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How Are Securities Issued?

Money : Stocks And Shares

The Process of Issuing Securities

Corporations sell stock to the public as one way to raise capital. Before it can issue new stock, a corporation must first file registration statements with the Securities and Exchange Commission A twenty-day wait is required before it can sell the stocks.

The issuing company may make their registration statement public with a preliminary prospectus called a red herring that summarizes the registration statement. Basic information about the new offering is also provided, including how many shares are being offered and which brokerage companies will distribute the stock to the public. At the time of issue, a final prospectus is presented. This includes the price of the stock (its offering price).

The Basics of Underwriting

A Corporation going public hires an investment banker to help it sell its stock. This process is called underwriting. The investment banker functions as an intermediary between the issuing corporation and the public. In most cases, the underwriter (investment banker) purchases the stocks from the company for resale to the public. To reduce its own risk, the investment banker may form an underwriting syndicate of other investment bankers to co-purchase the shares. The underwriting syndicate forms a selling group to sell specified allotments of the issue. The investment banker (underwriting syndicate) then marks up the price of the offering. This markup represents the fee for the syndicate's service. The difference between the price the underwriter pays and the price the public pays is called the underwriting spread.

The syndicate manager may bid on the stock in the offering to "stabilize" the price. This bid must be less than or equal to the offering price. By law, the prospectus must make this attempt to stabilize the stock price known to the public.

The SEC also requires the underwriter to investigate the issuing company-particularly any audits, how it uses proceeds, its financial statements and the management team. This process is called due diligence.

Types of Underwriting Arrangements

A stock issue can be underwritten by several methods.

The underwriter can act as an agent, in which it tries to sell as much of the issue as it can at market prices. This is a best effort arrangement.

The issuing company can also agree to issue new stock on the condition that all of it is sold. If all of the stock is not sold, then it will withdraw the issue. This is an all-or-none arrangement.

A negotiated underwriting is when the issuer and the corporation negotiate the terms of the issue, the price, the size and other details.

The issue may be subject to competitive bids from investment bankers. The top bidder underwrites the issue and resells it to the public.

When a public company issues more of its stock, it must first offer that stock to existing shareholders; that is their preemptive right. A standby is the public sale of whatever stock the existing shareholders have not yet purchased.

A firm commitment arrangement is when an investment banker buys all of the stock from the corporation and then resells it to the public at a higher price.

A private placement is an offering in which the company sells to private investors and not to the public. Private placements do not have registration fees.


By: Gaurav Bora

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