The Securities Offering Process

When a company needs to raise capital, it does not just print shares and hand them out. It runs a structured process: hiring investment bankers, registering with the SEC, and distributing the securities to investors. Before walking through that process, it helps to name the kinds of offerings you will see.

• An initial public offering (IPO) is a company's first-ever sale of stock to the public.
• A follow-on offering (or additional offering) is a later sale by a company that is already public.
• A secondary offering is a sale by existing shareholders rather than the company, so the company receives none of the proceeds.
• A private placement under Regulation D sells securities to a limited group of (mostly accredited) investors without full SEC registration. We cover the exemptions in detail later in the chapter.

Once a company decides to go public, it brings in underwriters to handle the sale, and the deal is structured one of two ways:

• Firm commitment: the underwriter buys the entire issue from the company and resells it. The issuer is guaranteed its full proceeds, and the underwriter takes on the risk of any shares that do not sell. This is the most common method for IPOs.
• Best efforts: the underwriter acts only as an agent, selling what it can without guaranteeing the whole issue. Here the issuer bears the risk of unsold shares.

The offering documents

Different offerings carry different disclosure documents. A prospectus is the required disclosure for registered offerings of stocks, bonds, and mutual funds. Municipal offerings use an Official Statement instead, and Reg D private placements use a Private Placement Memorandum (PPM).

A registered offering moves through three phases, and the SIE loves to test exactly what a representative may and may not do in each one. First comes the pre-filing period (before the registration statement is filed), then the cooling-off period (a minimum of 20 days while the SEC reviews the filing), and finally the post-effective period (once the registration is effective and sales can happen). Here is the full grid:

The key nuance: indications of interest collected during the cooling-off period are not binding orders. They are just expressions of potential interest that help the underwriter gauge demand and set the price, and no money changes hands until the offering is effective.

The offering process uses several different disclosure documents, and the exam expects you to tell them apart:

• The preliminary prospectus, nicknamed the red herring, is used during the cooling-off period. It contains nearly everything from the registration statement except the final price and effective date, and it is named for the red-ink disclaimer printed on its cover.
• The final (statutory) prospectus is the complete document, including the final price. It must be delivered to every purchaser at or before the confirmation of the sale.
• A summary prospectus is a shortened version that mutual funds may use; investors can always request the full statutory prospectus.
• A free writing prospectus is any written offer that is not a statutory or preliminary prospectus. It may be used during the cooling-off period only if the preliminary prospectus has already been filed, and it must be filed with the SEC.

Tombstone advertisements

A tombstone ad is not technically a prospectus at all. It is a bare-bones announcement that a new issue exists, carrying only the issuer's name, a brief description of the security, the offering price, and where to get a prospectus. Crucially, a tombstone is not an offer to sell, it simply points investors toward the real offering document.

Not every securities sale has to be registered with the SEC. The most important exemption for the SIE is Regulation D, which governs private placements. Three rules within it matter:

Rule 506(b): the traditional private placement

The classic version lets a company raise an unlimited amount, but with strict conditions: no general solicitation or advertising, unlimited accredited investors, and up to 35 non-accredited investors (who must be financially "sophisticated" enough to evaluate the deal). The securities are restricted, meaning they cannot be freely resold without registration or an exemption such as Rule 144.

Rule 506(c): general solicitation allowed

This newer version also permits an unlimited raise and, unlike 506(b), does allow general solicitation (advertising, social media, and the like). The trade-off: every purchaser must be an accredited investor, and the issuer must take reasonable steps to verify that status rather than just taking the investor's word for it.

Rule 504

Rule 504 is the small-offering version, capped at $10 million in a 12-month period, generally without general solicitation and with no specific investor-information requirements.

Regulation A (Reg A+)

Regulation A is a small-issue exemption, sometimes called a "mini-registration" because it is lighter than a full SEC registration but still requires a filing and an offering circular. It comes in two tiers, and the dollar caps are testable:

• Tier 1: up to $20 million in a 12-month period.
• Tier 2: up to $75 million in a 12-month period, with additional disclosure and audited financials.

Two more rules round out the offering material. Rule 144 governs the resale of two kinds of stock: restricted securities (the kind acquired in a private placement) and control securities (those held by insiders and affiliates). Selling either one back into the market comes with conditions, most importantly a required holding period and, for affiliates, volume limits on how much can be sold at a time.

Finally, a shelf registration (Rule 415) lets an issuer register a large block of securities once and then sell it off in pieces over time, up to three years, without filing a fresh registration for each sale.