Regulation of the Primary Market Underwriting activities are regulated by the Securities and Exchange

Regulation of the Primary Market Underwriting activities are regulated by the Securities and Exchange

Commission (SEC). The Securities Act of 1933 governs the issuance of securities. The act requires that a registration statement be filed with the SEC by the issuer of a security. The type of information contained in the registration statement is the nature of the business of the issuer, key pro- visions or features of the security, the nature of the investment risks associated with the security, and the background of management. Finan- cial statements must be included in the registration statement, and they must be certified by an independent public accountant.

The registration is actually divided into two parts. Part I is the pro- spectus. It is this part that is typically distributed to the public as an

Financial Institutions and the Cost of Money

offering of the securities. Part II contains supplemental information, which is not distributed to the public as part of the offering but is avail- able from the SEC upon request. The act provides for penalties in the form of fines and/or imprisonment if the information provided is inaccu- rate or material information is omitted. One of the most important duties of an underwriter is to perform due diligence.

The filing of a registration statement with the SEC does not mean that the security can be offered to the public. The registration statement must be reviewed and approved by the SEC’s Division of Corporate Finance before a public offering can be made. If the staff is satisfied, the SEC will issue an order declaring that the registration statement is “effective,” and the underwriter can solicit sales. The approval of the SEC, however, does not mean that the securities have investment merit or are properly priced or that the information is accurate. It merely means that the appropriate information appears to have been disclosed.

The time interval between the initial filing of the registration state- ment and the time the registration statement becomes effective is referred to as the waiting period: (also called the “cooling-off period”). During the waiting period, the SEC does allow the underwriters to dis- tribute a preliminary prospectus. Because the prospectus has not become effective, its cover page states this in red ink and, as a result, the preliminary prospectus is commonly called a red herring. During the waiting period, the underwriter cannot sell the security, nor may it accept written offers from investors to buy the security.

In 1982 the SEC approved Rule 415, which permits certain issuers to file a single registration document indicating that they intend to sell a certain amount of a certain class of securities at one or more times

within the next two years. 2 Rule 415 is popularly referred to as the shelf registration rule because the securities can be viewed as sitting on a “shelf,” and can be taken off that shelf and sold to the public without obtaining additional SEC approval. In essence, the filing of a single reg- istration document allows the issuer to come to market quickly because the sale of the security has been preapproved by the SEC. Prior to estab- lishment of Rule 415, there was a lengthy period required before a secu- rity could be sold to the public. As a result, in a fast-moving market, issuers could not come to market quickly with an offering to take advantage of what they perceived to be attractive financing opportuni- ties. For example, if a corporation felt that interest rates were low and wanted to issue a bond, it had to file a registration statement and could

2 The issuer qualifes for Rule 415 registration if the securities are investment-grade securities and/or are the securities of companies that have historically filed registra-

tion statements and whose securities comply with minimum flotation requirements.

FOUNDATIONS

not issue the bond until the registration statement became effective. The corporation was then taking the chance that during the waiting period interest rates would rise, making the bond offering more costly.