Form S-1. |
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act Rule 406 deals with confidential treatment of information filed with the SEC. Briefly explain what this rule allows. |
Rule 406 details the procedure for asking for confidential treatment for information submitted in a document required to be filed under the 33 Act. Examples of confidential treatment requests include corporate secrets, such as technical specifications (e.g., the recipe for Coca Cola or the processes or the designs of BMW engines) or specific sensitive pricing terms in contracts (i.e., how much Company A charges Company B for product C). Issuers should identify early in the IPO preparation process those documents (or critical parts of certain documents) that the Issuer wishes to keep private and make a confidential treatment request for such material to the SEC on the same date as the initial filing of the registration statement. The information in the request cannot be material and the Issuer must show why there would be competitive harm if the information were disclosed. The issuer must file the exhibit with the RS and redact the confidential information. The issuer must also prepare and file with the Secretary's office of the SEC the confidential request and include both the redacted and unredacted versions. |
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(MD&A) What are “critical accounting policies” and what disclosure about such policies is required? |
Critical Accounting Policies are decisions the issuer has made about how to present information (particularly financial information), where (1) the correct assumptions, methodology, etc. were substantially uncertain, and (2) if management had made a different choice, it would have materially affected the information presented. The SEC encourages companies to disclose that “materially different amounts would be reported under different conditions or using different assumptions.” Basically, the SEC is encouraging companies to perform a “sensitivity analysis.” There is currently a recommended rule that management disclose in its MD&A the following: (1) what decisions it made; why alternatives were available, what they were, why the decision was made; (2) how sensitive the results were; how great the change would have been if it had selected the other path; and (3) an illustration of what the results would have been at the ends of the spectrum if other choices are made. |
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(MD&A) At least four major topic areas are required to be discussed in the Full Fiscal Years section of MD&A. Name and briefly discuss three of the four and state where the requirement that such topics be discussed comes from. |
The MD&A requirements are set forth in Rule 303 of Reg S-K. Off-Balance Sheet Arrangements Must discuss, in a separately captioned section, the Issuer’s off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Issuer’s (i) financial condition, (ii) revenues or expenses, (iii) results of operations, (iv) liquidity, (v) capital expenditures or (vi) capital resources. Tabular Disclosure of Contractual Obligations: Information about contractual agreements and obligations of the issuer are often spread throughout the prospectus. This section requires the issuer to put them all in one place, so the reader of the prospectus has a complete understanding of potential creditors’ claims. Results of Business Operations. This section asks management to give its unique perspective on the drivers of the financial information set forth in the F-Pages. It covers the key factors that drive, risks that face, and specific historical events and transactions that affect both current and past indicators of performance. Thus, often, it involves a longitudinal comparison of performance over different periods and insight into why the numbers are as they are. Liquidity and Capital Resources. This section gives insight into the corporation’s ability to transform assets into cash as needed to fulfill business needs. |
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Post-Closing Reporting Obligations and Requirements (Which Need to be Addressed, or at least Explained, to the Issuer, Pre-Filing) What does Rule 12b-20 call for and what is the relationship with what it calls for and the disclosure requirements of Form 10-K? |
Rule 12b-20 calls for the disclosure of additional information as needed to make the information already included in the Form 10-K not misleading. As such, it supplements the required disclosures of Form 10-K with necessary contextual information that is not otherwise required. |
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Post-Closing Reporting Obligations and Requirements (Which Need to be Addressed, or at least Explained, to the Issuer, Pre-Filing) Provide three examples of events that require a company to file a report on Form 8-K. |
(1) Completion of an acquisition; (2) A delisting notice from the NYSE; (3) A significant judgment of liability against the company. (4) Bankruptcy and receivership (5) Termination of a Material Definitive Agreement (6) Entry into a Material Definitive Agreement (7) Completion of Acquisition or Disposition of Assets (8) Unregistered Sales of Equity Securities (9) Material Modifications to Rights of Security Holders (10) Change in Certifying Accountant (11) Change of Control (12) Change of a Director in the Board or Principal Officer (13) Amendment to Articles of Incorporation or Bylaws (14) Temporary Suspension of Trading Under Employee Benefits Plans (15) Reg FD Disclosures |
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Post-Closing Reporting Obligations and Requirements (Which Need to be Addressed, or at least Explained, to the Issuer, Pre-Filing) What is the difference between a Form 3 and a Form 4? |
Forms 3 and 4 relate to the insider disclosure requirements of § 16 of the ’34 Act. Under § 16, insiders (ex: officers, directors, beneficial holders of more than a 10% interest) must disclose their holdings in the company. The forms constitute the first of § 16’s three prongs: (1) disclosure, (2) liability (the short-swing profits rule: giving the company profits from sales of the securities effective date of the registration statement or the listing of the securities on the exchange. Form 4 is used later to reflect a change in insider or beneficial owner status. |
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SEC Comment and Review What if we disagree with the SEC staff comments? Can we argue against such comments, or do we have to comply with all comments, even the ones we disagree with? |
There are 2 types of SEC comments: (1) request for supplemental information and (2) "advise or revise." After receiving comments from the staff of the SEC, the Issuer will respond to each of the staff’s comments in a response letter, stating either that the Issuer: (1) Has made appropriate changes to reflect the staff’s comments in the registration statement; or (2) Disagrees with the staff’s comments and laying out the basis for its disagreements. It may take further convincing, either in writing or orally, to convince the staff of the SEC that the Issuer’s position is correct. All SEC staff comments must be resolved before the SEC will declare the registration statement effective. If the Issuer chooses to dispute a comment, a well-thought out, detailed answer should be carefully crafted, citing appropriate precedent if available, and the SEC staff should be provided ample data and other information needed for the SEC staff to make a decision whether or not to waive the comment. |
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SEC Comment and Review I heard that some registration statements get “no reviewed.” What does this mean, and what do you think is the likely level of review for our IPO registration statement? |
Most registration statements which receive no review are those of repeat issuers who have recently had another registration statement fully reviewed by the SEC, are current with respect to their 34 Act reporting obligations, do not have financial problems and do not raise any enforcement issues. An IPO RS is virtually guaranteed a full level of review. |
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Introductory Class Explain how the IPO proceeds the issuer receives will be affected by: (1) the gross underwriting spread and (2) the offering of primary shares and (3) the offering of secondary shares. |
(1) Gross Underwriting Spread. The gross underwriting spread is the difference between the price the Underwriters pay the Issuer and/or Selling Shareholders for each share of the Issuer's stock and the price that the shares are offered to the public. Thus, the GUS will decrease the amount of the proceeds the Issuer receives from the IPO. (2) Offering of Primary Shares. The Primary Shares represent the issuer's own stock which it will sell to the public to raise capital in the IPO. The proceeds the issuer receives from the sale of its primary shares are, as previously discussed, decreased by the GUS. (3) Offering of Secondary Shares. Secondary Shares are shares held by existing holders of the issuer's stock, not the issuer. Such shares are commonly held by insiders of the issuer, such as the CEO, CFO, and or the founders of the company. When these shares are sold to the public, the proceeds go to those respective shareholders. |
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Introductory Class What is an "Initial Organization Meeting" or "Org Meeting?" Who attends and what is typically discussed at that meeting? |
The Initial Organizational Meeting is a "kick-off" or "all-hands" meeting where the Managing Underwriter will distribute an agenda and a working group list. The company, lawyers, accountants, and bankers attend the meeting, the purpose of which is to focus the group on the task at hand and critical dates in the preparation of the needed documents, as well as to assign responsibilities for these tasks. A timetable for the offering will be discussed, in addition to the size of the offering, participation of selling shareholders, the green shoe option, financial statements and accounting issues, disclosure of confidential documents, gun jumping issues, and identifying critical issues. |
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Laws Relating to Securities Offerings What is the Investment Company Act of 1940 and why is it important to consider when doing a 33 Act offering such as an IPO? |
The Investment Company Act of 1940 regulates companies that are primarily engaged in investing, reinvesting and trading in securities. The 40 Act is important to consider during an IPO because if an issuer is an investment company, then for all practical purposes it cannot engage in a securities offering without registering under the Investment Company Act of 1940. |
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Laws Relating to Securities Offerings Explain the difference between registration under the Securities Act of 1933 and registration under the Securities Exchange Act of 1934. |
The 33 Act registers securities transactions and seeks to provide investors with full and fair disclosure by implementing strict registration requirements for companies who wish to engage in public securities offerings. The 34 Act registers classes of securities and seeks to maintain fair and efficient markets by implementing periodic reporting requirements for public companies and regulations for traders, SROs, and the markets themselves. |
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Laws Relating to Securities Offerings What are forward-looking statements? Should an issuer include them in its IPO prospectus? Why or why not? |
Forward-looking statements are statements that are not historical facts but instead express opinions about the future (and future performance of the company) with respect to a company’s plans, objectives, strategies, projected financials, operational figures, beliefs. See Rule 175(c). Such forward-looking statements are based on management’s expectations, assumptions, estimates, projections and beliefs in light of information currently available to it. Generally, it is safer not to include forward-looking statements in an IPO prospectus because Issuers cannot benefit from the Section 27A safe harbor that permits certain types of forecasts and projections. Therefore, the Issuer may face Section 11 (misstatements in an effective RS) or Section 12 (misstatements made in selling efforts) liability if its forecast or projection proves to be incorrect. However, Rule 175 provides issuers with a safe harbor from liability for certain statements such as certain projections and forecasts regarding revenues, income, loss, dividends, and others. The safe harbor will apply unless a plaintiff can prove that such forward-looking statement was made or affirmed without a reasonable basis or was disclosed other than in good faith. |
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NYSE Listing What is a "specialist" and what are its functions? |
The role of the NYSE specialists began to wane in the 1980's and are now succeeded by Designated Market Makers (DMMs). Specialists were the floor traders vested with the responsibility for manually managing the ebb and flow of volume for stock in their books. Similarly, DMMs are obligated to maintain fair and orderly markets for their assigned securities. They operate both manually and electronically to facilitate price discovery during market opens, closes and during periods of trading imbalances or instability. |
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NYSE Listing What are some of the minimum quantitative standards that the NYSE rules require a company to meet before it can be listed on the NYSE? |
In an IPO, the listing standards require a company to have at least 400 round lot shareholders (shareholders with 100 or more shares), at least 1.1 million publicly held shares, at least $40 million market value of publicly held shares, and at least a $4.00 minimum share price. |
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Publicity Issues Related to the Offering What should the issuer do with respect to the content of its website while the issuer is "in registration?" |
Federal securities laws apply to the content of an Issuer's website in the same way as any other statements made by the Issuer. In general, unless a 33 Act safe harbor is available, nothing should be posted to these websites that relates to the securities offering. Business information regarding the Issuer’s products and services and advertising of the issuer's products may continue to be posted in line with the Issuer’s current practices. But a website made contemporaneously with the offering may appear to be a selling effort, as may a substantial increase in the issuer's advertising budget. Business-related press releases may continue to be posted. Such press releases may not contain predictions of value, forecasts or financial projections. Previously posted materials or statements on an Issuer’s website that are accessed during the quiet period may be considered “republished” and create potential liability for an Issuer. Thus, previously posted materials or statements should be either separately identified as historical or previously posted materials or statements, including, for example, by dating the posted materials or statements; and located in a separate section of the company's Web site containing previously posted materials or statements. When using summaries or overviews on Web sites, companies should consider ways to alert readers to the location of the detailed disclosure from which such summary information is derived or upon which such overview is based, as well as to other information about a company on a company's Web site. Use appropriate titles to avoid confusion, use additional explanatory language, place hyperlinks to the more detailed information near the summary, or use a layer or tiered format so investors can follow a logical path to obtain greater details about any areas of the company in which they have an interest. A company is responsible for information contained in blogs, but a company is not responsible for the statements that third parties post on a Website the company sponsors, nor is a company obligated to respond to or correct misstatements made by third parties In general, hyperlinking to information on another website is dangerous and should be avoided because the Issuer does not want to take responsibility for the accuracy of the contents of a website over which it does not exercise control. Issuer responsibility for third-party information depends upon whether such information is attributable to the Issuer, which depends upon (i) whether the Issuer has involved itself in the preparation of the information or (ii) explicitly or implicitly endorsed or approved the information. The SEC believes the Section 5 analysis applies to both the information on the Issuer’s website as well as information on a third-party website to which the Issuer hyperlinks. In other words, an Issuer in registration must be careful (i) not to make any offer of any kind prior to the filing of a registration statement (See Section5(c) of the 33 Act), and (ii) that any written offer made during the period between filing and delivery of the final prospectus conform to the requirements of Section 10 of the 33 Act. An Issuer should have its lawyers review and make suggestions for updating the Issuer’s website at the beginning of the IPO process. Such suggestions should include: (1) Removing hyperlinks (or at least adding “pop-up” disclaimers indicating that the viewer is leaving the Issuer’s website and going to a separate website for which content the Issuer is not responsible); 2) Archiving old information; (3) Dating information; and (4) Insuring that any information that remains on the Issuer’s website is consistent with information that will be in the registration statement. An Issuer should implement a careful process during the IPO for pre-approving any new website content prior to it being posted to guarantee accuracy of the information, consistency with the content of the registration statement and to make sure that any potential Section 5 issues are considered. |
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Publicity Issues Related to the Offering Describe the concept of "conditioning the market." |
Conditioning the market is when an issuer attempts to stimulate public interest in the proposed offering before a registration statement has been filed. The publication of information and statements, and publicity efforts, generally, made in advance of a proposed financing, although not couched in terms of an express offer, may in fact contribute to conditioning the public mind or arousing public interest in the issuer or in the securities of an issuer in a manner which raises a serious question whether the publicity is not in fact part of the selling effort. This is often referred to as "gun jumping" and is a violation of Section 5 of the 33 Act. |
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Publicity Issues Related to the Offering Fill in the blanks in the following table dealing with publicity restrictions applicable during the three time periods. On your answer sheet, please write the correct answer next to the letters (a), (b), (c), and (d). Pre-filing period: In general, no offers, no _________(a). Avoid ___________(b). Waiting Period: Offers of securities can be made in three ways: __________(c), ____________(d) and Free Writing Prospectus. Post-effective Period: Final prospectus circulated, sales allowed. |
a) sales b) illegal offers or "gun jumping" c) oral d) preliminary prospectus |
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Underwriters and Liabilities What is due diligence, who conducts due diligence during the IPO process and why? Additionally, in In Re Worldcom, Inc. Securities Litigation, the court discussed the concept of "red flags." What are "red flags" in the context of securities offering due diligence? |
Due diligence is the process by which underwriters and their lawyers inspect, examine, and ask questions about a company’s operations, products, services, licenses, contracts, intellectual property rights, financial statements, corporate charter, current legal disputes (both court cases and arbitration cases) and related documents, in order to verify the accuracy of information that is to appear in the offering document and to ensure there are no material omissions. In addition to verifying the accuracy of the offering document, the underwriters conduct due diligence primarily to satisfy their obligations to assert a due diligence defense to any Section 11, 12, or 5 liability. Underwriters are an easy target for plaintiffs because they typically have substantial sums of money. So, if an underwriter satisfies the requirements of a due diligence defense, then it will be able to get a summary judgement and dismiss plaintiffs' claims before having to decide between an expensive settlement or an uncertain but possibly expensive trial and adverse outcome. Section 11(b)(3) requires underwriters to demonstrate that they “had, after reasonable investigation, reasonable ground to believe and did believe... that the statements therein [the registration statement] were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.” Experts and anyone else who signs the RS, except for the issuer, also does diligence because they also have due diligence defenses. With respect to red flags, if red flags arise from a reasonable investigation, underwriters will have to make sufficient inquiry to satisfy themselves as to the accuracy of the financial statements, and if unsatisfied, they must demand disclosure, withdraw from the underwriting process, or bear the risk of liability.” Generally, a red flag may arise if the underwriters' investigation leads them to question the accuracy of financial reporting. For example, if the issuer does not show the underwriter certain material contracts that it claims to have. In this case, an audit report or comfort letter will not excuse the failure to follow through with a subsequent investigation. |
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Underwriters and Liabilities What is a road show? When does it take place during the IPO process, and who participates in it? |
In its effort to sell securities to the public and individual investors, the Managing Underwriters will organize a series of meetings in major financial centers throughout the United States, as well as perhaps Europe and Asia. The press and public investors may be excluded. The Road Show begins only after the registration statement has been filed containing the preliminary prospectus. At these meetings, the issuer’s CEO, CFO and other top people make presentations to invited groups of institutional investors, money managers and securities salesmen. The Managing Underwriters may also set up “one-on-one”meetings between top company officials and important potential investors. |
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Underwriters and Liabilities Under Section 11 of the 33 Act, does the issuer have a due diligence defense? Why or why not? Do the underwriters have a due diligence defense? Why or why not? |
The issuer does not have a due diligence defense because it is presumed to know everything about itself. Because the issuer is in the best position to give complete and accurate information about itself, it is generally incentivized to ensure that this information is properly cultivated and shared, for example through all the provisions requiring disclosure of internal controls (ex: SOX 302). Underwriters are an easy target for plaintiffs because they typically have substantial sums of money. So, if an underwriter satisfies the requirements of a due diligence defense, then it will be able to get a summary judgement and dismiss plaintiffs' claims before having to decide between an expensive settlement or an uncertain but possibly expensive trial and adverse outcome. Also, underwriters are expected to be the gatekeepers of information that is allowed to reach investors. They must make sure that all of the information in the offering document is not misleading or inaccurate. Thus, the due diligence defense provides underwriters with an incentive to fulfill this gatekeeping role by absolving them of liability. If underwriters didn't have a due diligence defense, it would probably be significantly more expensive to conduct an IPO because the potential damages an underwriter could face from a material misstatement or omission in an effective RS are extremely high because potential damages are equal to the purchase price minus the value on the date of sale by the investor or lawsuit. Thus, underwriters would want a higher fee in exchange for this increased risk. |
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Underwriting Agreements and The Agreement Among Underwriters Describe what the term "indemnification" means, which party indemnifies which party (between the underwriter and the issuer) in an underwriting agreement and why. Also, does one party (the underwriter or issuer) indemnify the other to a greater extent and why? |
Indemnification allocates any potential losses, claims, damages or liabilities among the issuer, the selling shareholders, and the underwriters, that result from or are based upon untrue statements or omissions of material fact which are contained in any offering document. Theoretically, any one of these three parties (the issuer, the selling shareholders, and the underwriters) could indemnify any of the other parties for any losses stemming from misinformation furnished by the indemnifying party that was in writing for use in the offering document. However, the Issuer generally indemnifies the underwriter to a greater extent because underwriters limit the information they specifically provide for inclusion in the prospectus through a specific enumeration in the underwriting agreement or through the use of a "Blood Letter." This is because the Issuer receives a much greater benefit from the IPO than the UWs, as the Issuer receives an overwhelming majority of the proceeds. |
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Underwriting Agreements and The Agreement Among Underwriters What are issuer representations and warranties and what purposes do they serve? |
Issuer representations and warranties are factual statements the issuer makes to the underwriters about itself, its business, and/or the shares to be to distributed. The reps and warranties serve as a basis for terminating the Underwriting Agreement. If the reps and warranties are not correct, then the Underwriters may terminate their obligation to purchase the securities. They also serve as a basis for allocating risk among the various parties. Finally, they assist the underwriters in performing due diligence by helping the Issuer focus on potential problem areas and areas which the Underwriters believe may require disclosure in the offering document. |
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The Financials (F-pages) For each financial statement line item, place an X in either the balance sheet or income statement column to indicate the financial statement that such line item appears. For example, "cash" appears on the balance sheet. Cash - Balance Sheet Accounts Payable Interest Expense Additional Paid in Capital Prepaid Expenses Income Taxes Long-Term Debt |
Accounts Payable - Balance Sheet Interest Expense - Income Statement Additional Paid in Capital - Balance Sheet Prepaid Expenses - Balance Sheet Income Taxes - Income Statement Long-Term Debt - Balance Sheet |
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The Financials (F-pages) Explain the difference between cash and accrual accounting. |
Accrual basis accounting is the most commonly used accounting method, which reports (i) income when earned and (ii) expenses when incurred; as opposed to cash basis accounting, which reports (i) income when received and (ii) expenses when paid. Under the accrual method, a company has some discretion as to when income and expenses are recognized, but there are rules governing the recognition. In addition, a company must be prudent in its accounting estimates. |
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The Financials (F-pages) How many years of audited balance sheets, income statements, and statements of cash flow are required in an IPO prospectus, and where does this requirement come from? |
Balance Sheet 2 years Income Statement 3 years Stockholders’ Equity 3 years Cash Flow 3 years Comprehensive Income 3 years For Emerging Growth Companies only two years of each type of audited financial statement are required. Regulation S-X (3-01, 3-02, 3-04) |
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Accounting Issues and Comfort Letters What are GAAP and GAAS? |
GAAP are the Generally Accepted Accounting Principles, which are the rules that a company must follow when preparing its financial statements and recording the financial effect of
various business transactions. These rules are created by a body known as the Financial Accounting Standards Board (“FASB”). GAAP encompasses various conventions, rules, and procedures that accountants follow. GAAP is concerned with the measurement of economic activity, the time when such measurements are made and recorded, the disclosure surrounding these activities, and the preparation and presentations of summarized economic information in the form of financial statements. GAAS is no longer in use for issuers in the US. Instead, US issuers now use the PCAOB Auditing Standards. GAAS is the Generally Accepted Auditing Standards. GAAS governs the conduct of public accounting firms’ audits of public companies. GAAS is a set of systematic guidelines used by auditors when conducting an audit of an Issuer’s financial statements, ensuring the accuracy, consistency and verifiability of accounting firms’ actions and reports.
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Accounting Issues and Comfort Letters List and explain two of the "Accounting Tricks" that were discussed in class and the lecture notes. Recall that accounting tricks are methods that companies can use to make their operating results appear better than they would have been under GAAP. |
“Big bath” restructuring charges:
Big Bath in accounting is an earnings management technique whereby a one-time charge is taken against income in order to reduce assets, which results in lower expenses in the future. The write-off removes or reduces the asset from the financial books and results in lower net income for that year. A company may overstate such charges to provide a conservative cushion, which can become income in a future period. Cookie-jar reserves Using unrealistic assumptions to estimate certain liabilities, thereby accruing money in “cookie jars” during the good times, only later to be used when needed in the bad times. Also referred to as “general reserves,” “contingency reserves,” and “rainy day reserves. GAAP permits a company to establish reserves only for identifiable, probable and estimable risks, not to permit income smoothing. Failure to record or disclose all liabilities (e.g., Enron) “Immaterial” and intentional errors The concept of materiality allows flexibility in financial reporting. Insignificant items perhaps do not have to be measured and reported with exact precision, therefore allowing a company to intentionally record small errors. Capitalizing expenses and shifting expenses to later or earlier periods WorldCom Premature recognition of Revenue Recognizing revenue: (1) before sale is complete; (2) before the product is delivered; (3) even though the customer has the right to terminate, void or delay the sale; or (4) that did not exist. Channel Stuffing Channel stuffing is an accounting trick whereby the company provides incentives for a purchaser of its products to acquire more than it needs in a particular accounting period. A company may do this to improve its revenues during a bad time, thus smoothing its income over the course of market fluctuations.
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Accounting Issues and Comfort Letters In the context of a comfort letter, what is "negative assurance" and which party provides it to whom? |
Negative assurance consists of a statement by
the Issuer's independent auditors to the Underwriters and anyone else that has a due diligence defense under Section 11 that, as a result of performing specified procedures, nothing came to their attention that caused them to believe that any material modifications should be made to the unaudited financial statements or unaudited condensed financial statements for them to be in conformity with GAAP.
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Risk Factors (1) Why or why not should an issuer include the following in a risk factor: (i) example(s) illustrating the risk being discussed; (ii) countervailing considerations explaining what the company has done to mitigate the risk, and (iii) a discussion of the effect on the company if the risk comes to fruition? |
(i) Yes a risk factor should include specific examples demonstrating the type of risk that the issuer is trying to describe because it helps illustrate the precise risk, which will provide the investor with a more comprehensive understanding.
(ii) No, issuers should not include countervailing considerations explaining what the company has done to mitigate the risk because it greatly diminishes, if not completely erodes, the value of the warning that the risk factor is meant to convey. (iii) Yes a discussion of the effect on the company if the risk comes to fruition should be included because otherwise the risk factor would merely state a fact about the business but would not actually explain why the occurrence of a specific event would negatively impact the investor's investment. |
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Risk Factors (1) Why are risk factors included in an IPO prospectus and what purpose do they serve? |
Risk factors present a summary of the risk facing the issuer, and therefore identify to potential and existing investors, factors that should be considered when making an investment decision. The “Risk Factors” section should present a concise synopsis of risks identified in other places in the offering document. Their purpose is to explain to the investor why his/her investment could be risky which also absolves the issuer of liability if any of these "risky" events do occur because the investor will have made the investment with knowledge of the likelihood that a specific event could occur.
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Law Firm Opinions and Letters Please define each of the following terms as they apply to the required Exhibit 5 legal opinion in an IPO under the 33 Act: (i) validly issued; (ii) fully paid; and (iii) non-assessable. |
(i) “Legally issued” means that the securities have been duly authorized, the purchasers will pay proper consideration for them and that the
registrant has executed appropriate certificates evidencing the securities.
(ii) “Fully paid” means that the consideration has been paid in full and is legally sufficient. (iii) “Non-assessable” means that the security holder will not be liable for additional assessments or calls on the security by the registrant or its creditors as a result of being a security holder. |
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act Please discuss the differences between the financial statements contained in (i) the "F pages" (i.e., the financial pages) pursuant to Reg. S-X and (ii) the "Selected Financial Statements" pursuant to Item 301 of Reg. S-K. |
The financial statements contained in the F-pages pursuant to Reg. S-X include the company's balance sheet, income statement, and statement of cash flows. These statements are the 2-3 years of financial statements that are audited by the independent public accountants. They are included in a company's RS and are used to analyze the performance of, and make predictions about, the future direction of a company and its stock price.
The Selected Financial Statements described in Item 301 of Reg. S-K comprise of data for each of the last five fiscal years (or for the life of the issuer and its predecessors, if shorter) and any interim period included in the financial statements (together with comparative information for the corresponding interim period of the prior year). These statements are compiled by management and are unaudited. The purpose of the selected financial data is to highlight certain significant trends in the registrant’s financial condition and results of operations. |
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act What is "Plain English"? Why is this concept important in an IPO? |
The Plain English rule requires that the
registration statement be written using the following English grammatical principles: active voice; short sentences; definite, concrete, everyday words; tabular presentations of financial information and other applicable data; bullet lists for complex and material data, whenever possible; avoidance of legal jargon; avoidance of highly technical business terms; and no multiple negatives.
This rule is important in an IPO so that all investors, both sophisticated and unsophisticated, can fully comprehend the contents of the RS and have a complete understanding of the risks of their investment. |
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MD&A Explain the analysis an issuer should conduct to determine if it should provide segment analysis in its disclosure. |
In determining if segment analysis is necessary, companies should look at: Revenues; Profitability; and Cash needs of its significant industry segments. If any segment contributes in a materially disproportionate way to the above three items; or discussion on a consolidated basis would present an incomplete and misleading picture of the company, then segment discussion should be included.
Determining if Something is a Segment Three components of an operating segment under SFAS No.131. A component of a business: (1) that engages in activities from which it may earn revenues and incur expenses; (2) whose operating results are regularly reviewed by the company’s “chief operating decision maker” to make decisions about resources to be allocated to the segment and assess its performance; and (3) for which discrete financial information is available. Determining whether an operating segment requires separate disclosure A company generally must report separately information about an operating segment that meets any of three thresholds: (a) Its reported revenue (including both sales to external customers and intersegment sales and transfers) is 10% or more of the combined revenue of all reported operating systems, whether generated inside or outside the company; (b) Its reported profit or loss is 10% or more of the greater of: (1) The combined reported profit of all operating segments that did not report a loss, or (2) The combined reported loss of all operating segments that did report a loss; or (c) Its assets are 10% or more of the combined assets of all operating segments. |
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(MD&A) What is the "Buried Facts" Doctrine? |
Disclosure could be considered to be false and misleading if the overall significance of a fact is obscured because it is “buried” within a disclosure document, such as in a footnote or appendix. This doctrine applies when a fact is hidden in a large document, or disclosed piecemeal such that an investor cannot understand the overall importance of the various facts which are interspersed throughout the disclosure document.
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(MD&A) Item 303 of Reg. S-K requires at least four major topic areas to be discussed in the Full Fiscal Years section of MD&A. Name and briefly discuss three of the four. |
The MD&A requirements are set forth in Rule 303 of Reg S-K.
Off-Balance Sheet Arrangements Must discuss, in a separately captioned section, the Issuer’s off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Issuer’s (i) financial condition, (ii) revenues or expenses, (iii) results of operations, (iv) liquidity, (v) capital expenditures or (vi) capital resources. Tabular Disclosure of Contractual Obligations: Information about contractual agreements and obligations of the issuer are often spread throughout the prospectus. This section requires the issuer to put them all in one place, so the reader of the prospectus has a complete understanding of potential creditors’ claims. Results of Business Operations. This section asks management to give its unique perspective on the drivers of the financial information set forth in the F-Pages. It covers the key factors that drive, risks that face, and specific historical events and transactions that affect both current and past indicators of performance. Thus, often, it involves a longitudinal comparison of performance over different periods and insight into why the numbers are as they are. Liquidity and Capital Resources. This section gives insight into the corporation’s ability to transform assets into cash as needed to fulfill business needs.
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Post-Closing Reporting Obligations and Requirements (Which Need to be Addressed, or at least Explained, to the Issuer, Pre-Filing) The CEO of the issuer will own 25% of the issuer's common stock after an IPO. List what filings the CEO will have to make under the Securities Exchange Act of 1934 going forward after the IPO is completed. |
13D Under Section 13(d), any person who acquires beneficial ownership of more than 5% of a class of an equity security registered pursuant to Section 12 must, within 10 days after such acquisition: (1) Send the Issuer of the security at its principal executive office a Schedule 13D; (2) Send to the securities exchange where the security is traded a Schedule 13D; and (3) File with the SEC a Schedule 13D.13G Not applicable in this situation because it is over 20% -- Schedule 13(G) -- Schedule 13G is shorter and requires less information from the filing party. To be able to file 13G instead of 13D, the party must own between 5% and 20% in the company. It must also be clearly understood that the party acquiring the stake in the company is only a passive investor and does not intend to exert control. If these criteria are not met, and if the size in the stake exceeds 20%, a 13D must be filed. Section 16(a) – Disclosure Requirement – This section requires each beneficial owner of more than 10% of a class of equity securities registered under Section 12 (however, securities of certain foreign private issuers are exempted), and each director or officer of the Issuer of such a security, to file statement of ownership reports. Reports that must be filed under Section 16
Form 3 – The initial statement of beneficial ownership on Form 3 must be filed within 10 days after a person becomes an insider. However, in an IPO, an insider must file a Form 3 no later than the date the registration statement becomes effective pursuant to section 12(g) or at the time of the registration of such security on a national securities exchange. Form 4 – The change in beneficial ownership on Form 4 must be filed before the end of the second business day following the day on which a transaction resulting in a change in beneficial ownership is executed. Certain exceptions apply. Form 5 – This year-end reconciliation on Form 5 must be filed within 45 days after the end of the Issuer’s fiscal year by any person who was an insider at any time during the fiscal year. Form 5 is used to report transactions that should have been previously reported on Form 4 or transactions for which deferred reporting is acceptable. |
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Post-Closing Reporting Obligations and Requirements (Which Need to be Addressed, or at least Explained, to the Issuer, Pre-Filing) State what the following forms are used for and give an example of the disclosure required by each of the following forms: Form 10-K, Form 10-Q, and For 8-K |
Form 10-K
Issuers that are subject to Section 13 or 15(d) of the 34 Act must file an annual report on Form 10-K. The Form 10-K disclosure requirements are based on the idea that there is a basic information package that most investors expect to be furnished. This must be filed annually with the SEC and contains detailed information about the Issuer’s business, finance, management, selected financial information, and audited financial statements. Form 10-Q Issuers subject to Section 13 or 15(d) of the 34 Act must file quarterly reports on Form 10-Q for each of the first three fiscal quarters of each fiscal year of the Issuer. This Form is meant to provide investors with information in a similar manner as Form 10-K, but on a quarterly basis. The Form consists of 2 parts, Part I– unaudited financial statements, MD&A, certain quantitative and qualitative disclosures about market risk, and disclosure controls and procedures. Part II – legal proceedings, unregistered sales of equity securities and use of proceeds, defaults upon senior securities, other information, and exhibits. Form 8-K With certain exceptions, every Issuer subject toSections 13 and 15(d) of the 34 Act must file current reports on Form 8-K when certain material events occur that a reasonable investor would deem important and would want to be informed about. Examples of material events include entry into a material definitive agreement, bankruptcy, and completion of an acquisition. |
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SEC Comment and Review What is an acceleration request and what is its purpose? For an underwritten offering like an IPO what parties will have to provide an acceleration request? |
When the Issuer and the Underwriters are ready, both the Issuer and the managing underwriters must ask the SEC to accelerate the effective date of the registration statement to a certain date and time.
Requests for acceleration are made by the Issuer and Underwriters in writing, or orally if the SEC allows it, provided that if made orally, a letter indicating that fact and stating that the Issuer and the Managing Underwriters are aware of their obligations under the 33 Act must accompany the registration statement (or a pre-effective amendment thereto) at the time of filing with the SEC. If such acceleration request asks the SEC to declare the registration statement effective at a particular day and time, the Issuer and Underwriters should advise the SEC to that effect no later than two business days (48 hours) before the day on which the Issuer/Underwriters want the registration statement to become effective – 48 hours is the time the SEC needs to internally process acceleration requests. FINRA will also need to call (or provide a letter to) the SEC staff to confirm that it has reviewed and expressed no objection to the underwriting compensation. The Issuer and the managing underwriters will ask the SEC for acceleration of both its 33 Act registration statement on Form S-1 and its 34 Act registration statement on Form 8-A. |
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SEC Comment and Review Briefly name the four possible levels of SEC staff review for a registration statement filed under the Securities Act of 1933. |
1) Deferred Review
2) Monitor 3) No review 4) Full Review |
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Introductory Class Describe a situation in which a private company that may not want to go public is forced to go public under the securities laws. Specify any relevant thresholds or tests that may apply to make the determination. |
Section 12(g) of the 34 Act mandates registration of securities with the SEC for issuers engaged in
interstate commerce with (1) assets exceeding $10 million and (2) a class of equity securities held of record by either (a) 2,000 persons or (b) 500 persons who are not accredited investors. The definition of “held of record” does not include securities held by persons who received those securities pursuant to an employee compensation plan in transactions exempt from registration under the Securities Act or those persons who purchased securities under Section 4(a)(6) (crowd funding). See Section 12(g)(1) of the 34 Act and Rule 12g-1.
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Introductory Class True or False: The lock-up period is a 180-day period after an IPO or other registered securities offering during which specified parties are prohibited by the securities laws from selling their shares unless the offer and sale of those shares is registered under the Securities Act. |
False. The time period, usually 180 days for IPOs, after an offering of securities when some party is restricted by a Lock-up Agreement with the Managing Underwriter from directly or indirectly selling, contracting to sell, pledging or otherwise transferring their shares without first receiving permission from the Managing Underwriter. Lock-ups are used for a variety of reasons, including preventing the sale of the Issuer’s securities from putting downward pressure on the trading price, and thereby decreasing shareholder value, by selling more shares to the general public in the near future.
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Introductory Class True or False: The difference between the opening trading price and the public offering price is the gross spread. |
False. The Gross Spread is the difference
between the price the Underwriters pay the Issuer and/or Selling Shareholders for each share of the Issuer’s stock and the price that the shares are offered to the public. The gross spread in smaller IPOs is often as high as 7%.
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Laws Relating to Securities Offerings Does a company doing an IPO have to disclose the name of its largest customer (largest based on revenue the company derives from that customer) in the registration statement? Why or why not? |
If the customer's identity is a material fact, then yes, the customer's name would have to be disclosed in the RS. The customer's identity would be a material fact if a reasonable investor would consider it important in making an investment decision. Basic v. Levinson. SCOTUS held that a fact is material if there is a substantial likelihood that the fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available. TSC Industries
Although the company derives more revenue from the customer than any other customer, if the amount of revenue derived is not a material amount of its total revenue, then it would not need to be disclosed. For example, if the customer only generated 2% of the company's revenue, while still being the largest revenue generator, its identity would likely not need to be disclosed in the RS. However, if the customer generated a larger portion of the company's revenue, such that it would account for a significant amount of the total revenue of the company, then the customer's name should be disclosed so that investors know where the company's revenue is coming from and can then research the customer to assure themselves that this revenue stream is likely to continue. |
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NYSE Listing True or False: A company listing shares of common stock on the NYSE in connection with its IPO must pay an NYSE listing fee that will cover all of the shares it is authorized (by its charter) to issue. |
False. Issuer only has to pay fees for the shares it is listing on the exchange. Listing Fees the first time an issuer lists a class of common shares are charged at a rate of $0.0032 per share. The first time that an issuer lists a class of common shares, the issuer is also subject to a one-time special charge of $50,000, in addition to fees calculated according to the Listing Fee schedule. Minimum and Maximum Listing Fees. The minimum and maximum Listing Fees applicable the first time an issuer lists a class of common shares are $125,000 and $250,000, respectively, which amounts include the special charge of $50,000.
Total shares are multiplied by .0032 + 50k special charge If the total falls between 125k and 250k, that number is your total If it’s outside that range, then 125k is the min, 250k is the max |
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NYSE Listing Assume a company with 50,000,000 shares of common stock outstanding is proposing to sell 50,000,000 primary and 20,000,000 secondary shares of common stock in its IPO. Does that company have to have an audit committee of the board of directors after the IPO is completed?Why or why not? |
If the company wants to be listed on a national securities exchange such as the NYSE, then yes, it must have an independent audit committee of the board of directors that satisfies the requirements of Rule 10A-3 of the Exchange Act.
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NYSE Listing Assume the same company in question (50,000,000 shares of common stock outstanding is proposing to sell 50,000,000 primary and 20,000,000 secondary shares of common stock in its IPO) completes its IPO (selling all of the shares it proposed to sell in that IPO), the 15% overallotment option is not exercised and the company’s common stock is listed on the NYSE. The company is now proposing to issue 15,000,000 primary shares of its common stock to shareholders of another company (“Target”) in exchange for all of the Target shareholders’ shares, in connection with the company’s acquisition of Target. Will the company have to obtain shareholder approval in connection with the acquisition transaction? Why or why not? |
Prior to the IPO, the company had 50 million shares outstanding and was offering 50 million primary and 20 million secondary shares in its upcoming IPO. Thus, post-IPO the company has 100 million shares outstanding. Therefore, because the 15 million is not more than 20% of the current outstanding stock of the company, Section 303A.08 of the NYSE Listing Standards do not require the company to obtain shareholder approval. However, if the company does not have 15 million non-outstanding shares authorized, then the shareholders would have to vote to increase the amount of shares the board can issue. |
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Laws Relating to Securities Offerings As issuer’s counsel, how would you respond to your client telling you that “there is no way we can put that fact in the offering document. If we do, no one will buy the stock!”? |
I would tell my client that although a particular fact or opinion may cast a negative light on the company, if the fact is material, then it must be disclosed in the offering document. For if it is not disclosed, then investors will have grounds to sue the company and recover their investment, which could cost the company billions of dollars. We would be subject to Section 11, 12(a)(2), and 10b-5 liability. The concept of materiality helps define what information must be included in the IPO prospectus. The prospectus must disclose all material required information, in addition to additional information that would be necessary to make that material required information not misleading. Information is material if a reasonable investor would consider the information important in making an investment decision. Stated differently, material information would alter the total mix of information available to the investor in a way that could influence his decision. See TSC Industries. |
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Laws Relating to Securities Offerings True or False: The safe harbor for forward looking statements contained in Section 27A of the Securities Act does not apply under any circumstances during the waiting period in connection with an IPO. |
True. Section 27A does NOT apply to statements made in connection with an initial public offering. See 27A(b)(2)(D). |
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Laws Relating to Securities Offerings True or False: A misstatement about a company’s earnings is not always material. |
True. The SEC has stated that misstatements regarding earnings information need to be carefully reviewed to determine if they are material, especially if the misstatement masks a change in earnings, hides a failure to meet expectations, changes a loss into income, or affects the issuer's compliance with regulatory or contractual requirements. However, earnings misstatements are still subject to the materiality threshold in that they are only material if there is a substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision or if it “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” to the shareholder.
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Publicity Issues Related to the Offering NYSE Rule 472. Communications With The Public. (Fill in the blanks) Position of Underwriter ----- Type of Offering ----- Research Report Restrictions Managing Underwriter /Co-Manager* ------ IPO --------- Must not distribute a research report (or make a public appearance regarding the issuer) for ____ calendar days following the date of the offering. Underwriter or dealer(other than Managing Underwriter or CoManager) ------ IPO ------ Must not distribute a research report (or make a public appearance regarding the issuer) for ____ calendar days following the date of the offering |
40 calendar days
25 calendar days |
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Publicity Issues Related to the Offering What five factors does the SEC examine to determine whether a statement by an issuer is part of the issuer’s selling effort, or is simply a legitimate business disclosure unrelated to the issuer’s securities offering? |
(1) The nature of the statement;
(2) The source of the statement; (3) How the statement is distributed; (4) The timing of the statement; and (5) The purpose and effect of the statement.
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Underwriters and Liabilities Assume that unbeknownst to the underwriters and anyone affiliated with the company, the company CFO lies to a few potential investors during the company’s IPO road show –whispering to those few potential investors that the company has a huge contract with the federal government that will cause the company’s sales to double in the next year, where the company in reality has no such contract. Under which sections of the federal securities laws could the Company be held liable for such statements. Securities Act Section 11 _____ (Yes or No) Securities Act Section 12(a)(1) _____ (Yes or No) Securities Act Section 12(a)(2) _____ (Yes or No) Securities Act Section 15 _____ (Yes or No) |
Section 11 - No Section 12(a)(1) - No Section 12(a)(2) - Yes Section 15 - No |
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Underwriters and Liabilities True or False: The federal securities laws do not prevent an issuer from filing a final IPO prospectus that differs from the preliminary IPO prospectus to reflect that the IPO priced within the offering range. |
True
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Underwriters and Liabilities What is “bring down” diligence and when is it conducted? |
Immediately prior to pricing, the underwriters will want to confirm that there has been no major developments causing the information in the Offering Document (i) to be materially misleading or (2) to have a material omission.
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Underwriters and Liabilities When is the earliest point at which an IPO Electronic Road Show may be used during the IPO process? (only check ONE answer) ____ After Effectiveness ____ At the Beginning of the Waiting Period ____ After the Red Herring Prospectus is Filed ____ Immediately After Pricing |
After the Red Herring Prospectus is filed (I believe this is the case because it needs a price range)
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Underwriters and Liabilities Does the IPO Electronic Road Show have to be filed with the SEC? Why/why not? |
Road shows that do not originate live, in real-time to a live audience and are graphically transmitted are electronic road shows that will be considered written communications and, therefore, free writing prospectuses. Road Shows for securities offerings that are written communications are Free Writing Prospectuses.
In the case of a Road Show that is a written communication for a company not registered with the SEC, such as a company conducting its initial public offering, the Road Show must be filed with the SEC unless the issuer makes available to the public without restriction at least one version of a “bona fide electronic road show” by means of graphic communication. |
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Underwriting Agreements and The Agreement Among Underwriters eToys Fiduciary Duty Disclaimer – What is it? |
“No Fiduciary Duty. The Company acknowledges and agrees that in connection with this offering, sale of the Stock, or any other services the Underwriters may be deemed to be providing
hereunder, notwithstanding any preexisting relationship, advisory or otherwise, between the parties or any oral representations or assurances previously or subsequently made by the Underwriters: (i) no fiduciary or agency relationship between the Company and any other person, on the one hand, and the Underwriters, on the other, exists; (ii) the Underwriters are not acting as advisors, expert or otherwise, to the Company, including, without limitation, with respect to the determination of the public offering price of the Stock, and such relationship between the Company, on the one hand, and the Underwriters, on the other, is entirely and solely commercial, based on arms-length negotiations; (iii) any duties and obligations that the Underwriters may have to the Company shall be limited to those duties and obligations specifically stated herein; and (iv) the Underwriters and their respective affiliates may have interests that differ from those of the Company. The Company hereby waives any claims that the Company may have against the Underwriters with respect to any breach of fiduciary duty in connection with this offering.”
As a fiduciary, an underwriter would be obligated to act in the issuer’s best interest and would owe a heightened level of care and loyalty. Alternatively, if, as the New York appellate court held, an underwriter is merely the issuer’s advisor, then the obligations of the underwriter are purely contractual, resulting in a higher threshold for potential liability in the event of a dispute. |
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The Financials Financial Terminology – Define the following terms: Accounts receivable Accrual basis accounting Liquidity Pro forma |
Accounts receivable – Money which is owed to a company by a customer for products and
services provided on credit. This is treated as a current asset on the balance sheet as long as it is expected to be collectible within one year.
Accrual basis accounting – The most commonly used accounting method, which reports (i) income when earned and (ii) expenses when incurred; as opposed to cash basis accounting, which reports (i) income when received and (ii) expenses when paid. Under the accrual method, a company has some discretion as to when income and expenses are recognized, but there are rules governing the recognition. In addition, a company must be prudent in its accounting estimates. Liquidity - The ability of a company to convert assets into cash in a short period of time without significant loss. The proportion of cash or cash equivalents in a company’s assets. Sometimes used as a measure of the near term financial health of a company. Pro forma – Description of financial statements that have one or more assumptions or hypothetical conditions built into the data. Often used with balance sheets and income statements. Example – Pro forma financial information showing what the combined balance sheet and income statement of two merging companies would look like in order to assist investors in analyzing the future prospects of the combined company. See Article 11 of Reg S-X for rules on presenting pro forma information. |
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The Financials Regulation S-X – Fill in the table with the appropriate number of years for an IPO Financial Statement Regulation S-X (3-01, 3-02, 3-04) Balance Sheet __ years Income Statement __ years Stockholders’ Equity __ years Cash Flow __ years |
Balance Sheet 2 years
Income Statement 3 years Stockholders’ Equity 3 years Cash Flow 3 years NOTE – For Emerging Growth Companies only two years of each type of audited financial statement are required.
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Accounting Issues and Comfort Letters Explain the difference between GAAP and GAAS? |
GAAP are the Generally Accepted Accounting Principles, which are the rules that a company must follow when preparing its financial statements and recording the financial effect of various business transactions. These rules are created by a body known as the Financial Accounting Standards Board (“FASB”). GAAP encompasses various conventions, rules, and procedures that accountants follow. GAAP is concerned with the measurement of economic activity, the time when such measurements are made and recorded, the disclosure surrounding these activities, and the preparation and presentations of summarized economic information in the form of financial statements.
GAAS is no longer in use for issuers in the US. Instead, US issuers now use the PCAOB Auditing Standards. GAAS is the Generally Accepted Auditing Standards. GAAS governs the conduct of public accounting firms’ audits of public companies. GAAS is a set of systematic guidelines used by auditors when conducting an audit of an Issuer’s financial statements, ensuring the accuracy, consistency and verifiability of accounting firms’ actions and reports.
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Accounting Issues and Comfort Letters What is an adverse opinion? |
Auditor's Opinion: An auditor’s opinion regarding whether the financial statements fairly present the company’s financial position, results of operation, and cash flow in conformity with GAAP.
An adverse opinion is an opinion in which the auditor opines that the financial statements do not present fairly the financial position, results of operations, or cash flows of a company in conformity with GAAP.
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Accounting Issues and Comfort Letters What is “channel stuffing?” |
Channel stuffing is an accounting trick whereby the company provides incentives for a purchaser of its products to acquire more than it needs in a particular accounting period. A company may do this to improve its revenues during a bad time, thus smoothing its income over the course of market fluctuations.
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Risk Factors (1) Name the three broad categories that risk factors loosely fall into. |
Industry Risk – risks companies face by virtue of the industry they’re in. For example, many REITs run the risk that, despite due diligence, they will acquire properties with significant environmental issues.
Company Risk – risks that are specific to the company. For example, a REIT owns four properties with significant environmental issues and cleaning up these properties will be a serious financial drain. Investment Risk – risks that are specifically tied to a security. For example, in a debt offering, the debt being offered is the most junior subordinated debt of the company.
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Risk Factors (1) Is it acceptable to include countervailing considerations in the Risk Factors section? Why or why not? |
No, issuers should not include countervailing considerations explaining what the company has done to mitigate the risk because it greatly diminishes, if not completely erodes, the value of the warning that the risk factor is meant to convey.
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Risk Factors (1) Once a company has completed its IPO, does a company have to include risk factors in 34 Act filings? If so, which filings? |
Yes, in companies' annual reports on Form 10-K and periodic reports on Form 10-Q.
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Law Firm Opinions and Letters What does “negative assurances” in an IPO legal opinion refer to? |
"Negative assurance” that neither the registration statement nor the prospectus contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. It helps the Underwriters to establish their due diligencedefense under sections 11 and 12 of the 33 Act.
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Law Firm Opinions and Letters True or False: In a common stock firm commitment IPO, a legal opinion is always required by SEC rules and regulations. |
True. Reg S-K, Item 601(a)(1) indicates that an opinion of counsel specified in Reg S-K, Item 601(b)(5) is required as an exhibit to any of the registration statement forms provided under the 33 Act. Reg S-K, Item 601(b)(5)(i) states in part the requirement for: “[a]n opinion of counsel as to the legality of the securities being registered, indicating whether they will, when sold, be legally issued, fully paid and non-assessable.”
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act True or False: Projections of future economic performance are required in the IPO prospectus. |
False. The SEC encourages the use of projections of future economic performance “that have a reasonable basis and are presented in an appropriate format.” Most Issuers do not, and should not, use projections in their IPO registration statements.
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act Rule 406 deals with confidential treatment of information filed with the SEC. Briefly explain what this rule allows. |
Rule 406 details the procedure for asking for confidential treatment for information submitted in a document required to be filed under the 33 Act. Examples of confidential treatment requests include corporate secrets, such as technical specifications (e.g., the recipe for Coca Cola or the processes or the designs of BMW engines) or specific sensitive pricing terms in contracts (i.e., how much Company A charges Company B for product C).
Issuers should identify early in the IPO preparation process those documents (or critical parts of certain documents) that the Issuer wishes to keep private and make a confidential treatment request for such material to the SEC on the same date as the initial filing of the registration statement. The information in the request cannot be material and the Issuer must show why there would be competitive harm if the information were disclosed. The issuer must file the exhibit with the RS and redact the confidential information. The issuer must also prepare and file with the Secretary's office of the SEC the confidential request and include both the redacted and unredacted versions.
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act True or False: In an IPO, a company cannot register the sale of additional securities on the registration statement after the registration statement is declared effective. |
Kind of both. Rule 413 states that a separate registration statement is required when registering additional securities of the same class as other securities for which a registration statement is already effective.
Rule 462(b) permits the registration of additional shares in the same offering by filing an abbreviated registration statement that incorporates the original one by reference. This abbreviated registration statement may be filed after the original registration statement is declared effective and may register an increase in the offering size of up to 20%. It becomes effective immediately upon filing and does not require any SEC review or action. Have to file a 462 RS on Form S-1 and reference the original RS, a signature page, a legal opinion, and a new accountant’s consent. This acts as a new RS to get the additional 20% of shares. Then file under 424 a final prospectus for all of the shares. You can only use 462(b) before confirmations of sale have been sent (basically cannot have any sales before we do this). Usually this is the night of effectiveness when this happens. |
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(MD&A) True or False: Reg S-K, Item 303 requires at least the following four topics to be covered in the Full Fiscal Years section: Results of Operations; Liquidity and Capital Resources; Off-Balance Sheet Arrangements; and Tabular Disclosure of Contractual Obligations |
True.
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(MD&A) Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments – the first of which is whether it is likely to come to fruition, and if it determines it is not reasonably likely to occur, no disclosure is required. The second assessment regards what, if any, disclosure obligations exist if management cannot make that first determination. If in fact management cannot make that first determination, management must then make what assumption and determination to decide whether disclosure is required? |
If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.
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(MD&A) Explain the buried facts doctrine |
Disclosure could be considered to be false and misleading if the overall significance of a fact is obscured because it is “buried” within a disclosure document, such as in a footnote or
appendix.
Disclosure could be deemed inadequate if it is presented in a way that conceals or obscures the information sought to be disclosed. This doctrine applies when a fact is hidden in a large document, or disclosed piecemeal such that an investor cannot understand the overall importance of the various facts which are interspersed throughout the disclosure document. |
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Post-Closing Reporting Obligations and Requirements What are Form 10-Q reports, when do they have to be filed, and what type of financial statements, if any, must they contain? |
Issuers subject to Section 13 or 15(d) of the 34 Act must file quarterly reports on Form 10-Q for each of the first three fiscal quarters of each fiscal year of the Issuer. The Form 10-Q disclosure requirements are based on the idea that there is a basic information package that most investors expect to be furnished. The Form consists of 2 parts, Part I– unaudited financial statements, MD&A, certain quantitative and qualitative disclosures about market risk, and disclosure controls and procedures. Part II – legal proceedings, unregistered sales of equity securities and use of proceeds, defaults upon senior securities, other information, and exhibits.
Deadline for filing: for large accelerated filers and accelerated filers, 40 days after the end of each of the first three fiscal quarters of the year, 45 days for all other registrants. |
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Post-Closing Reporting Obligations and Requirements What three types of persons (insiders) must file with the SEC Forms 3 under Exchange Act Section 16 immediately after the IPO? |
Issuer’s officers, directors, and beneficial owners of more than 10% of a class of equity securities registered under Section 12
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Post-Closing Reporting Obligations and Requirements After the IPO, the CFO presents a report to a small group of research analysts. What disclosure obligations should the company consider in connection with presentation? |
Reg. FD
Regulation FD prohibits issuers from selectively disclosing material nonpublic information to certain persons –securities analysts, broker-dealers, investment advisers and institutional investors – before disclosing the same information to the public. Whenever an Issuer, or any person acting on its behalf, discloses any material nonpublic information regarding that Issuer or its securities to any person described in paragraph (b)(1) of this Rule 100, the Issuer shall make public disclosure of that information as provided in Regulation FDRule 101(e): Simultaneously, in the case of an intentional disclosure; and Promptly, in the case of a non-intentional disclosure. (Per Rule 101 (d), “Promptly” means as soon as reasonably practicable but in no event after the later of 24 hours or the commencement of the next day’s trading on the NYSE) |
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SEC Comment and Review What is an acceleration request and what is its purpose? For an underwritten offering like our IPO, what parties will have to provide an acceleration request? |
When the Issuer and the Underwriters are ready, both the Issuer and the managing underwriters must ask the SEC to accelerate the effective date of the registration statement to a certain date and time.
Requests for acceleration are made by the Issuer and Underwriters in writing, or orally if the SEC allows it, provided that if made orally, a letter indicating that fact and stating that the Issuer and the Managing Underwriters are aware of their obligations under the 33 Act must accompany the registration statement (or a pre-effective amendment thereto) at the time of filing with the SEC. If such acceleration request asks the SEC to declare the registration statement effective at a particular day and time, the Issuer and Underwriters should advise the SEC to that effect no later than two business days (48 hours) before the day on which the Issuer/Underwriters want the registration statement to become effective – 48 hours is the time the SEC needs to internally process acceleration requests. FINRA will also need to call (or provide a letter to) the SEC staff to confirm that it has reviewed and expressed no objection to the underwriting compensation. The Issuer and the managing underwriters will ask the SEC for acceleration of both its 33 Act registration statement on Form S-1 and its 34 Act registration statement on Form 8-A.
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SEC Comment and Review What if we disagree with the SEC staff comments? Can we argue against such comments, or do we have to comply with all comments, even the ones we disagree with? |
There are 2 types of SEC comments: (1) request for supplemental information and (2) "advise or revise." It may take further convincing, either in writing or orally, to convince the staff of the SEC that the Issuer’s position is correct. All SEC staff comments must be resolved before the SEC will declare the registration statement effective.
If the Issuer chooses to dispute a comment, a well-thought out, detailed answer should be carefully crafted, citing appropriate precedent if available, and the SEC staff should be provided ample data and other information needed for the SEC staff to make a decision whether or not to waive the comment. |
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SEC Comment and Review Do we need to worry about what we say in our written response letters to the SEC staff comments? Will anyone in the public, or our competitors, be able to see our responses? |
In mid-2004, the SEC changed its prior policy and decided to make all SEC comment letters and responses to those letters available to the public without a FOIA (Freedom of Information Act) request. Beginning on May 12, 2005, the SEC made public comment letters and response letters relating to disclosure filings made after August 1, 2004, that had been reviewed by the Division of Corporation Finance and the Division of Investment Management. Issuers and their counsel must therefore understand that their correspondence with the SEC will now be more open to public scrutiny.
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Introductory Class A company with a fiscal year that ends on December 31 each year had $1.2 billion of revenue for the year ended December 31, 2011, and $900 million of revenue for the year ended December 31, 2012. It wants to sell common stock in an IPO in 2013. Can the company take advantage of the Draft Registration Statement / Confidential Submission procedure under the Securities Act in connection with its 2013 IPO? Briefly explain why or why not, and what other information you would need, if any, to make this determination. |
Confidential Submission (or Draft Registration Statement “DRS”) - An Emerging Growth Company (EGC) is permitted to confidentially submit drafts of its IPO registration statement to the SEC and the SEC staff confidentially reviews and comments on them. Confidential submissions are not considered “filed” and therefore do not start the waiting period. A registration statement and all DRSs must actually be filed (publicly) not later than 21 days prior to the start of the Road Show for the offering.
Emerging Growth Company (“EGC”) – An issuer with total annual gross revenues of less than $1 billion, computed as of the last day of its most recently completed fiscal year. An EGC retains that status until the earlier of: (i) the last day of the fiscal year in which the issuer had $1 billion or more in annual gross revenues; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s registered initial public offering of common equity securities; (iii) the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt securities; and (iv) the date on which the issuer is deemed to be a “large accelerated filer.” Here, the issuer would have to be an EGC to take advantage of the Confidential Submission Process. The issuer satisfies the first requirement in that it did not have at least $1 billion in revenue in its most recent fiscal year. However, we would need to know whether the issuer has issued, during the previous 3-year period, more than $1 billion in non-convertible debt securities. |
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Introductory Class True or False: There is no legal requirement to include an overallotment option as part of an IPO. |
True.
Green Shoe – The “over-allotment” option (often referred to as the “Green Shoe” after the first company to use it) gives the Managing Underwriter on behalf of the underwriting syndicate the option to buy additional shares from the Issuer and/or Selling Shareholder (typically up to 15% of the total offering size) at the same price as the other shares purchased by the underwriters. The Green Shoe is typically used if the offering is extremely popular or was overbooked (i.e., oversold) by the Underwriters. The Green Shoe is a tool by which the Managing Underwriter can support an offering’s success by over-allotting the offering and filling those over-allotments with stock acquired in the aftermarket or by way of its over-allotment option. The Green Shoe provides the Managing Underwriter with additional buying power after the offering is declared effective.
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Laws Relating to Securities Offerings What is the Investment Company Act of 1940 and why is it important to consider when doing a 33 Act offering? |
The Investment Company Act of 1940 regulates companies that are primarily engaged in investing, reinvesting and trading in securities. The 40 Act is important to consider during an IPO because if an issuer is an investment company, then for all practical purposes it cannot engage in a securities offering without registering under the Investment Company Act of 1940.
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Laws Relating to Securities Offerings Name four types of information or events that need to be reviewed carefully to determine if they are material according to the SEC, as stated in the Regulation FD release we discussed in class. |
Earnings information;
Mergers, acquisitions, tender offers, joint ventures, or changes in assets; New products or discoveries, or developments regarding customers or suppliers (e.g., the acquisition or loss of a contract); Changes in control or in management; Change in auditors or auditor notification that the Issuer may no longer rely on an auditor’s audit report; Events regarding the Issuer’s securities -- e.g., defaults on senior securities, calls of securities for redemption, repurchase plans, stock splits or changes in dividends, changes to the rights of security holders, public or private sales of additional securities; and Bankruptcies or receiverships.
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Laws Relating to Securities Offerings A client calls and says the company has just been sued for $1 billion and wants to know if that it is material. What information will you need to know to make that determination? |
I will need to know several things. First, I will need to know the basis of the lawsuit (i.e., whether we are being suing for patent infringement on a patent that is integral to our business). Second, I will need to know how likely it is that we will lose the lawsuit. In other words, I will need to know if the plaintiffs have a colorable claim. If a frivolous lawsuit is being brought against our company that has no merit, then it is unlikely to be material because it is unlikely that a reasonable investor would consider such an irrelevant fact when determining whether to invest in the company. Further, a lawsuit without merit would not alter the total mix of information provided to the investor regarding the investment.
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NYSE Listing The NYSE listing application requires the company filing it to provide: A copy of the corporate charter with all amendments, certified by ___________________; and A copy of the corporate by-laws with all amendments, certified by ___________________. |
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NYSE Listing True or False: A company that is majority owned by stockholders (who are not affiliates of the company) that is listed on the NYSE is required to have a majority of its directors be independent directors, and only independent directors on its audit committee. |
True.
NYSE Listed Company Manual, Item 303A.01 Independent Directors: Listed companies must have a majority of independent directors.
Item 303A.06 Audit Committee: Listed companies must have an audit committee that satisfies the Requirements of Rule 10A-3 under the Exchange Act. 10A-3 requires audit committees to be completely independent. Item 303A.07 Audit Committee Additional Requirements: In addition to any requirement of Rule 10A-3(b)(1), all audit committee members must satisfy the requirements for independence set out in Section 303A.02. |
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Publicity Issues Related to the Offering True or False: “Test-the-waters” communications are not offers under the Securities Act. |
False. EGCs or their authorized persons can engage in oral or written communications with QIBs and accredited institutions in order to “test-the-waters” before or after the filing of any Securities Act registration statement filed by an EGC.
However, these communications may be deemed “offers” under the Securities Act. In connection with these communications liability would attach under Section 12(a)(2) and the anti-fraud provisions of the federal securities laws would apply.
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Laws relating to Securities Offerings True or False: Under the JOBs Act, there are no restrictions on research following an IPO of a domestic issuer. |
The JOBS Act only removes the restrictions on research reports following IPOs of EGCs.
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Laws relating to Securities Offerings At what point in the IPO process may an issuer use a free writing prospectus? |
In the case of an IPO issuer, a “statutory
prospectus” must proceed or accompany the Free Writing Prospectus. A statutory prospectus must include a price range, and therefore IPO issuers will effectively not be able to use a Free Writing Prospectus, at least until the price range is added into the prospectus. Also, this only occurs after the Prospectus has been filed with the SEC; that is, the waiting period.
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Underwriters and Liabilities What are the four types of due diligence request lists? |
Documentary
This is a list of documents that the underwriter and its counsel would like to examine. It usually includes documents such as the articles of incorporation, loan agreements, documents (if any) filed recently with the SEC (other than those publicly available), reports and communications sent to shareholders, material contracts, information regarding material litigation and various other documents. It should be individually tailored to the Issuer, but not too narrow so as to miss possibly important pieces of information. The Issuer will normally compile copies of the relevant documents in a real or virtual data room for the working group to examine. Management This is a list of questions which the underwriters and their counsel would like management to address in detail in order to better understand the Issuer. It usually includes subjects covering areas such as the company’s operations, strategy, financial situation, prospects for the future (including trends), accounting issues, management, employees, and legal and regulatory issues. The questions will normally be answered orally during a management due diligence session in which most members of the working group will attend. Oral Q&A allows for follow-up questions if answers are not clear or new issues are raised. Auditor The underwriters will want to question the Issuer’s accountants without the presence of management to ask some specific questions about the Issuer’s finances. Remember, other than the Issuer itself, the Issuer’s accountants are the best source of financial information about the Issuer as they are responsible for auditing such information. Bring-Down Immediately prior to pricing, the underwriters will want to confirm that there has been no major developments causing the information in the Offering Document (1) to be materially misleading or (2) to have a material omission. |
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Underwriters and Liabilities True or False: slides projected on to a television screen used as part of a roadshow are “writings” under the Securities Act. |
False. The slideshow presentation is considered to be an “oral” presentation as it probably does not have a greater impact than an oral statement, and is thus permissible. Written offers are more tangible and can have a greater impact on a prospective investor than oral offers which have less of the permanence of something that appears in writing.
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Underwriters and Liabilities What is the only document that should be handed out at the Road Show? |
The only written document that should be handed out at the Road Show presentation is the Preliminary Prospectus (which has already been filed as part of the Registration Statement with the SEC), and any documents which are incorporated by reference. Annual reports, catalogues and other written materials should not be distributed.
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Underwriters and Liabilities Under Section 11 of the Securities Act, does the issuer have a due diligence defense? Why or why not? |
The issuer does not have a due diligence defense because it is presumed to know everything about itself. Because the issuer is in the best position to give complete and accurate information about itself, it is generally incentivized to ensure that this information is properly cultivated and shared, for example through all the provisions requiring disclosure of internal controls (ex: SOX 302).
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Underwriters and Liabilities Assume that unbeknownst to the company, the lead underwriter lies to a few potential investors during the company’s IPO road show – whispering to those few potential investors that the company has a huge contract with the federal government that will cause the company’s sales to double in the next year, where the company in reality has no such contract. Under which sections of the federal securities laws could the lead underwriter be held liable for such statements. Securities Act Section 11 Y/N Securities Act Section 12(a)(1) Y/N Securities Act Section 12(a)(2) Y/N Exchange Act Section 10(b) and Rule 10b-5 Y/N |
Securities Act Section 11 - No
Securities Act Section 12(a)(1) - No Securities Act Section 12(a)(2) - Yes Exchange Act Section 10(b) and Rule 10b-5 - Yes
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Underwriting Agreements and The Agreement Among Underwriters Most underwriting agreements will state that the various underwriters’ obligations to purchase shares is “several and not joint.” Why is this the case? |
Several and not joint: meaning that each underwriter is only accountable to purchase an agreed to amount of shares, not the entire amount of shares being offered.
If the purchase obligation was “joint”, then this would have important effects on the net capital requirements of each underwriter participating in the offering. Therefore, to minimize the amount charged against an underwriter’s net capital, the commitments are several. Section 11(e) of the 33 Act – Liability is limited to the price at which the securities underwritten by each underwriter were distributed to the public. If each underwriter was jointly liable for the entire offering amount, then the underwriters would not get the protection of this hold-down provision. |
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Underwriting Agreements and The Agreement Among Underwriters How do the reps and warranties help the underwriters in performing their due diligence? |
The reps and warranties help the Issuer to focus on potential problem areas and areas which the Underwriters believe may require disclosure in the offering document.
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The Financials Financial Terminology – Define the following terms: Cash basis accounting Capitalize Liability Working Capital |
Cash basis accounting: The bookkeeping practice of recording sales and expenses only when cash is actually received or paid out, as opposed to accrual basis. Generally cash basis bookkeeping is simpler than accrual basis bookkeeping.
Capitalize: To classify a cost as a long-term investment, rather than charging it to current operations as an expense. A capitalized cost does not appear on the income statement, but instead appears as a debit in the long-term assets account and a credit on the cash account of the balance sheet. By “capitalizing” a cost rather than expensing it immediately, the timing of expense recognition is changed (i.e., delayed), but eventually all expenses will be recognized on the income statement. Liability: A financial obligation, debt, claim, or potential loss. Examples of liabilities are accounts payable, short and long term debt, and income taxes payable. Working Capital: The capital of a business that is used in its day-to-day operations, calculated as the current assets minus the current liabilities. |
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The Financials What are the three principal financial statements for external reporting? |
Balance Sheet
Income Statement Statement of Cash Flows |
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The Financials Regulation S-X – Fill in the table with the appropriate number of years for an emerging growth company: Balance Sheet __ years Income Statement __ years |
2 years
2 years |
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Accounting Issues and Comfort Letters Who prepares a company’s financial statements? Who performs the audit? |
Preparation of financial statements – The management of a company is primarily responsible for the preparation and accuracy of its financial statements and related disclosures documents. A company’s internal accountants compile and prepare the financial statements.
Audit of financial statements – After the company and its internal accountants have prepared the financial statements and related disclosure documents, then the outside independent auditor performs its audit, providing a written opinion as to whether the financial statements are fairly stated and comply in all material respects with GAAP.
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Law Firm Opinions and Letters True or False: In a common stock firm commitment IPO, the legal opinion to the company required by Item 601(b)(5) of Regulation S-K is filed with the SEC but is not part of the prospectus. |
True. It is not part of the prospectus. Instead, it is filed as an Exhibit to the RS.
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Law Firm Opinions and Letters True or False: In a common stock firm commitment IPO, the legal opinion of issuer’s counsel required by the underwriting agreement is filed with the SEC after the registration is effective. |
False. I don't think these opinions are filed with SEC at all.
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Law Firm Opinions and Letters True or False: Negative assurances are given by the auditors to issuer’s counsel in connection with the legal opinions issuer’s counsel gives in an IPO. |
False. The legal opinions do not give negative assurance as to any of the financial statements. And the negative assurance provided by auditors is given to the UWs not issuer's counsel.
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Risk Factors (1) True or False: The prospectus summary should not contain any risk factor disclosure, as risk factor disclosure immediately follows the prospectus summary. |
False. The summarysection should provide a brief, but balanceddescription of the key aspects of the companyas of the latest practicable date. The summary should also discuss any negativeaspects of the company’s experience, strategyand prospects. For example, you shouldinclude disclosure discussing the risks involvedin an aggressive growth strategy.
Item 503(c) of Reg. S-K does not contain a requirement that the summary must include a summary of the risk factors. |
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act What does Regulation S-K contain and what is the relationship between Regulation S-K and Form S-1? |
The Form S-1 is used for registration under the 33 Act of securities of all registrants for which no other form is authorized or prescribed, except that it is not used for securities of foreign governments. Form S-1 itself is only a few pages long because the detailed disclosure it requires is found in Regulation S-K, to which Form S-1 references. Reg S-K contains the requirements for the non-financial parts of the Form S-1.
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(MD&A) What is an operating segment? What disclosure is required for companies that have more than one operating segment? |
In determining if segment analysis is necessary, companies should look at: Revenues; Profitability; and Cash needs of its significant industry segments. If any segment contributes in a materially disproportionate way to the above three items; or discussion on a consolidated basis would present an incomplete and misleading picture of the company, then segment discussion should be included.
Determining if Something is a Segment Three components of an operating segment under SFAS No. 131. A component of a business: (1) that engages in activities from which it may earn revenues and incur expenses; (2) whose operating results are regularly reviewed by the company’s “chief operating decision maker” to make decisions about resources to be allocated to the segment and assess its performance; and (3) for which discrete financial information is available. Determining whether an operating segment requires separate disclosure A company generally must report separately information about an operating segment that meets any of three thresholds: (a) Its reported revenue (including both sales to external customers and intersegment sales and transfers) is 10% or more of the combined revenue of all reported operating systems, whether generated inside or outside the company; (b) Its reported profit or loss is 10% or more of the greater of: (1) The combined reported profit of all operating segments that did not report a loss, or (2) The combined reported loss of all operating segments that did report a loss; or (c) Its assets are 10% or more of the combined assets of all operating segments.
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Post-Closing Reporting Obligations and Requirements What is Form ID? What is it used for? |
Prior to submitting documents to the SEC’s EDGAR system, an Issuer needs to register with the SEC in order to obtain EDGAR access codes. This is accomplished by completing and submitting a Form ID to the SEC electronically. Upon
approval of the Form ID, the Issuer will be permitted to create the required filing codes. These codes enable the Issuer to submit documents to the SEC via EDGAR.
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Post-Closing Reporting Obligations and Requirements What does Rule 12b-20 call for and what is the relationship with what it calls for and the disclosure requirements of Form 10-K? |
Rule 12b-20 – “In addition to the information expressly required to be included in a registration statement, there shall be added such further material information, if any, as may be necessary to make the required statements, in the light of the circumstances under which they are made, not misleading.”
Rule 12b-20 calls for the disclosure of additional information as needed to make the information already included in the Form 10-K not misleading. As such, it supplements the required disclosures of Form 10-K with necessary contextual information that is not otherwise required. |
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Introductory Class You represent an emerging growth company that has filed a draft registration with the SEC and received and responded to several rounds of SEC comments. The lead underwriter tells you they want to start the roadshow on June 26. What must be filed with the SEC and by when at the latest, so that the issuer may begin the roadshow on June 26? |
A registration statement and all Draft RSs must actually be filed (publicly) not later than 21 days prior to the start of the Road Show for the offering.
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SEC Comment and Review What is a request for acceleration, and in an IPO which parties submit these requests to the SEC. |
When the Issuer and the Underwriters are ready, both theIssuer and the managing underwriters must ask the SEC toaccelerate the effective date of the registration statement toa certain date and time.
Requests for acceleration are made by the Issuer andUnderwriters in writing, or orally if the SEC allows it,provided that if made orally, a letter indicating that fact andstating that the Issuer and the Managing Underwriters areaware of their obligations under the 33 Act mustaccompany the registration statement (or a pre-effectiveamendment thereto) at the time of filing with the SEC. If such acceleration request asks the SEC to declarethe registration statement effective at a particularday and time, the Issuer and Underwriters shouldadvise the SEC to that effect no later than twobusiness days (48 hours) before the day on whichthe Issuer/Underwriters want the registrationstatement to become effective – 48 hours is the timethe SEC needs to internally process accelerationrequests.
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SEC Comment and Review True or False: Issuers need to be very careful about what information they include in their response letters to SEC comment letters, because those letters will be made public during the SEC review process. |
In mid-2004, the SEC changed its prior policy and decided to make all SEC comment letter and responses to those letters available to the public without a FOIA (Freedom of Information Act) request. Beginning on May 12, 2005, the SEC made public comment letters and response letters relating to disclosure filings made after August 1, 2004, that had been reviewed by the Division of Corporation Finance and the Division of Investment Management. Issuers and their counsel must therefore understand that their correspondence with the SEC will now be more open to public scrutiny.
However, the Division of Corporation Finance makes this correspondence public no earlier than20 business days after it has declared a registration statement effective. |
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Post-Closing Reporting Obligations and Requirements Briefly describe the purpose of each of the following forms: Form 10-K, Form 10-Q and Form 8-K. |
Form 10-K
Issuers that are subject to Section 13 or 15(d) of the 34 Act must file an annual report on Form 10-K. The Form 10-K disclosure requirements are based on the idea that there is a basic information package that most investors expect to be furnished. This must be filed annually with the SEC and contains detailed information about the Issuer’s business, finance, management, selected financial information, and audited financial statements. Form 10-Q Issuers subject to Section 13 or 15(d) of the 34 Act must file quarterly reports on Form 10-Q for each of the first three fiscal quarters of each fiscal year of the Issuer. This Form is meant to provide investors with information in a similar manner as Form 10-K, but on a quarterly basis. The Form consists of 2 parts, Part I– unaudited financial statements, MD&A, certain quantitative and qualitative disclosures about market risk, and disclosure controls and procedures. Part II – legal proceedings, unregistered sales of equity securities and use of proceeds, defaults upon senior securities, other information, and exhibits. With certain exceptions, every Issuer subject toSections 13 and 15(d) of the 34 Act must file current reports on Form 8-K when certain material events occur that a reasonable investor would deem important and would want to be informed about. Examples of material events include entry into a material definitive agreement, bankruptcy, and completion of an acquisition.
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Registering under the 33 Act on Form S-1, Form Checks and Registering under the 34 Act What is “Plain English”? Why is this concept important in an IPO? |
The Plain English Rule 421 requires that the registration statement be written using the following English grammatical principles: active voice; short sentences; definite, concrete, everyday words; tabular presentations of financial information and other applicable data; bullet lists for complex and material data, whenever possible; avoidance of legal jargon; avoidance of highly technical business terms; and no multiple negatives.
This rule is important in an IPO so that all investors, both sophisticated and unsophisticated, can fully comprehend the contents of the RS and have a complete understanding of the risks of their investment.
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Introductory Class Describe a situation in which a private company may not want to go public, but is forced to go public under the federal securities laws. Specify any relevant thresholds or tests that may apply to make the determination. |
Section 12(g) of the 34 Act mandates registration of securities with the SEC for issuers engaged in
interstate commerce with (1) assets exceeding $10 million and (2) a class of equity securities held of record by either (a) 2,000 persons or (b) 500 persons who are not accredited investors. The definition of “held of record” does not include securities held by persons who received those securities pursuant to an employee compensation plan in transactions exempt from registration under the Securities Act or those persons who purchased securities under Section 4(a)(6) (crowd funding). See Section 12(g)(1) of the 34 Act and Rule 12g-1.
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Introductory Class The Fritter CFO wants to know if Fritter is an emerging growth company (EGC). Answer and explain. |
Emerging Growth Company (“EGC”) – An issuer with total annual gross revenues of less than $1 billion, computed as of the last day of its most recently completed fiscal year. An EGC retains that status until the earlier of: (i) the last day of the fiscal year in which the issuer had $1 billion or more in annual gross revenues; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s registered initial public offering of common equity securities; (iii) the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt securities; and (iv) the date on which the issuer is deemed to be a “large accelerated filer.”
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Introductory Class The Fritter CEO says that other than scaled back disclosure requirements (e.g., fewer years of financial statements), she has heard there are a couple accommodations/benefits the company can take advantage of if it is an EGC that do not apply if the company is not an EGC. What are those two benefits and explain them briefly (they were mentioned in class several times)? |
Confidential Submission (or Draft Registration Statement “DRS”) - An Emerging Growth Company (EGC) is permitted to confidentially submit drafts of its IPO registration statement to the SEC and the SEC staff confidentially reviews and comments on them. Confidential submissions are not considered “filed” and therefore do not start the waiting period. A registration statement and all DRSs must actually be filed (publicly) not later than 21 days prior to the start of the Road Show for the offering.
Test-the-Waters Communications Permitted: EGCs or their authorized persons can engage in oral or written communications with QIBs and accredited institutions in order to “test-the-waters” before or after the filing of any Securities Act registration statement filed by an EGC. However, these communications may be deemed “offers” under the Securities Act. In connection with these communications liability would attach under Section 12(a)(2) and the anti-fraud provisions of the federal securities laws would apply. |
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Laws Relating to Securities Offerings The CFO says that the company’s auditors have raised concerns about it being an investment company. What does it mean to be an investment company? The CFO also asks you if, based upon the information above, the company appears to be an investment company, and why you think it might or might not be an investment company (illustrate any calculations you need to determine this –(back of the envelope test from class)). Assets Cash and Cash Equivalents $700,000 Accounts Receivable $300,000 Property and Equipment $200,000 Municipal Bonds (long term) $200,000 Investment Securities (long term) $400,000 Liabilities Accounts Payable $200,000 Long-Term Debt Securities $1,200,000 Owner’s Equity $400,000 Income Statement DataRevenue $995,000 Total Expenses $999,000 Net Income (Loss) ($4,000) |
The Investment Company Act of 1940 regulates companies that are primarily engaged in investing, reinvesting and trading in securities. The 40 Act is important to consider during an IPO because if an issuer is an investment company, then for all practical purposes it cannot engage in a securities offering without registering under the Investment Company Act of 1940.
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Calculate Fritter’s working capital at December 31, 2014. Assets Cash and Cash Equivalents $700,000 Accounts Receivable $300,000 Property and Equipment $200,000 Municipal Bonds (long term) $200,000 Investment Securities (long term) $400,000 Liabilities Accounts Payable $200,000 Long-Term Debt Securities $1,200,000 Owner’s Equity $400,000 Income Statement Data Revenue $995,000 Total Expenses $999,000 Net Income (Loss) ($4,000) |
$800,000
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Financials Fritter would like to go effective on its IPO registration statement and price its IPO in July. Given its December 31 year end, financial statements at and for what then most recent financial reporting period will have to be included in the registration statement? |
If the IPO will commence after the 45th day of the fiscal year, then the issuer must provide audited annual financial statements for the previous fiscal year.
If the IPO will commence after the 134th day of the fiscal year, then the issuer must provided unaudited interim financial statements for the first quarter. (The audited annual financials from the previous year go stale at the end of the 134th day of the next fiscal year) The accountants will only provide negative assurance on the unaudited financial information as of a date less than 135 days from the end of the most recent period for which the accountants have performed an audit or review. When the accountants have audited the December 31, 19X6, financial statements, the accountants may provide negative assurance on increases and decreases of specified financial statement items as of any date up to May 14 (135 days subsequent to December 31). When the accountants have audited the December 31, 19X6, financial statements and have also conducted an SAS No. 71 [section 722] review of the interim financial information as of and for the quarter ended March 31, 19X7, the accountants may provide negative assurance as to increases and decreases of specified financial statement items as of any date up to August 14, 19X7 (135 days subsequent to March 31). The accountants will not provide negative assurance as of a date 135 days or more subsequent to the end of the most recent period for which the accountants have performed an audit or review. In such a case, the accountants are limited to reporting procedures performed and findings obtained. If financial statements are stale, the SEC will typically give a notice of Deferred Review to the issuer. This means that the SEC will not even review the registration statement until the financial statements are "fresh."
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NYSE Listing The CFO asks you to please explain the difference between a (1) record holder and (2) someone who owns stock in street name. He wants to know how the difference between the two pertains to the Company getting listed on the NYSE. Please explain what record holders and street name holders are. Also, explain how the number of each type of holder affects whether the company can get listed on the NYSE? (Answering this last question will require some rudimentary knowledge and very brief explanation of part of the listing requirements.) |
Record Holder - If your shares of common stock are registered directly in your name on a company's stock records, you are considered the stockholder of record, or the “record” holder of those shares. As the record holder you have the right to vote your shares in person or by proxy at the annual meeting.
Street Name Holders - If your shares of common stock are held in an account at a brokerage firm, bank, or other similar entity, then you are the beneficial owner of shares held in “street name.” The entity holding your account is considered the record holder for purposes of voting at the annual meeting. As the beneficial owner you have the right to direct this entity on how to vote the shares held in your account. However, as described below, you may not vote these shares in person at the annual meeting unless you obtain a legal proxy from the entity that holds your shares giving you the right to vote the shares at the meeting.
To be listed on the NYSE, the company must have at least 400 round lot shareholders. The number of shareholders includes shareholders of record and beneficial holders of shares held in street name. A round lot shareholder is a shareholder with 100 or more shares. |
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NYSE Listing The CFO wants to know if Fritter can get its common stock listed on the NYSE even if it is not a going concern. He notes (correctly) that Twitter had net losses in each of the three years before it went public and listed on the NYSE. Please (1) explain what a “going concern” is and (2) state if the company can get its stock listed on the NYSE if it is not a going concern. |
Going concern - Going concern is an accounting term for a company that has the resources needed to continue normal business operations indefinitely, and this term also refers to a company's ability to make enough money to stay afloat or avoid bankruptcy.
Aside from the minimum numerical standards in the NYSE listing standards, other factors are taken into consideration. The company must be a going concern or be the successor to a going concern. Although the amount of assets, earnings, and the aggregate market value are considerations, greater emphasis is placed on such questions as the degree of national interest in the company, the character of the market for its products, its relative stability and position in its industry, and whether or not it is engaged in an expanding industry with prospects for maintaining its position. |
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NYSE Listing The CFO says, “The NYSE listing fee seems high. But, we only have to pay it once for the IPO for our common stock, right? Kind of like how we only need to register the company under the Exchange Act once. Right?” Are these statements correct or incorrect? Explain briefly why or why not. |
Once listed, if an issuer lists additional shares of a class of previously listed securities, additional listing fees apply. Up to and including 75 million shares cost $.0048 per share, over 75 million up to and including 300 million cost $.00375 per share, and over 300 million cost $.0019 per share.
An issuer that applies to list an additional class of common shares at any time will be charged a fixed Listing Fee of $5,000 in lieu of the per share schedule. Such additional class of common shares includes, but is not limited to, a tracking stock. The Annual Fee for each class of equity security listed is equal to the greater of the minimum fee or the fee calculated on a per share basis. Type of Security/ Minimum Fee/ Fee Per Share
Primary class of Common Stock/ $52,500/ $.001025 Each additional class of common shares/ $20k/ $.001025 |
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Publicity Issues Related to the Offering The CEO says that if Fritter qualifies as an EGC, it would like to post a Twitter feed on its website and Tweet about the general status of the IPO before it files the registration statement. Is this legal? Why or why not? |
Rule 163A
Pursuant to Rule 163A, communications by issuers and those acting on their behalf are permitted when made more than 30 days before the registration statement is filed, provided the proposed offering is not mentioned; also cannot mention the underwriters. Rule 135 Rule 135 permits the issuer (alone with selling shareholders and those acting on behalf of either of them) to announce the issuer’s intention to make a public offering by stating (1) the amount and type of security to be offered, and (2) the timing, manner, and purpose of the offering. The announcement must also state that the offering will be by prospectus, but cannot identify prospective underwriters or the expected offering price. Lastly, the announcement must include a legend stating that an effective registration statement is forthcoming, which is when the shares will be sold. Section 5(d) Section 5(d) creates an exemption that allows Emerging Growth Companies to make oral or written offers prior to filing a registration statement. However, Emerging Growth Companies may only make these offers to accredited institutional investors or qualified institutional buyers. Thus, a twitter feed that does not stay within the bounds of any of these 3 exemptions would be deemed an offer and violate Section 5 of the Securities Act. |
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Publicity Issues Related to the Offering As part of the roadshow presentation, the CEO would like to pass out paper copies of the roadshow powerpoint slides and key chains with the Fritter company logo emblazoned in gold. Is it permissible under the Securities Act to do this?What issues need to be considered? Briefly explain why or why not. |
If a communication, such as slides or other visual aids, is provided or transmitted simultaneously as part of a live road show that is not a written communication, including a live, in real-time graphically transmitted road show, and that communication is provided or transmitted in a manner designed to make it available only as part of the road show and not separately, that communication is deemed part of the road show. Such a communication is thus deemed not to be a written communication.
However, hard copies of the slides should not be distributed to the prospective investors and should not leave the meeting room. The slideshow presentation is considered to be an “oral” presentation as it probably does not have a greater impact than an oral statement, and is thus permissible. The only way you could hand out paper copies of the slides is if they are incorporated by reference in the Preliminary Prospectus. In the case of a Road Show that is a written communication for a company not registered with the SEC, such as a company conducting its initial public offering, the Road Show must be filed with the SEC unless the issuer makes available to the public without restriction at least one version of a “bona fide electronic road show” by means of graphic communication. Rule 164 Rule 164 of the 2005 Public Offering Reforms permits issuers and other participants in an offering to use a “free writing prospectus” during the waiting period to satisfy the requirements of Section 10(b). A free writing prospectus is any written or graphic communication by the issuer or on its behalf that satisfies the conditions delineated in Rule 433, and that is not Sales Literature, or a Section 10(a) or Section 10(b) prospectus. The free writing prospectus must include a legend that advises the investor to read the preliminary prospectus and how to obtain a copy (in an IPO, it must also include a price range). The FWP also cannot conflict with any of the information provided in the preliminary prospectus. It must also be filed with the SEC on or before the first day used. For non-reporting and unseasoned issuers, the free writing prospectus must be accompanied or preceded by a preliminary prospectus. If the free writing prospectus is electronic, this condition can be satisfied by including a hyperlink to the preliminary prospectus. |
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Publicity Issues Related to the Offering Recently, Fritter commissioned an unrelated third party to research and write a report about the major companies in its industry. The report will say, among other things, that Fritter is expected to become the largest and most successful company in its industry. The General Counsel states that Fritter can legally reference this report in the IPO prospectus and that because it was prepared by an independent third party, Fritter will have no liability as to any information from the report that Fritter mentions in its IPO prospectus. Can Fritter mention the report or information from the report in its IPO prospectus? If not, why not? If so, is Fritter potentially liable under some theory of liability for information from the report it would include in the prospectus? Which theory or theories? |
The JOBS Act permits a broker-dealer to publish or distribute a research report about an EGC that proposes to register an offering under the Securities Act or has a registration statement pending, and the research report will not be deemed an “offer” under the Securities Act, even if the broker-dealer will participate or is participating in the offering.
With respect to mentioning the report in the prospectus and being subjected to liability therefrom, the Issuer would need to temper the language in the report that states the company is expected to become the largest and most successful company in its industry, as it appears to be a forward-looking statement. The issuer would need to explain that this is the opinion of one analyst and while the company hopes that it can prove the analyst correct, there is no guarantee that the company will become an industry leader. Also, because the Issuer is paying for the report, and including it within its prospectus, it will retain Section 11 and 12(a)(2), and Rule 10b-5 liability. This seems like it would be similar to endorsing a third-party website. Also, this seems like one of those "We are number one!" statements. Therefore, the SEC will want support for this statement and because it is coming from a report paid for by the company, it likely will not be sufficient support. If it is not an EGC: The analysis could not even create the research report because it is participating in the offering. It does not fit within Rule 139 because the issuer is not a 34 Act reporting company. Rule 137 is no good because the analyst is participating in the offering. Rule 138 is no good because the analyst is opining on securities is helping issue.
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(MD&A) Fritter derives some of its revenue from outside the United States. The value of the dollar relative to other currencies has been increasing, making Fritter’s services more expensive in many other countries. What questions would you ask Fritter’s CFO to help determine whether this is material? If it is material, in what sections of the IPO prospectus would it likely be discussed? |
Questions I would ask:
(1) How much more expensive will your services be in foreign countries? (2) How much of your revenue is derived from foreign countries? (3) Is this price increase going to decrease the revenue derived from foreign countries? (4) If so, by how much? (5) Will that reduction in revenue significantly impact the overall revenue of the company? (6) How likely is it that this reduction will occur? (7) Do you know how long this drop in revenue will last? Where should this be disclosed? MD&A because it is meant to provide information about the quality of, and potential variability of, a company’s earnings and cash flow, to enable investors to determine the likelihood that past performance is indicative of future performance. Maybe also Risk factors. |
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act Fritter’s General Counsel pulls you aside and shows you a few newspaper articles chronicling that the Fritter CFO was accused and recently acquitted of charges of reckless endangerment of a child, and that the CFO in turn is suing the prosecuting authorities civilly for wrongful prosecution and defamation. The CFO has told the General Counsel that since he was acquitted and Fritter is not a party to the actions, that no disclosure in the IPO registration statement is required. The General Counsel asks if any of this has to or should be disclosed in the registration statement and if so, why and where therein? |
Item 401 of Reg. S-K requires a section of the RS be devoted to a description of the directors, executive officers, promoters, and control persons. It is in this section that the Issuer would describe involvement of executives in legal proceedings. Item 401 requires the Issuer to describe any events that occurred in the past ten years and that are material to an evaluation of the ability or integrity of any executive officer.
Here, allegations of child endangerment would likely not show whether the CFO has the ability to act as a competent CFO. It could be argued that child endangerment could be indicative of the CFO's integrity if one views integrity as a synonym of morality. However, this requirement likely requires disclosure of crimes in which the executive acted dishonestly. Furthermore, the CFO in this case was acquitted of all charges and presumably denies that he endangered any child. Therefore, the allegations likely do not need to be disclosed.
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(MD&A) The CFO tells you he has heard that in MD&A, disclosures of immaterial information are required in the registration statement if management cannot determine they are unlikely to have a future material impact. He asks if this is true or false? (just answer true or false, no explanation please) |
True. Where a trend, demand, commitment, event or uncertainty is known, management must make two assessments:
(1) Is the known trend, demand, commitment, event or uncertainty likely to come to fruition? If management determines that it is not reasonably likely to occur, no disclosure is required. (2) If management cannot make that determination, it must evaluate objectively the consequences of the known trend, demand, commitment, event or uncertainty, on the assumption that it will come to fruition. Disclosure is then required unless management determines that a material effect on the registrant’s financial condition or results of operations is not reasonably likely to occur.
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Law Firm Opinions and Letters Explain what negative assurances are as they relate to legal opinions in an IPO, who provides them and why? |
The Issuer's counsel provides to the Underwriters a negative "negative assurance” that neither the registration statement nor the prospectus contained an untrue statement of material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading. It helps the Underwriters to establish their due diligence defense under sections 11 and 12 of the 33 Act.
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act The General Counsel tells you that Fritter just entered a contract with Facebook. Under the terms of the contract, Facebook will be required to make payments to Fritter over the next 12 months that will double Fritter’s revenue. The GC says that the underwriters and the CEO are pushing hard to tout the contracts revenue potential in the IPO registration statement, but that some of the contract’s terms are competitively sensitive. Discuss the disclosure issues in connection with this contract – (1) how and where in the registration statement should this contract and its terms be disclosed, if at all? (2) Will the competitively sensitive terms have to be disclosed (explain why/why not)? |
First, this contract is clearly material, as it will double Fritter's revenue. Thus, it must be disclosed pursuant to Item 601 of Reg. S-K as an exhibit to the RS. Therefore, it should be disclosed in the Tabular Disclosure of Contractual Obligations.
Second, because the terms of the contract are competitively sensitive, Fritter will have to request confidential treatment of those specific terms under Rule 406. This request should be filed on the same day as the initial filing of the RS. To be granted the request, the specific terms must not be material and Fritter must show why there would be competitive harm if the information were disclosed. Fritter should then file with the Secretary's office of the SEC both the redacted and unredacted versions of the contract. |
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Underwriting Agreements and The Agreement Among Underwriters When is the underwriting agreement in a firm commitment IPO typically signed? Why does signing occur at this time? |
Typically, the underwriting agreement is not signed until after the SEC has declared the registration statement effective, and when the deal is priced. The typical timing for non-shelf offerings is the registration statement becomes effective around the close of market, then the pricing call occurs after the close of market and the underwriters and Issuer will then sign the underwriting agreement once the price has been agreed to.
Generally, unless the managing underwriter accumulates a book of indications of interest from investors at least equal to the amount of securities being offered, and thus minimizes the underwriters’ risk of holding unsold shares, the underwriters will not sign the underwriting agreement. Thus, the underwriters wait until the shares have been priced to sign the underwriting agreement to ensure that they have enough buyers for all of the shares at the sell price so they are not left holding unsold shares. |
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SEC Comment and Review In addition to company’s acceleration requests, for an underwritten offering, will any other party or parties also have to contact the SEC staff before the SEC takes the IPO registration statement effective? If so, what information will this party or parties have to communicate to the SEC staff? |
FINRA will also need to call (or provide a letter to) the SEC staff to confirm that it has reviewed and expressed no objection to the underwriting compensation.
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Post-Closing Reporting Obligations and Requirements Explain which persons have to file reports under Exchange Act Sections 13 and 16 after the company goes public. |
Section 13 Under Section 13(d), any person who acquires beneficial ownership of more than 5% of a class of an equity security registered pursuant to Section 12 must, within 10 days after such acquisition: (1) Send the Issuer of the security at its principal executive office a Schedule 13D; (2) Send to the securities exchange where the security is traded a Schedule 13D; and (3) File with the SEC a Schedule 13D.
A beneficial owner of equity securities is any person who directly or indirectly, through any formal or informal contract, arrangement, understanding, relationship or otherwise, has either: (1) voting power, including the power to vote or direct the voting, over equity securities; or (2) investment power, including the power to dispose of or to direct the disposition of such shares, with respect to equity securities. 13(G) Asks people to look at their ownership at 45 days into the year. If they are a beneficial owner, they must file some information with the SEC. Schedule 13G is shorter and requires less information from the filing party. To be able to file 13G instead of 13D, the party must own between 5% and 20% in the company. It must also be clearly understood that the party acquiring the stake in the company is only a passive investor and does not intend to exert control. If these criteria are not met, and if the size in the stake exceeds 20%, a 13D must be filed. Section 16 Section 16(a) – Disclosure Requirement – This section requires each beneficial owner of more than 10% of a class of equity securities registered under Section 12 (however, securities of certain foreign private issuers are exempted), and each director or officer of the Issuer of such a security, to file statement of ownership reports. Form 3 – The initial statement of beneficial ownership on Form 3 must be filed within 10 days after a person becomes an insider. However, in an IPO, an insider must file a Form 3 no later than the date the registration statement becomes effective pursuant to section 12(g) or at the time of the registration of such security on a national securities exchange. Form 4 – The change in beneficial ownership on Form 4 must be filed before the end of the second business day following the day on which a transaction resulting in a change in beneficial ownership is executed. Certain exceptions apply. Form 5 – This year-end reconciliation on Form 5 must be filed within 45 days after the end of the Issuer’s fiscal year by any person who was an insider at any time during the fiscal year. Form 5 is used to report transactions that should have been previously reported on Form 4 or transactions for which deferred reporting is acceptable. |
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Post-Closing Reporting Obligations and Requirements The CEO and CFO have to “certify” the Form 10-K. Briefly describe the required certification or certifications. |
Sarbanes-Oxley added two separate certification requirements for periodic reports filed by public companies to ensure that the senior officers are actively involved in the preparation of, and are accountable for, various reports filed with the SEC.
Sections 302 and 906 require certifications (Exhibit 32 per Reg S-K 601) with respect to periodic reports that contain financial statements and imposes criminal liability upon CEOs and CFOs who willfully or knowingly make a false certification. They must certify that such reports fully comply with the requirements of Section 13(a) or 15(d) of the 34 Act, and that the information contained in the reports fairly present, in all material respects, the financial condition and results of operations of the company, that the financial statements are accurate and complete, and that they have established and maintained adequate internal controls for public disclosure. Section 302 also requires each of these officers to certify that he has reviewed the report and, based on the officer’s knowledge, the report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by the report. |
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act Explain why and when Fritter will have to file a Form 8-A in connection with the IPO. |
Form 8-A is a filing with the Securities and Exchange Commission (SEC), also known as the Registration of Certain Classes of Securities. The Form is used to register securities under the 34 Act. The Form 8-A goes effective on the effectiveness of the RS, or 60 days from filing the 8-A. If the 8-A goes effective before the RS, then you're a reporting company without raising any money. Hence, the 8-A should be filed no more than 60 days before the RS goes effective. In the worst case scenario, you can withdraw the 8-A.
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Introductory Class Unicorn wants to know whether it qualifies as an Emerging Growth Company (EGC). Advise Unicorn whether it qualifies as an EGC and provide your analysis. Assume the company has never issued any debt securities. |
Emerging Growth Company (“EGC”) – An issuer with total annual gross revenues of less than $1 billion, computed as of the last day of its most recently completed fiscal year. An EGC retains that status until the earlier of: (i) the last day of the fiscal year in which the issuer had $1 billion or more in annual gross revenues; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s registered initial public offering of common equity securities; (iii) the date on which the issuer has, during the previous 3-year period, issued more than $1 billion in non-convertible debt securities; and (iv) the date on which the issuer is deemed to be a “large accelerated filer.”
A large accelerated filer is one that after 60 days into the fiscal year, has at least $700 million in public float, for at least 12 months has been public, and has filed at least one 10-K. |
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Introductory Class Unicorn wants to “test the waters.” Explain what this means, and when Unicorn is permitted by law to do this. |
Test-the-Waters Communications - EGCs or their authorized persons can engage in oral or written communications with qualified institutional buyers (QIBs) and institutional accredited investors to “test-the-waters” before or after the filing of any Securities Act registration statement filed by an EGC.
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Laws relating to Securities Offerings Unicorn received a Food and Drug Administration (FDA) notice that the FDA was investigating a possible causal link between SniffZ and temporary shortness of breath after usage by users of SniffZ. In addition, a small number of plaintiffs commenced a class action product liability lawsuit against Unicorn alleging that they suffered temporary shortness of breath after using SniffZ . The demand for relief in the class action suit is $50 million. The CFO asks whether any of this needs to be disclosed in the prospectus. State the materiality standard you would apply to determine what Unicorn should disclose in the prospectus regarding this, and explain your analysis as to why this information should or should not be disclosed. |
In determining whether any of this information should be disclosed in the prospectus, we must first determine whether the information is material. Or, in other words, whether this would be information that a reasonable investor would consider important in making an investment decision with respect to Unicorn. Because the events in question are yet to occur, determining whether we should disclose the possibility of their occurrences depends on the probability and magnitude of the events.
Thus, if the events were to occur, but the magnitude of their effect was so minimal that that it would not provide a meaningful impact on the company with respect to earnings or publicity, then it is unlikely that the events would need to be disclosed. However, if the magnitude of the class action claim and the FDA investigation would significantly impact the company such that their occurrence would significantly reduce Unicorn's revenues or cause negative public attention that could result in a reduction of revenue, then the possibility of their occurrence would need to be disclosed, even if the probability of their occurrences were low. Here, it appears that the FDA has already notified Unicorn that it will be conducting an investigation. The mere fact that the FDA is conducting an investigation could be material because it could cause negative public attention if the investigation were made public, and because it is an investigation into Unicorn's number one product that accounts for most of its revenue. Therefore, the investigation may need to be disclosed. Further, if the FDA investigation were to discover that Sniffz was the causal link to shortness of breath, it would be detrimental to Unicorn because the investigation would likely severely reduce the revenue generated by Sniffz, which is Unicorn's top revenue producer. Therefore, the investigation likely needs to be disclosed in the prospectus. The class action claim likely does not need to be disclosed because the potential loss is only $50 million, even if it is certain to occur. This amount is likely not large enough to cause a material impact on the company. However, if the class of plaintiffs could grow, thus increasing liability and shining a brighter light on the negative effects of Sniffz, then the class action may need to be disclosed because a large class action against Unicorn asserting claims against its top revenue-producing product could significantly impact the company. |
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Laws relating to Securities Offerings Unicorn received a Food and Drug Administration (FDA) notice that the FDA was investigating a possible causal link between SniffZ and temporary shortness of breath after usage by users of SniffZ. In addition, a small number of plaintiffs commenced a class action product liability lawsuit against Unicorn alleging that they suffered temporary shortness of breath after using SniffZ . The demand for relief in the class action suit is $50 million State in what sections of the prospectus, if any, disclosure about this should appear. |
I think this would go in the Legal Proceedings section, but it could also go in the Risk Factors section.
Maybe MD&A if this is a possible trend that change financial data. |
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Laws relating to Securities Offerings Unicorn received a Food and Drug Administration (FDA) notice that the FDA was investigating a possible causal link between SniffZ and temporary shortness of breath after usage by users of SniffZ. In addition, a small number of plaintiffs commenced a class action product liability lawsuit against Unicorn alleging that they suffered temporary shortness of breath after using SniffZ . The demand for relief in the class action suit is $50 million After the company files a prospectus including a price range, a broker at Spartan-Ives, the managing underwriter for the IPO, is asked by one of its clients about the Unicorn offering and the FDA notice. The broker tells the customer the FDA notice is “no big deal.” Shortly after the IPO, the stock price drops because the FDA pulls SniffZ off the market. Under what provisions does Spartan-Ives have potential liability to the investor? __ Section 12(a)(2) of the Securities Act of 1933 __ Section 11 of the Securities Act of 1933 __ Rule 10b-5 under the Securities Exchange Act of 1934 __ Section 15 of the Securities Act of 1933 |
Section 12(a)(2)
Section 11 if it was not disclosed in RS/Prospectus
Rule 10b-5 under the Securities Exchange Act of 1934 if there was intent |
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Introductory Class Unicorn is in discussions with Spartan-Ives to underwrite the IPO. Spartan-Ives is deciding whether it should agree to a firm commitment or best efforts underwriting of the IPO. Explain the difference between these two types of offerings. |
Firm commitment offering – The Underwriter agrees to purchase the entire amount of the offering from the Company (the “Issuer”) and then re-offers it to the general public or, in the case of a 144A / Regulation S Offering, to sophisticated purchasers or those located outside the United States. If the shares purchased by the Underwriters in a firm commitment offering are not resold to the public, then the Underwriters will hold these shares for their own account. This type of underwriting provides the greatest assurance to the company that they will receive the desired funds.
Best Efforts offering – In this type of offering, the Underwriter only acts as the agent for the Issuer, agreeing to do its best to sell the shares to the public. If purchasers are not found, then the securities are not sold.
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NYSE Listing The CFO has asked you what a transfer agent does and whether the company needs to hire one because it is doing the IPO. What are your answers to these questions. |
A transfer agent is a trust company, bank, or similar financial institution assigned by a corporation to maintain records of investors and account balances. The transfer agent records transactions, cancels and issues certificates, processes investor mailings and deals with other investor problems (e.g., lost or stolen certificates). The transfer agent is an integral part of the IPO process by telling the DTC which investors get a certain number of shares. Thus, the Issuer should hire a transfer agent.
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Accounting Issues and Comfort Letters The working group proposes to file the IPO registration statement on May 7, 2016, with its latest financial statements, which are attached to this exam packet. The CFO asks whether the SEC will review the registration statement because he believes the financial statements will be stale. Is the CFO correct? Explain when these financial statements would go stale and what effect that would have on SEC review of Unicorn’s filing. |
If the IPO will commence after the 45th day of the fiscal year, then the issuer must provide audited annual financial statements for the previous fiscal year. If the IPO will commence after the 134th day of the fiscal year, then the issuer must provided unaudited interim financial statements for the first quarter. (The audited annual financials from the previous year go stale at the end of the 134th day of the next fiscal year) The accountants will only provide negative assurance on the unaudited financial information as of a date less than 135 days from the end of the most recent period for which the accountants have performed an audit or review. When the accountants have audited the December 31, 19X6, financial statements, the accountants may provide negative assurance on increases and decreases of specified financial statement items as of any date up to May 14 (135 days subsequent to December 31). When the accountants have audited the December 31, 19X6, financial statements and have also conducted an SAS No. 71 [section 722] review of the interim financial information as of and for the quarter ended March 31, 19X7, the accountants may provide negative assurance as to increases and decreases of specified financial statement items as of any date up to August 14, 19X7 (135 days subsequent to March 31). The accountants will not provide negative assurance as of a date 135 days or more subsequent to the end of the most recent period for which the accountants have performed an audit or review. In such a case, the accountants are limited to reporting procedures performed and findings obtained. If financial statements are stale, the SEC will typically give a notice of Deferred Review to the issuer. This means that the SEC will not even review the registration statement until the financial statements are "fresh."
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Law Firm Opinions and Letters Regulation S-K requires that Unicorn’s counsel file a legal opinion as to the legality of the common stock being sold by Unicorn in the IPO. Counsel must opine as to three things– that the securities will be: ________________________________, ___________________________ and ___________________________. |
(1) Legally issued
(2) Fully Paid (3) Non-assessable |
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Publicity Issues Related to the Offering After the registration statement is filed, Unicorn announces in a press release that one of its product candidates has just received FDA approval. Underwriters counsel claims this is an offer, but the Unicorn’s general counsel believes the Rule 169 safe harbor for release of factual business information applies. What factors will you look to in order to determine who is correct? |
Rule 169 provides a safe harbor for Issuers to continue their regular release of communications containing factual business information. The safe harbor is conditioned upon (1) the Issuer having previously released or disseminated factual business information in the ordinary course of business; (2) the timing, manner and form in which the information is released or disseminated is materially consistent with past practice; and (3) the information is released or disseminated: (a) for the intended use of persons other than investors or potential investors, such as customers or suppliers; and (b) by the Issuer’s employees or agents who have historically provided the information to customers or suppliers.
Here, one issue may be that this was intended to be used by investors.
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Underwriting Agreements and The Agreement Among Underwriters Assume that the morning after the IPO registration statement is declared effective, the FDA tells Unicorn’s CEO that it will ban the sale of SniffZ (product accounts for 40% of its revenue). Does the underwriter have to proceed with the offering if it is a firm commitment? Why or why not? |
Because it is the morning after the IPO RS has been declared effective, it is almost certain that a final price has been determined and the underwriting agreement has already been signed by the Underwriters. Therefore, it is likely that a termination provision in the Underwriting Agreement will have been triggered because those provisions are usually only triggered by a material adverse change or any development involving a prospective material adverse change in or affecting the earnings, assets, operations, or financial condition of the Issuer that has occurred between the time of offering and pricing. Hence, because pricing will have already been determined by the following morning, it is likely that the Underwriters will be able to enforce this provision.
However, there may be other provisions in the Underwriting Agreement that may allow the underwriter to refrain from purchasing the securities. For example, the issuer typically agrees to keep the underwriters advised of any action taken by the SEC or state authorities with respect to the Issuer, prepare the prospectus in a form approved by the Underwriters and not further amending it, and keep the prospectus current in all material respects. Hence, if the prospectus did not disclose the possibility of the FDA taking Sniffz off the market or if the Issuer did not keep the underwriters advised of an investigation by the FDA, then the underwriters likely have grounds to refrain from purchasing the securities. However, if the prospectus included this possibility and the underwriters knew of its likelihood, then they will likely be obligated to purchase the securities. The several obligations of the Underwriters to purchase the securities on the Closing Date are subject to: (1) the accuracy, as of the Closing Date, of the representations and warranties of the Company; (2) the performance by the Company of its covenants and obligations in the Underwriting Agreement; and (3) the additional conditions contained in this section. |
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Post-Closing Reporting Obligations and Requirements Bobby Axelrod is the Chairman of Unicorn’s Board of Directors. He is the founder of Unicorn and was also its CEO until 2014, when he retired. Bobby currently beneficially owns 20% of the company’s common stock. Assuming the completion of the IPO, he would beneficially own less than 10% of the company’s common stock. Can Unicorn file an IPO registration statement if Bobby doesn’t sign it? Also, list what filings, if any, Bobby himself will have to make with the SEC after Unicorn becomes a public company? |
No. Bobby does not need to sign the Registration Statement. The RS is signed by each issuer, its principal executive officer or officers, its principal financial officer, its comptroller or principal accounting officer, and the majority of its board of directors or persons performing similar functions.
Once the company is public, Bobby will have to file several forms with the SEC. Section 13 Under Section 13(d), any person who acquires beneficial ownership of more than 5% of a class of an equity security registered pursuant to Section 12 must, within 10 days after such acquisition: (1) Send the Issuer of the security at its principal executive office a Schedule 13D;(2) Send to the securities exchange where the security is traded a Schedule 13D; and(3) File with the SEC a Schedule 13D. A beneficial owner of equity securities is any person who directly or indirectly, through any formal or informal contract, arrangement, understanding, relationship or otherwise, has either: (1) voting power, including the power to vote or direct the voting, over equity securities; or (2) investment power, including the power to dispose of or to direct the disposition of such shares, with respect to equity securities. 13(G) Asks people to look at their ownership at 45 days into the year. If they are a beneficial owner, they must file some information with the SEC. Schedule 13G is shorter and requires less information from the filing party. To be able to file 13G instead of 13D, the party must own between 5 and 20% in the company. It must also be clearly understood that the party acquiring the stake in the company is only a passive investor and does not intend to exert control. If these criteria are not met, and if the size in the stake exceeds 20%, a 13D must be filed. Section 16 Section 16(a) – Disclosure Requirement – This section requires each beneficial owner of more than 10% of a class of equity securities registered under Section 12 (however, securities of certain foreign private issuers are exempted),and each director or officer of the Issuer of such a security, to file statement of ownership reports. Form 3 – The initial statement of beneficial ownership on Form 3must be filed within 10 days after a person becomes an insider.However, in an IPO, an insider must file a Form 3 no later than the date the registration statement becomes effective pursuant to section 12(g) or at the time of the registration of such security on a national securities exchange. Form 4 – The change in beneficial ownership on Form 4 must be filed before the end of the second business day following the day on which a transaction resulting in a change in beneficial ownership is executed. Certain exceptions apply. Form 5 – This year-end reconciliation on Form 5 must be filed within 45 days after the end of the Issuer’s fiscal year by any person who was an insider at any time during the fiscal year. Form5 is used to report transactions that should have been previously reported on Form 4 or transactions for which deferred reporting is acceptable. |
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Registering Under the 33 Act on Form S-1, Form Checks and Registering Under the 34 Act Unicorn’s CEO is an independent director of a different biotechnology company whose common stock is traded on the NYSE and is called Four Leaf Clover. Four Leaf Clover just received a subpoena from the SEC as part of an insider trading investigation the SEC is conducting. What if any of this information does Unicorn have to disclose in its IPO registration statement regarding all of this and why? |
Item 401 of Reg. S-K requires a section of the RS be devoted to a description of the directors, executive officers, promoters, and control persons. It is in this section that the Issuer would describe involvement of executives in legal proceedings. Item 401 requires the Issuer to describe any events that occurred in the past ten years and that are material to an evaluation of the ability or integrity of any executive officer. Further, it requires disclosure of events in which a director is a named subject of a pending criminal proceeding. Hence, if the director is a named subject in the insider trading investigation of Four Leaf Clover, then the investigation would definitely have to be disclosed. Further, the investigation may have to be disclosed if a reasonable investor would consider it important in making an investment decision. Because we are talking about the CEO, who is seen as the leader of the company, a reasonable investor would likely consider it important that another company of which the CEO is a director is subject to an insider trading investigation because the investor might prefer not to invest in a company whose CEO is also the CEO of another company that might be engaged in insider trading.
The company would definitely have to disclose the fact that the CEO is a director of another company, as is required by item 401 of Reg. S-K. |
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Five minutes after the SEC declares Unicorn’s IPO registration statement effective, Unicorn’s General Counsel calls you (she is very excited) and says that the underwriters want to sell 5,000,000 more primary shares than the total 20,000,000 shares that were registered in the IPO registration statement. How can Unicorn do this given that Securities Act Rule 413 states that a separate registration statement is required when registering additional securities of the same class as other securities for which a registration statement is already effective? Maybe it cannot? What should you tell the General Counsel as to how to proceed and what to tell the underwriters? |
Overallotment Option The green shoe, or overallotment option, is a right held by the underwriter of an offering to purchase additional shares from the issuer at the same price as the initial shares when the demand for the offering exceeds the quantity of initial shares. This option is written into the underwriting agreement between the issuer and the underwriter (i.e., the investment bank that has (under § 2(a) of the ’33 Act) either (1) purchased shares from the issuer with a view toward distributing them, or (2) is offering or selling securities on behalf of the issuer).Underwriters will often intentionally aim to produce this excess demand, because it makes it look like a hot offering (especially if the demand exceeds the number of shares by 4 or 5times). As with all shares, the issuer must register the green shoe with the SEC and pay the appropriate fees. Rule 462(b) Rule 462(b) permits the registration of additional shares in the same offering by filing an abbreviated registration statement that incorporates the original one by reference. This abbreviated registration statement may be filed after the original registration statement is declared effective and may register an increase in the offering size of up to 20%. It becomes effective immediately upon filing and does not require any SEC review or action.Have to file a 462 RS on Form S-1 and reference the original RS, a signature page, a legal opinion, and a new account’s consent. This acts as a new RS to get the additional 20% of shares. Then file under 424 a final prospectus for all of the shares. You can only use 462(b) before confirmations of sale have been sent (basically cannot have any sales before we do this). Usually this is the night of effectiveness when this happens.
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SEC Comment and Review Name the four levels of SEC review. |
1) Deferred Review
2) Monitor 3) No review 4) Full Review
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Post-Closing Reporting Obligations andRequirements A beneficial owner of equity securities is any person who directly or indirectly, through any formal or informal contract, arrangement, understanding, relationship or otherwise, has either sole or shared:__________________________________ power; or ________________________________ power with respect to equity securities. |
Voting
Investment |
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Laws relating to Securities Offerings The IPO investors will purchase Unicorn’s shares of common stock based on the information in the preliminary prospectus or “red herring,” and any free writing prospectuses. True or false? |
True. |
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Accounting Issues and Comfort Letters Why do auditors’ provide a comfort letter? (a) Required by the SEC rules and regulations. (b) Required as a condition to the IPO closing in the underwriting agreement. (c) Required by the underwriters as part of their due diligence defense under Section 11 of the 1933 Securities Act. (d) Required by U.S. GAAP. (e) Both (a) and (d) above. (f) Both (b) and (c) above. |
f) - But only if this means that the underwriters require it from the auditors; Section 11 does not explicitly require a comfort letter |
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Post-Closing Reporting Obligations and Requirements Following the IPO, Unicorn’s management wants to disclose a material impairment of goodwill related to the expected decline of SniffZ product sales. Management plans to disclose this information to analysts that follow Unicorn. What regulation prohibits issuers from selectively disclosing material nonpublic information to securities analysts before disclosing the same information to the public? |
Reg. FD
Regulation FD prohibits issuers from selectively disclosing material nonpublic information to certain persons –securities analysts, broker-dealers, investment advisers and institutional investors – before disclosing the same information to the public. Whenever an Issuer, or any person acting on its behalf, discloses any material nonpublic information regarding thatIssuer or its securities to any person described in paragraph(b)(1) of this Rule 100, the Issuer shall make public disclosure of that information as provided in Regulation FDRule 101(e): Simultaneously, in the case of an intentional disclosure; and Promptly, in the case of a non-intentional disclosure.(Per Rule 101 (d), “Promptly” means as soon as reasonably practicable but in no event after the later of24 hours or the commencement of the next day’s trading on the NYSE)
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Underwriters and Liabilities Section 11 liability attaches at the time of effectiveness of the registration statement, whereas Section 12(a)(2) liability attaches at the time of sale of the securities. True or false? |
False. Section 12(a)(2) liability attaches at the time of investment decision, not at the time of sale.
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Underwriters and Liabilities Under Section 11 of the Securities Act of 1933, the audited fiscal year-end financial statements and the most recent quarterly financial statements included in a registration statement are considered expertised. True or false? |
False. Audited annual financial statements are considered expertised, but quarterly financials are not because they are not audited.
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The Financials State what line items on Unicorn’s financial statements you would need to know to calculate working capital. (Refer to Financial Statements in 2016 exam) |
The net working capital formula is calculated by subtracting the current liabilities from the current assets.
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Introductory Class In a firm commitment IPO of the type we studied in class, the obligation of the underwriters to purchase the shares is ________________________ and not__________________________. |
a) subject only to issuer satisfying its covenants and conditions in the UA
b) contingent on the underwriters finding interested buyers |
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Publicity Issues Related to the Offering An issuer is “in registration” beginning at the time it files with the SEC an IPO registration statement or submits to the SEC a draft registration statement if it is an EGC, until 25 days after the registration statement has been declared effective or the security was bona fide offered to the public, whichever is later. This time period is often referred to as the “quiet period.” True or False? |
False. An Issuer is “in registration” from the time it reaches an understanding with an investment bank that such investment bank will act as the managing underwriter for the Issuer’s IPO until 25 days after the registration statement has been declared effective or the security was bona fide offered to the public, whichever is later. This time period is often referred to as the “quiet period.”
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Publicity Issues Related to the Offering A live, in real-time road show to a live audience that is transmitted graphically is not a graphic communication and therefore is not a written communication, or a free writing prospectus, and will not be subject to Securities Act Section 11 liability. True or False? |
True.
A live, in real-time road show to a live audience that is transmitted graphically will not be a graphic communication and therefore is not a written communication, or a free writing prospectus. It will still, however, be an offer subject to Section 12(a)(2) liability as well as other liability provisions of the federal securities laws.
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(MD&A) If a company has two operating segments, it must present separate financial information for both segments, if management regularly evaluates separate financial information in deciding how to allocate resources and assess performance of the two segments. True or False. |
True kind of.
In determining if segment analysis is necessary, companies should look at: Revenues; Profitability; and Cash needs of its significant industry segments. If any segment contributes in a materially disproportionate way to the above three items; or discussion on a consolidated basis would present an incomplete and misleading picture of the company, then segment discussion should be included. Determining if Something is a Segment Three components of an operating segment under SFAS No. 131. A component of a business: (1) that engages in activities from which it may earn revenues and incur expenses; (2) whose operating results are regularly reviewed by the company’s “chief operating decision maker” to make decisions about resources to be allocated to the segment and assess its performance; and (3) for which discrete financial information is available. Determining whether an operating segment requires separate disclosure A company generally must report separately information about an operating segment that meets any of three thresholds: (a) Its reported revenue (including both sales to external customers and intersegment sales and transfers) is 10% or more of the combined revenue of all reported operating systems, whether generated inside or outside the company; (b) Its reported profit or loss is 10% or more of the greater of: (1) The combined reported profit of all operating segments that did not report a loss, or (2) The combined reported loss of all operating segments that did report a loss; or (c) Its assets are 10% or more of the combined assets of all operating segments. |
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SEC Comment and Review When the working group is ready for the registration statement to go effective, ______________________ and ____________________ ask the SEC to accelerate the effective date of the registration statement to a certain date and time. |
Registrant and managing underwriters
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NYSE Listing A company can go public by listing its common stock on the New York Stock Exchange without conducting an IPO. True or False. |
I think this is true. A company can register a class of securities under Section 12(b) without doing a registration statement and having a transaction. This is the trigger for 34 Act reporting when you are listed on a national securities exchange. The Company must file a Form-10 with the SEC and a Form 8-A. When the registration statement with the SEC goes effective, the Form 8-A will go effective.
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Post-Closing Reporting Obligations and Requirements A company must file Exchange Act reports with the SEC if it has more than 2,000 record holders of a class of equity securities even if it has not done an IPO. True or False. |
True, but only if it has total assets exceeding $10 million. Otherwise, False.
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Once a company goes public and sells shares of its common stock using a registration statement, it can sell more securities publicly if it registers the sale under the Securities Act, but cannot sell securities of the same class (common stock in this case) pursuant to an exemption from registration. True or False. |
False.
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