The Offering Process

The ’33 Act

In 1933, Congress, in conjunction with its formation of the SEC, passed the Securities Act of 1933. Known sometimes as the ’33 Act, the Act introduced the first modern set of rules and procedures for a company that wanted to issue securities to the public. Essentially, the Act took a fresh look at the entire offering process and tried to determine exactly what the process was all about. Ultimately, it reached two conclusions:

1. Disclosure
The foremost rules of the securities offering process involve disclosure. As part of the '33 Act, Congress determined that any and all corporate information that could be valuable to a potential investor should be disclosed to such investors during the offering process. Such information must include (after several later revisions):

• Management’s opinions as to the current state of the business, in addition to limited forward looking statements
• The company’s financial statements, including a balance sheet, and certain cash flow statements
• Information regarding significant transactions the company had undertaken within recent months
• The nature of the business and the industry that the business operates in
• General information about the company’s major shareholders and financial backers
• Information regarding the offering, including the rights of the shares offered, the number of shares offered, and the proposed use of the funds from the offering

See 15 USCS § 78l. 

The list above is non-exhaustive. The actual rules of the ’33 Act encompass the space of a book that is well over an inch thick. Even more voluminous are the various letters and pronouncements that the SEC has produced in interpreting the particular rules of the ’33 Act. Ultimately, however, you will note a trend in the above requirements. Specifically, they are all designed to give a potential investor as much information as is reasonably possible. See Bank of America Nat'l Trust & Sav. Ass'n v. Douglas, 70 App. D.C. 221 (D.C. Cir. 1939).

You will further note that what the list does not allow for is a great deal of latitude on the part of management to interpret the possible outcomes of the company’s future. The one allowance for such projections – in management’s discussion and analysis – is strictly limited as to what management is allowed to say. 

EXAMPLE: UpandDown, Inc. had decided to engage in an initial public offering. The company spent approximately eight months preparing its offering documents. In preparing the material, the company spent a great deal of time on its financial statements and preparing the documents in general. However, the company spent the vast bulk of its time in preparing the management’s discussion and analysis section. The reason for this was that the company wanted to put as positive a spin as possible on its operations and to show a very strong face to its potential investors. However, the company had been very ambitious in its wording of the statement, and on several occasions, after having submitting drafts of the offering documents to the SEC, was told that it needed to moderate the exuberance of its language in order to not “condition the market” to expect performance by the company in a manner that the company might not be able to fulfill.

2. Organization
A second goal of the ’33 Act is to encourage companies to get their books and operations in order prior to placing their shares on the open market. There is no question that putting shares in the hands of the investing public is an inherently risky move for a company. It was the position of the drafters of the SEC Act that any such risk might be mitigated if the company has gone through all of the steps to get its operations and books into shape for public inspection. As such, the ’33 Act operates as a fairly complex but manageable blueprint for a company that is truly prepared to place its ownership in the hands of the public.

EXAMPLE: High Roller, Inc. has recently begun contemplating an IPO. However, the company has been held by a single family for the past ten years and its financial books and records are in a shambles. Thus, in order to begin preparing the company for the offering, the company hired an accounting firm to start making sense of the financial history and status of the firm. The accountants informed the company that prior to any public issuance, the company would first be required to get its books in order such that they could comply with the Generally Accepted Accounting Principles (GAAP) as provided by the Financial Accounting Standards Board (FASB)

The Prospectus

Perhaps the single most important piece of the offering process is the creation and dissemination of the offering prospectus. The prospectus takes account of all of the information discussed above and much more. See 15 USCS § 77j.

The prospectus is initially drafted by the company’s board, its legal counsel, and the bank or banks that are going to be backing and selling the securities once they reach market. These parties combine their efforts to produce a document that conforms to the letter of the law and offers a full slate of information about the company and its finances. 

After the initial draft of the prospectus is prepared, the company forwards the prospectus to the SEC where it is reviewed. During this time, the company, through its bankers, will begin circulating a draft of the prospectus to investors – typically large investors such as mutual funds and large investment funds – to gauge their interest in the offering. 

Subsequently, the SEC will respond to the prospectus with comments regarding concerns that it may have with the first draft. Typically, the concerns raised by the SEC will be largely in regards to the presentation of information. The SEC will attempt to ensure that the prospectus contains statements of fact as opposed to statements of advertisement. Essentially, the SEC is concerned with two things. First, it is intent on ensuring the   truth of the material in the prospectus. While it would be impossible for the SEC to independently verify all of the information as presented by the company, the SEC staff will issue suggestions as to what it believes may be   misleading statements. Of course, if the prospectus does contain false statements, the authors of the prospectus can be liable to investors who detrimentally relied on those statements and lost money investing in the company. See Escott v. Barchris Constr. Corp., 283 F. Supp. 643 (S.D.N.Y. 1968).

Additionally, the SEC staff will be concerned as to whether or not the company is stating its operations and potential in such a way that it is attempting to “condition the market”. In either situation – where the company is conditioning the market or not being totally honest about its finances - the staff will order the company to revise the prospectus.

In response to the staff’s comments, the company will then alter the prospectus where necessary, and redistribute it to all the potential investors who were originally issued the material. As law firms are usually hired to draft and revise the prospectus, it will likely fall on the paralegal’s shoulders to ensure that the prospectus is properly redistributed to all investors. Failure to do so may result in censure by the SEC and/or delay in the offering.

EXAMPLE: Getting Going Co. has entered into the IPO process. The company previously prepared and submitted a draft of its prospectus to the SEC. Subsequently, the SEC’s staff members who had been assigned to work with the company sent the firm a list of changes that they would require of the prospectus before the SEC would allow the prospectus to be declared valid so as to let the company begin issuing securities. When Getting Going’s board and attorneys read the SEC’s proposed changes, they were concerned as to the extent of the changes. Thus, they responded to the changes with a modified draft of the prospectus along with a list of their reasons for agreeing or disagreeing with the staff’s proposed changes.

The Issuance

After the prospectus has been viewed by a sufficient number of individual investors, the company and its bankers will then send a final draft of the prospectus to the SEC for approval. Upon the SEC’s certification of the prospectus, the company is then legally allowed to issue the securities and sell them on the open market. However, before this final step is taken, the company, the banks, and the company’s counsel will determine the final issuance price for the security. Finally, once the security has been priced, the company or its bank will then print the final prospectus and begin selling shares to the investors. 

As shares begin to trade, it will become clear whether the company has done a good job of providing the information required by potential investors and whether or not the bank has done a reasonable job of pricing the securities. Ideally, the price should appreciate to a limited extent in the aftermarket after the IPO issuance. 

EXAMPLE: Finally, after over 8 months of work, IPO Co. was cleared for its first offering. On the evening before the issuance, the company had the final version of the prospectus, which had been approved by the SEC, printed and prepared for distribution when the shares began trading. As the shares hit the market at the price of $18 per share, the market showed clear signs of support for the offering as the price rose as high as $22 per share in the first day’s trading.

Your Job

Ultimately, the role of the paralegal professional in a share issuance is varied and complex, depending on the transaction. You should familiarize yourself with the general layout of a prospectus. You can download an example of a past prospectus for mutual funds that have been issued by looking at the SEC’s web site at http://www.sec.gov/edgar/searchedgar/prospectus.htm. In doing so, you will be able to familiarize yourself with their layouts and contents. While you will certainly not be responsible for ensuring that all necessary information required in a prospectus is present, having some idea as to the content for a prospectus will help you identify any glaring omissions from prospectus preparations that you participate in.

Additionally, if you are called upon to track the dissemination of prospectus initial drafts and subsequent versions of the draft, a task that is sometimes fulfilled by paralegals, you should be particularly cognizant of the   responsibility that you have been given. The law requires that every investor who received a prospectus draft must receive each subsequent draft. If an investor fails to receive a subsequent draft and the SEC is alerted to the discrepancy, then it may delay final clearance of the issuance until the problem is rectified. Such a delay, no matter how slight, can result in extensive additional costs. Moreover, the resultant delay may also cost the company the window of time that it had for completing the issuance. The securities markets are unstable. While the company may be in a position to offer its shares on one day, that window of opportunity may well be lost a moment thereafter if news reaches the market that conditions it against the issuer. Thus, while this job may seem merely logistical in nature, it is extremely important that you perform it appropriately.

EXAMPLE: Oops Inc. had spent months preparing an IPO. However, it was discovered in the final few days of the preparation period, that a large number of potential investors had not been given the final draft of the prospects. When the SEC discovered this oversight, they required the company to postpone the offering for several days to ensure that all investors received the proper prospectus versions. However, during that few days, a company that was a competitor of Oops was found to have a group of investors who had been operating certain portions of their firm’s business illegally. While Oops had no such legal troubles, it became quickly apparent that the market was worried that similar circumstances might be rampant in companies within the industry. As such, and despite the fact that Oops now had full SEC approval, the company chose to delay its IPO until the markets had regained its confidence in companies in Oops’ industry.