Securities Law 1 7 17 1 Explain what is meant by information asymmetries and how these affect the raising of capital 17 2 Explain the purpose of securities law and regulations in the financial markets ID: 332973
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Investment Banking and Securities Law
17
17
.1
Explain what is meant by “information asymmetries” and how these affect the raising of capital.
17
.2
Explain the purpose of securities law and regulations in the financial markets.
17
.3
Explain what a prospectus is, what it contains, and why it is critical for initial public offerings (IPOs).
17
.4
Outline the basic steps in taking a firm public through an initial public offering (IPO) of securities.
17
.5
Explain why continuous disclosure requirements are important for investors and how they affect secondary offerings.Slide3
17.1 CONFLICTS BETWEEN ISSUERS AND INVESTORS
Issuers of SecuritiesCorporations must issue securities to raise capital in order to invest in plant, equipment, working capital, research and development in order to produce products and services that meet needs in a competitive market environment
Corporations must design securities that meet the needs of investors
Investors in Securities
Investors have surplus cash at the moment, but hope to invest the cash and increase its valueSome investors have long investment horizons and the capacity to accept risk (e.g., large pension funds)Other investors have shorter investment horizons, require liquid investments and can only accept minimal risk
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In addition to issuers and investors, other participants in the financial markets include:
Financial intermediaries (e.g., brokers) that bring buyers and sellers togetherUnderwriters that help bring new security issues to marketSpeculatorsArbitrageursGiven the diversity of parties, interests, goals, skills and access to information, the financial marketplace is an attractive target for scam artists who seek to take advantage of others.
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© John Wiley & Sons Canada, Ltd.17.1 CONFLICTS BETWEEN ISSUERS AND INVESTORSSlide5
Asymmetric Information
Information asymmetries occur when one party in a deal has more information than another partyThe party with superior information can use that information for their own benefit at the expense of another partyImplications of Fraud for Financial MarketsIf investors are not convinced that markets are reasonably fair and that participants obey the law, they will not invest.
Healthy capital markets are necessary for businesses to have access to capital so they can invest and create economic growth, thereby raising peoples’ standards of living.
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17.1 CONFLICTS BETWEEN ISSUERS AND INVESTORSSlide6
Examples of Fraudulent Activities
William Lyons attempting to sell US$220 million of fraudulently issued zero-coupon bonds to Bear Sterns, Merrill Lynch, Goldman Sachs, and Chase ManhattanThe use of bearer bonds in Europe
Ponzi
schemes
Madoff scandalSecurities dealers dealing in penny stocks through “bucket shops”Highly speculative mining and real estate companies issue shares“Wash sales” and high pressure sales tactics are usedThe case of Norbourg Asset Management Inc., where its founder was accused of stealing $84 million of investors money from the firm he controlled
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17.1
CONFLICTS BETWEEN ISSUERS AND INVESTORSSlide7
17.2 A PRIMER ON SECURITIES LEGISLATION IN CANADA
Securities Legislation—Basic Responsibilities
Under the Canadian Constitution provinces are responsible for securities regulation
Many argue that a national securities regulator would improve the efficiency of Canadian financial markets by harmonizing laws and their enforcement
Provincial regulators, like the Ontario Securities Commission, meet regularly to coordinate efforts through the Canadian Securities Administrator (CSA)The CSA issues national policy statements that provide recommendations for provincial regulators, and maintains the System for Electronic Data Access and Retrieval (SEDAR), a website that publishes information on all publicly-traded companies in CanadaBooth • Cleary – 3rd Edition
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Securities Legislation—Basic Responsibilities
What is a security?A security includes “any document, investment or writing commonly known as a security.”The factors considered to determine if a security exists are:Whether the promoter raises money and leads the investor to expect a profitWhether the investor has any control on how the money is spent
Whether there is risk involved
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A PRIMER ON SECURITIES LEGISLATION IN CANADASlide9
Securities Legislation—Basic Responsibilities
Ontario Securities Commission (OSC) OversightSince the largest Canadian stock market, the Toronto Stock Exchange, is in Ontario, the OSC has considerable responsibility and influence over securities regulation in Canada
The OSC is involved in five major areas where securities are either transferred or traded:
Primary market offerings
Secondary market tradingActivities of investment professionalsInsider tradingTakeover bidsBooth • Cleary – 3rd Edition
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17.2
A PRIMER ON SECURITIES LEGISLATION IN CANADASlide10
Security Offerings
Initial Public Offerings (IPOs) are primary offerings of securities to the public in a first-time distribution by the issuer which must be accompanied by a prospectus
A
prospectus
is a document in support of a public offering of securities that must provide “full, true and plain disclosure of all material information pertaining to the security being issued.”A long-form prospectus contains information about the corporate issuer, directors, financial performance, operations, etc.Booth • Cleary – 3rd Edition
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17.2
A PRIMER ON SECURITIES LEGISLATION IN CANADASlide11
Security Offerings
A short-form prospectus contains information about the particular securities being offered including the price, type of security, intended use of proceeds, etc.An
offering memorandum
is a disclosure document in support of an offering of securities in the
exempt market, and has the same objectives of disclosure as a prospectus but offers significantly less information because of the nature of exempt (i.e., sophisticated) investors.Booth • Cleary – 3rd Edition11© John Wiley & Sons Canada, Ltd.
17.2
A PRIMER ON SECURITIES LEGISLATION IN CANADASlide12
The Motivation for
IPOsGoing public requires a firm to incur significant changes and costs, including:Costs of meeting market listing requirements such as information disclosure requirementsUnderwriting and distribution costs, e.g., prospectus costs, underwriter’s spread and any
underpricing
of the IPO
Listing feesBooth • Cleary – 3rd Edition12© John Wiley & Sons Canada, Ltd.
17.3 IPOs AND INVESTMENT BANKINGSlide13
The Motivation for
IPOsThe motivations for going public include:Access to capitalGreater public visibility, which could increase the market demand for the firm’s products and servicesProviding venture capital firms and entrepreneurs the opportunity to harvest their investment
Rewarding managers through options that have a market value
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17.3 IPOs AND INVESTMENT BANKINGSlide14
17.3 IPOs AND INVESTMENT BANKING
The Stages of the IPO Process
Stage 1
: Initial discussion with an investment dealer, which then triggers the formal IPO process
Stage 2: Drafting an initial prospectus and deciding on the broad type and terms of the public offering (choosing from four types: best efforts offerings, firm commitment offerings, bought deals
, or standby/rights
offerings)Stage 3: Finalizing
the prospectus and
waiting for clearance
from the securities
commission (
commonly called the
“
waiting period
”)
Stage 4
: Pricing
and distributing the issue and providing after-market
stabilization
(commonly called the
“
distribution period
”)
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17.3 IPOs AND INVESTMENT BANKING
The Stages of the IPO Process
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IPO
UnderpricingIPO underpricing occurs when the initial offering price of an IPO is less than its market value on the first day of tradingSystematic underpricing in occurs in some OECD countries because of:
Competition for underwriting business
Litigiousness of investors
Spinning, where the underwriter allocates IPOs to favoured clients knowing they will make a large profit on the first day of tradingBooth • Cleary – 3rd Edition16
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17.3
IPOs AND INVESTMENT BANKINGSlide17
17.4 POST-IPO REGULATION AND SEASONED OFFERINGS
The Post-IPO MarketFollowing the IPO a quiet period is required before the investment dealer’s research analysts can initiate coverage on the company, since the prospectus is assumed to provide sufficient information during the distribution phase.
Misleading research reports were identified in the U.S. during the Internet bubble of the 1990s and analysts from major U.S. underwriters were charged for providing these reports.
Some of the guilty underwriting firms encouraged and rewarded the practice of providing misleading information because of “self-dealing.” The underwriter had a financial interest in the success of the security offering and so encouraged its analysts to write overly positive reports on the security’s prospects.
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Continuous Disclosure Requirements
After an IPO, investors do not receive a prospectus when they invest in the securitiesPublic companies are expected to become reporting issuers and provide continuous disclosure, including:
Quarterly and annual financial statements
Annual information forms (AIFs)
Proxy and information circularsPress releases on any material informationAll required information for public issuers in Canada is available at www.sedar.com Booth • Cleary – 3rd Edition18
© John Wiley & Sons Canada, Ltd.
17.4 POST-IPO REGULATION AND SEASONED OFFERINGSSlide19
Seasoned Offerings and Short-Form Prospectuses
Reporting issuers in Canada can take advantage of the annual information form and short-form prospectus (a system known as the Prompt Offering Prospectus, POP, system) in order to speed their access to capital markets.
The short-form prospectus system has given rise to the use of the “bought deal” in Canada, where the underwriting contract is signed even before the drafting of the preliminary prospectus.
The underwriting market in Canada has become extremely competitive as information requirements have been decreased through the POP system.
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17.4 POST-IPO REGULATION AND SEASONED OFFERINGSSlide20
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The Size of the Investment Banking Market
17.4
POST-IPO REGULATION AND SEASONED OFFERINGSSlide21
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