One of the focuses of the Series 7 exam is important for understanding the broader structures of capital markets: how companies are initially formed. A company first files a corporate charter that institutes the company’s bylaws, which has all of the information you’d expect (the name of the business, what it does, who founded it, its address, etc.). This becomes the backbone for the company’s next step: becoming a public security, which it does by registering with the SEC.
The registration program is something we’ve had for nearly a century, as these rules were set up initially in 1933 in the Securities Act, which remains one of the most important pieces of legislation in American corporate history, alongside its younger sibling, the 1934 Securities Exchange Act—which, as you may remember, deals with secondary exchanges (hence the name) of securities already established according to the 1933 rule. These were of course set up in the aftermath of the Great Depression to ensure that kind of speculative bubble never happened again—and, even taking into account the calamity of the 2007-2009 Great Recession, it did work.
On the Series 7, you will be expected to know the details that are on the registration statement that follows a company’s attempt to go public, although many of these (the issuer’s name, address, business description, articles of incorporation, names and addresses of underwriters, etc.) are common sensical things to have on a registration statement. Other details are important too, however, such as the security’s expected price when it goes IPO, the names/addresses of all company control persons—meaning you need to remember that means the company’s directors and anyone owning more than 10% of the company’s securities, including debts, as well as how much of the company they own. The registration statement also will show the estimated net proceeds of the sale and what they will be used for, alongside the company’s current capitalization, complete financial statements, any legal proceedings against the firm, as well as any net proceeds received from any security sold by the company in the last 2 years. The Series 7 exam likes to ask about numbers, so remember that last two years bit.
The information within the registration statement outlined above is known as the Schedule A, while the Schedule B applies to municipal bonds and similar local government issued assets. For a Schedule B, the issuer also needs to include if it has defaulted on any debt in the last 20 years and a legal opinion made by counsel regarding the legality of the issuance, whether it is tax free, etc.
When issuers register this statement alongside their Schedule A, they will often save some securities to sell later. This is known as a Shelf Registration and is regulated by SEC Rule 415. It is important to remember that shelf registration provisions allow issuers up to 2 or 3 years (depending on the status of the company—the detail of this status isn’t typically tested on the Series 7) to sell these previously registered assets.
After this statement has been filed, there’s a 20-day cooling off period, which you may remember from the SIE exam. If the SEC clears the issuer, the IPO can commence. If not, the SEC sends a deficiency letter that halts the registration process but allows the company to provide the missing information to commence its IPO. If the SEC finds the statement misleading, it can issue a stop order, which suspends the registration and requires the issuer to amend its registration.
Before the cooling-off period ends, underwriters can get indications of interest from investors, but these are always non-binding to customers or underwriters.
This is also the period when companies can release “tombstone advertisements”, so called because they have the tombstone shape and are placed in newspapers, which invites potential investors to seek a prospectus.
Before the cooling-off period ends, the lead underwriter holds a due diligence meeting as a legal requirement, where the underwriter provides information about the firm and the use of proceeds from the sale, which syndicate members, brokers, analysts, and institutional investors can use to inform their clients (or decide themselves) whether they want to commit. This is the last time syndicate members can back out of an underwriting agreement, and typically this happens because of negative market conditions.
There are also blue sky laws, which are state laws that apply to security offerings, and it is important to remember issuers have to comply with these as well as SEC rules. They do this by notifying through a filing of a registration their intent to sell securities, coordinating with the SEC who helps the issuer comply with state laws, or qualifying by seeking an exemption through the relevant State Administrator.
When the cooling off period is finally over, the effective date notes the first day that the security can be sold to the public, and it is at this point that the offering price will be determined.
It’s important to note who is involved in this process:
The investment bank helps the issuer raise money and helps them proceed within the letter of the law. The underwriter is the broker-dealer that helps the securities go to market by finding interested buyers, while the managing or lead underwriter is the firm that is responsible for handling syndicates, if there are any. The syndicate helps underwriters by finding for a portion of the securities being sold an interested buyer. And if the issue is really big, syndicates can find selling groups that are kind of syndicates of the syndicates, helping them find even more buyers.