Financial Markets and Institutions (2-downloads)

registration statement with the SEC. This statement contains information about

the firm’s financial condition, management, competition, industry, and experience.

The firm also discloses what the funds will be used for and management’s assess-

ment of the risk of the securities. The issuer must then wait 20 days after the reg-

istration statement is filed with the SEC before it can sell any of the securities. The

SEC will review the registration statement, and if it does not object during a 20-day

waiting period, the securities can then be sold.

The SEC review in no way represents an endorsement of the offering by the SEC.

Their approval merely means that all of the required statements and disclosures

are included in the statement. Nor does SEC approval mean that the information is

accurate. Inaccuracies in the registration statement open the issuing firm’s man-

agement up to lawsuits if it incurs losses. In extreme cases, inaccuracies could result

in criminal charges.

A portion of the registration statement is reproduced and made available to

investors for review. This widely circulated document is called a prospectus. By law,

investors must be given a prospectus before they can invest in a new security.

While the registration document is in the process of being approved, the investment

banker has other chores to attend to. For issues of debt, the investment banker must:

• Secure a credit rating from one or more of the credit review companies,

such as Standard and Poor’s or Moody’s.

●

Hire a bond counsel who will issue a statement attesting to the legality of

the issue.

●

Select a trustee who is responsible for seeing that the issuer fulfills its oblig-

ations as stated in the security’s contract.

●

Have the securities printed and prepared for distribution.

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Chapter 22 Investment Banks, Security Brokers and Dealers, and Venture Capital Firms

547

For equity issues, the investment banker may arrange for the securities to appear

on one of the stock exchanges. Clearly, the investment banker can be of great assis-

tance to an issuer well before any securities are actually offered for sale.

Underwriting

Once all of the paperwork has been completed, the investment banker

can proceed with the actual underwriting of the issue. At a prespecified time and

date, the issuer will sell all of the stock or bond issue to the investment banking

firm at the agreed price. The investment banker must now distribute this issue to the

public at a greater price to earn its fee. (The 10 largest underwriters in the United

States are listed in Table 22.1.)

By agreeing to underwrite an issue, the investment banking firm is certifying

the quality of the issue to the public. We again see how asymmetric information helps

justify the need for an intermediary. Investors do not want to put in weeks and weeks

of hard technical study of a firm before buying its stock. Nor can they trust the

firm’s insiders to accurately report its condition. Instead, they rely on the ability of

the investment bank to collect information about the firm in order to accurately estab-

lish the firm’s value. They trust the investment bank’s assessment, since it is back-

ing up its opinion by actually purchasing securities in the process of underwriting

them. Investment bankers recognize the responsibility they have to report informa-

tion accurately and honestly, since once they lose investors’ confidence, they will

no longer be able to market their deals.

The investment banking firm is clearly taking a huge risk at this point. One way

that it can reduce the risk is by forming a syndicate. A syndicate is a group of invest-

ment banking firms, each of which buys a portion of the security issue. Each firm

in the syndicate is then responsible for reselling its share of the securities. Most secu-

rities issues are sold by syndicates because it is such an effective way to spread the

risk among many different firms.

Investment banks advertise upcoming securities offerings with ads in the Wall

Street Journal. The traditional advertisement is a large block ad in the financial sec-

tion of the paper. These ads are called tombstones because of their shape, and

TA B L E   2 2 . 1

Top 10 U.S. Underwriters of Global Debt and Equity

Issues, 12/31/09