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Issuing Securities to the Public

This chapter looks at how corporations issue securities to the investing public. Thegeneral procedures for debt and equity are quite similar. This chapter focuses on eq-uity, but the procedures for debt and equity are basically the same.

Before securities can be traded on a securities market, they must be issued to the pub-lic. A firm making an issue to the public must satisfy requirements set out in various federallegislation and statutes and enforced by the Securities and Exchange Commission (SEC). Ingeneral, investors must be given all material information in the form of a registration state-ment and prospectus. In the first part of this chapter we discuss what this entails.

A public issue of equity can be sold directly to the public with the help of underwrit-ers. This is called a general cash offer. Alternatively, a public equity issue can be sold to thefirm’s existing stockholders by what is called a rights offer. This chapter examines the dif-ference between a general cash offer and a rights offer.

Stock of companies going public for the first time is typically underpriced. We describethis unusual phenomenon and provide a possible explanation.

THE PUBLIC ISSUE

The basic steps in a public offering are depicted in Table 19.1. The Securities Act of 1933sets forth the federal regulation for all new interstate securities issues. The Securities Ex-change Act of 1934 is the basis for regulating securities already outstanding. The SEC ad-ministers both acts.

The Basic Procedure for a New Issue
1. Management’s first step in any issue of securities to the public is to obtain approvalfrom the board of directors.
2. Next, the firm must prepare and file a registration statement with the SEC. This state-ment contains a great deal of financial information, including a financial history, details of theexisting business, proposed financing, and plans for the future. It can easily run to 50 or morepages. The document is required for all public issues of securities with two principal exceptions:
a. Loans that mature within nine months.
b. Issues that involve less than $5.0 million.The second exception is known as the small-issues exemption. Issues of less than $5.0million are governed by Regulation A, for which only a brief offering statement—ratherthan the above registration statement—is needed. For Regulation A to be operative, no morethan $1.5 million may be sold by insiders.
3. The SEC studies the registration statement during a waiting period. During thistime, the firm may distribute copies of a preliminary prospectus. The preliminary prospec-tus is called a red herring because bold red letters are printed on the cover. A prospectus contains much of the information put into the registration statement, and it is given to po-tential investors by the firm. The company cannot sell the securities during the waiting pe-riod. However, oral offers can be made.
A registration statement will become effective on the 20th day after its filing unless theSEC sends a letter of comment suggesting changes. After the changes are made, the 20-daywaiting period starts anew.
4. The registration statement does not initially contain the price of the new issue. Onthe effective date of the registration statement, a price is determined and a full-fledged sell-ing effort gets under way. A final prospectus must accompany the delivery of securities orconfirmation of sale, whichever comes first.
5. Tombstone advertisements are used during and after the waiting period. An exam-ple is reproduced in Figure 19.1.

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