|Selling Group |
A selling group is a group of broker dealers who help distribute the stock - they are graciously invited to participate in this process by the managing underwriter, who in dulcet tones says: "You take all of my deals or none of them. If you don't like that setup get the hell out of my office." \par \par In the underwriting business you are only as good as your last deal. You can have twenty straight underwritings that go to the moon, but come up with one bad apple your firm becomes persona non grata on Wall Street.
Formerly, Wall Street underwriters created successful issues by carefully placing the stock in the hands of brokers who bought it as an investment rather than as a source of quick profits. In the old days, the guys that would really hold onto stuff were the institutions. Today, in an intensely competitive market, five minutes can be long term for the new breed peripatetic institution.
Another strange characteristic of an underwriting is that there must be enough shareholders when it is all over for the company to qualify for one of the exchanges or NASDAQ. (seven hundred is kind of minimum) Even if the institutions were willing to hold the stock until hell froze over, it wouldn't do the shareholders any good if it wasn't traded anywhere. Therefore, there has to be a mix between institutional and retail underwriters of the stock.
Wall Street brokers also seek out broker/dealers who are regionally orientated within close proximity of the Target Company. If the company is located in Iowa, often finding the top regional Iowa broker-dealer to come into the deal will add buying power and credibility to the transaction. People that are familiar with the company on a day to day basis make better long-term players than traders having no ongoing interest in its affairs. Nobody, including Wall Street underwriters, discounts the home court advantage.
The more focused Wall Street underwriters, if it isn't a wire house (the term originated from all the branches being connected by telephone or telegraph wire) such as Merrill or Smith Barney is extremely specialized in their approach to the IPO business. Their deals tend to share common characteristics, and the group of firms that they tend to allow into their underwritings historically remains intact over the years. These firms are called "selling group" members. These people have no particular axe to grind.
They have no financial interest in bringing out the deal other than the commissions that they receive and the good will, which is generated if the deal goes to a premium. They receive a much-diminished commission because they are taking on a reduced risk. Selling groups receive none of the glory that comes with a successful underwriting but share none of the shame if it goes bad. They are the mules of the underwriting business. As long as they continue to be good lads and bring more buyers than sellers to the table, the managing underwriter continues to abide them. When the managing underwriter is "hot" every member of its selling group makes money. When the managing underwriter is not "hot" the loyal group soon dissolves and looks for a new fearless leader type.
In firm underwritings, the underwriter's capital is at risk on of the effective date. The underwriter buys the shares of the company that is going public at the cost of the shares less his underwriter's commission based on the terms of the letter of intent. At this time more often than not for the purposes of being in the securities business, he goes "out of ratio". This means that in the complex formula used to compete whether brokers are healthy or not, this guy has just become critically ill. His penalty for this affliction is either promptly raising more money or getting rid of some of the risk.
For this reason, underwriters form "syndicates" which operate somewhat akin to the Mafia. Syndicate members are placed in "brackets" which define their hierarchy in the organization just as the Mafia places "made men" on top, the most important members, next come the "captains" or "capos" who are important but not in the inner circle and bringing up the rear are the "soldiers" who if need be a dispensable. When the Tombstone is appears in print you have the managing underwriter or underwriters appearing over everyone else, kind of floating above the lower ranking members. The next group appears alphabetically for several lines and then the alphabet start over. This is the point when we enter the second tier underwriters, and then a third and a fourth and even a fifth depending on the transaction's size. It you want to get a better idea of how the firm you do business with is perceived by the Street, find a tombstone bearing their name and see what group they are in. Remember, some guys aren't there are all, and these are the selling group members or those not even qualified for that.
In order for underwriting members to become more important to the organization (syndicate) they must perform outstanding things such as being perceived by institutions as being bigger than life. This is an extremely had thing to do and usually people remain in the same niche during the life of the syndicate.
Usually, the only way to break out of this rut is to buy out your higher-ranking competition, which catapults you ahead of other members into the "bracket" of the firm you acquired, subject to approval of the loftiest members, usually consummated at a sit-down. This effectuates three things at once, you are allowed to lose or make more money in each transaction, your name appears ahead of your peers in the newspaper whenever the "syndicate" transacts business making you appear magisterial in the public's eyes and least important you have eliminated substantive competition, increased your profitability and added to your management base.
The organizer of the syndicate, you know, the fellow whose firm didn't have enough in the bank to finance the deal, still runs the show as "syndicate manager" the "Don" of the underwriting world, he determines who will make up his syndicate and what each one's participation in the profits will be. This is usually determined by how well the member performed in his last assignment. (Performance is usually determined by how many shares of the deal his customers purchased in the market after the underwriting books were closed. ("After market"). You do not stay in the organization very long without showing results.
For all of his organizational skills and more importantly his convincing the target company that they should sign with him, the managing underwriter receives an override of all of the spoils before the profits are divvied up among the participants. Although these groups remain together without changes for long periods of time, from time to time certain unforeseen circumstances arise and specialists must be brought in to help the syndicate in nuances of the transaction. (Similar needing an expert safecracker when committing in a bank robbery, usually these people are brought in from out of town just for the one deal).
At the successful culmination of the underwriting, the syndicate proudly displays the members of the group and their respective position in the hierarchy in the press. Substantial outlays of money are expended to proclaim the members, their roles, the subject of the transaction that they put together and how much money was involved. Members that appear at the bottom of the list usually do not feel ashamed because they, for some reason, are proud to be in the company of such an esteemed company. These newspaper announcements are for some reason called "tombstones", and the only reason that we know of for that name, is that by comparing the current "tombstone" with its predecessor you can determine which firms have ceased business or have committed an unnatural act since the previous deal.
Often firms stop appearing in a "Tombstone" when they have gone out of business or committed a violation of the syndicate's code. This information is not part of the tombstone and the public often is unaware that a grave sin has been committed by the former member. Often when people see this handsome advertisement they become interested in purchasing stock in the underwriting. When they call their broker there are informed that if they had read the "fine print" in the ad, they would have seen that this was not an offering of securities, it was just a matter of record of a transaction that had been completed.
It has been said that tombstone advertising is the most costly form of advertising, it offers nothing and says little. It is historic in nature, requires no comment, and contains no redeeming characteristics other than giving members self-gratification. We could have told the tombstone reader that the stock had been allocated among favored clients of the various firms that participated in the deal. The reason is that these people gave great amounts of business to the firms and are rewarded for their loyalty if it was known in advance that the deal was going to go to a premium. If it were expected that the price would diminish, you can rest assured that the caller that came in late would have somehow been offered the ability to participate in the transaction.
Sales of Hot Issues
Hot Issue -- New Issue of stock that is in great demand and is oversubscribed.
Firms are restricted in the sale to:
A Broker Dealer's proprietary acct.
Accounts of officers, directors, partners, employers of Company
Senior officers of a bank, insurance company, or any employee involved in a securities department.
General speaking the price at which an IPO will come to market and where it will then trade are uncomplicated to figure out, but that is only if you are on the inside. An underwriter is in the inexplicable position of representing both the buyer and seller as principal. This in terms of law is an extremely tenuous position to be placed and can result in substantial legal problems. Strangely brokers are not apprehensive of being put into this strange legal position because it is such a profitable place to be. On one hand, he has the legal obligation as a fiduciary to always try to get his client the best possible price when executing an order. On the other hand, his obligation to the company going public is to get them the maximum amount of money he can. Historically making a decision between the two has been a no-brainer for the broker. His client is in the market everyday and represent the brokers bread and butter, so that if there is latitude in the pricing of the underwriting, and there is, the broker will price it so that it will go to a premium immediately upon becoming effective. Thus demonstrating to the world that the company was shortchanged. This makes all of the brokers friends who were on his "A" list happy campers. The broker also is made contented because everyone will see in the tombstone that he was the underwriter and recognize he had a winner. It will probably make the company that went public sad to know that the underwriter could have gotten them much more for their property and literally sold them down the river. They probably will never know that the how much it really was. When asked by company officials the syndicate manager usually replies that they have no control over public demand for an issue and therefore do the best they can when pricing the deal. If you believe that then we have a bridge here in New York that can be purchased from Chapman Spira and a bargain price. how do they know what the price will be.
Sounds good in principal, but they know almost to the nickel what the price is going to be. The managing underwriter keeps the books, he knows exactly how many shares are desired by other brokers, he knows how many shares his firm wants, he also knows how many he is going to give them. So in the interest of simplicity, let us say that there are requests for three times as much stock as are going to be underwritten, a certain number of those people will purchase the shares at a higher price in the market, a number represents an historic percentage that varies somewhat based on the degree of premium. (difference between the effective price and the price the share are selling at in the marketplace). In brokerage parlance, running the books in a syndicate is like betting on a horse a week after the race is over.
Some brokers make it mandatory that if you are assigned share at the original price, more shares must be purchased at higher prices.. (this is illegal but common) There are many people that think this is a good idea, those are the same people that fought so hard to get the deck shares on the Titanic. This causes the stock to rise even higher and friends and nominees of the broker are the only ones allowed to sell. When the smoke has cleared, often the deal is in shambles and the money has found its way into the underwriters pocket. Luckily most firms do not specialize in this business, but the unsuspecting can ferret them out without to much trouble. Doctor Bob has dealt with almost every one and look where he is. After a number of years, the owners of the brokerage firm become philanthropists and are looked upon as public-spirited citizens who promote import projects in the community. The securities industry is not the only one in which people turn legitimate only after they retire.
There are more sophisticated ways that new issues can be used to help the broker become very rich. Some money managers are very greedy people, others have little or no conscience. These people have many friends in the brokerage community. In exchange for shares having been allocated to the money managers personal account, the manager agrees to place substantial of the funds under his management (belonging to other people) at the disposal of the broker. Thus the broker has provided himself with source of funding for his pet projects. Many people that have entered into these types of transactions are now in jail, but not enough. Many of the people that have entered into these types of transactions are still on the Street and highly regarded in their profession. They will probably never be caught.
A more important way for a broker to profit from his own underwritings is to open an offshore account domiciled in a country where there are laws keeping depositors identities secret. This account becomes a retirement nest egg and if set up in the right place totally avoids all taxation. Often brokers find it convenient to have money stowed away somewhere else when they are required to leave the country very abruptly. These are forward thinking people who probably did well in college.
Often when an underwriting is being contemplated the brokerage firm that has been chosen for the job has conflicts of interest that may prevent them from being totally objective about the deal. These conflicts can assume various forms but the most common is the instance where the brokerage firm or its principals are also large shareholders in the issue. The National Association of Securities Dealers (NASD) does not find a problem with a brokerage firm selling the stock in a firm that is controlled by the managing underwriter, they don't even have a problem with the fact that it is the brokerage house negotiating all sides of the transaction, the price at which the issue will be brought public, the percent interest the public will receive, the amounts spent on professional fees, corporate salaries and management's stock options.
What the NASD says is required for the brokerage firm to get away with murder is simply that they must hiring another broker has been in the business for a reasonable amount of time and has had a good record to participate in the evaluation of the deal's pricing to determine the fairness in the pricing of the proposed transaction. They do not tell you that you can't hire your college roommate who still owes you six big ones that you lent him when his girlfriend got pregnant. This is the same character that the last time this guy did an underwriting was the historic instance of the president of the company fleeing the country with the proceeds of the deal just ahead of his parole officer and the tobacco and firearms people. The deal's selling group members that lost their shirt when the president skipped were so mad that rumor has it, a hit was put on the underwriter. In spite of all of that, his name will appear in the prospectus along with his charitable statements regarding the deal's pricing. Even Doctor Bob said that he thought something was wrong with this.
Green shoe - the broker has other ways of controlling his own income and the price of the underwritten security. Most agreements call for the use of a "green shoe" at the underwriters discretion. A green shoe is one in which the brokerage syndicate is allowed to expand the size of the offering by up to 10% at the last minute solely at the underwriters discretion. This is done for several reasons, it increases the money that the broker makes, it increases the money going to the company and it allows more participation in the deal. The additional shares also have a tendency of holding the price down a bit.
The background for the name green shoe is somewhat obscure, but an influential Wall Street person once told me that green is the color of money and shoes are what you can buy with the additional profits generated from the extra stock. I think he must have been thinking about the expression from crap games where the shooter hollers something about his baby needing a new pair of green shoes. Some ninny once said that there was a company by the name of Green Shoe Company in which the term was first applied. We don't see any reason why anyone would want to name a company Green Shoe. This is probably just an old wives tale.
Free riding and withholding -- member firms may not withhold securities that are part of a new issue if hay have unfilled public orders. The underwriter has the deck totally stacked in his favor because they know how many shares there are to buy and sell coming into the market, they are usually making the market in the securities and are able to field all the inquires from the straight relative to the issue, they have the pent-up demand of people obligated to buy additional shares and they have a magic time stamp machine.
The time stamp is an integral part of a brokerage operation. Every order that is entered on the books of the broker-dealer must be stamped at that time. When the trade is executed another time stamp is made on the order so that a complete record is made of when the order went into the system and when it came out. This is an excellent method of determining who is right when a customer complains that his price should have been different than what was reported to him.
The name of the contra-party (the other side of the trade, all transactions of another side) is listed on the same ticket as the time stamp, thus in the case of a dispute reference can be made to the contra-parties time stamp as well. If that isn't enough, the transaction was reported and this too is stamped. Thus a pretty good case can be made at all times, what the stock was selling for in the market when the order was executed. As a matter of fact the system seems almost foolproof. \par \par \par When a firm commitment underwriting is completed the stock is taken down in one piece by the brokerage firm and then reassigned to customers. These transactions can be of record in the places indicated above. However, Doctor Bob was telling us a funny story about that. He was sitting in the broker's office and there was this guy with a timestamp putting the time on hundreds of tickets, Doctor Bob introduced himself to timestamp Harry and asked what was going on. Harry said that there was this big offering coming out and he was getting ready for it by stamping the tickets. "How do you know how many to stamp?" asked Doctor Bob, "I don't see you keeping an account." "Well". Harry said, " they don't tell me, because maybe they are going to need extras" You see they wait to see how well the deal does, how much of premium it goes to. If it goes way up they take the tickets that are stamped and are in blank and put their own names on them. If it doesn't do so well, they give it to customers that have discretionary accounts with the firm. When I'm done stamping I have to have enough to two sets of tickets, it's a more exact job than you think. Time stamping is really complicated you know and I report only to the boss because I do such a good job. He told me that we were really working together and I shouldn't discuss this with anyone else, but I've seen you around and know that you're OK."
Bob wasn't sure what Harry meant, but since he never heard of anyone doing nothing but time stamping things all day he thought that it was worth repeating. Bob wondered whether this was something that you could go to school to learn.
Doctor Bob said that he became very nervous around timestamp Harry when he Harry informed him that he was the one in the company responsible for reporting to Edgar. He mentioned that everything anyone in the firm did was Edgar's affair and that Edgar was expecting to update shortly on the final elements of the deal he was time stamping. This sounded really scary, Doctor Bob thought the top guy was working right here, in the big office down the hall. It now seemed to Doctor Bob that he was really a figurehead and someone much bigger was running the show.
Bob became really concerned because he had a lot of money sitting at the firm and he called the SEC and told them that the brokerage firm he was dealing with was reporting everything to Edgar. The fella Doctor bob was talking said that this was good and hung up. Believing he had discovered a massive securities plot where even the SEC had become involved Bob left no stone unturned in his efforts to find out what was really going on.
Ultimately, the U. S. Attorney asked Doctor Bob to put his problem in writing and when they got back to Bob they explained that it wasn't a guy named Edgar but a computer program called EDGAR (Electronic Data Gathering Analysis and Retrieval).It seems that this computer system was created and is operated by the SEC to eliminate unnecessary paper work and speed the securities processes along. Relieved, Doctor Bob and Timestamp Harry became fast friends and would often lunch together after Harry had finished his work.
Stabilization -- form of price manipulation permitted by the Securities and Exchange Commission. If the underwriter didn't posses enough tools, the SEC itself allows him to stabilize the deal. In other words, the SEC doesn't want this thing trading all over the place where nobody can keep up with what's going on. They're interested in a "fair and orderly" market being maintained in the issue and appoint the underwriter as their representative with the power manipulate the market so that trading becomes non-chaotic.
Dishonest brokers can use this to their advantage. Whereas the rules state that the stabilization should take place at the deal's offering price, they do not address the price at which the securities in question can be sold. The underwriter then legitimately issues the shares to his clientele and the stock goes nowhere. Becoming disenchanted with the deal the clients sell the stock, which under the regulations can be purchased by the dealer. When he has accumulated a large enough amount of the float and there are no sellers left, the issue suddenly sprouts wings and becomes a success. The underwriter did not make many friends among his customers with this tactic but he did make a lot of money and felt that this was good.
Lawyer - Someone who went to law school and passed the bar exam in at least one state. This person instead of becoming a legitimate member of his community began practicing securities law. This is a good field for someone with a computer because having once completed an offering, you can use the same documents over and over again by just making minor changes in the name, amount of money being raised and the name of the underwriter. Although lawyers in securities work complain of long hours and grueling work, we think it is mostly for effect. As long as the word processor is in good order, lawyers are capable of making a good living.
Underwriter's counsel - A lawyer that represents the underwriter and passes on the legal merits of the deal for the brokerage house.
Issuer's counsel - A lawyer that represents the issuer, how in manner cases is picked by the underwriter because he has all of this stuff on his word processor and for other high sounding reasons. Underwriter's counsel and issuer's counsel often are good friends after hours, which makes the negotiations go much faster. Both lawyers are paid substantial amounts of money, much of which comes from the proceeds of the transaction. It is in both of their interests under the circumstances that the underwriter stays healthy, at least until the deal is completed. They try to arrange that underwriter does not have to lose his temper and get his blood pressure up in his dealings with the parties involved. Because of the substantial concern that these good people maintain for the underwriter's health, most arguments are quickly settled in his favor.
The Process of Registration
The process is much more complex, expensive and harrowing then can possibly be envisioned by a few short paragraphs in a memorandum such as this. You will be entering a battlefield that will require all of you guile to transverse all of the obstacles that have been placed between you and your objective. Critically important is not to make the process even more difficult that it already is. This requires teamwork between your accountants, lawyers and broker. You as the field marshal must make certain that they are constantly coordinating their efforts so that all required documents are submitted not only on a timely basis but that they are submitted in the form required by the Securities and Exchange Commission.
The process begins when a proper preliminary prospectus is filed with the SEC. This gets you into the queue, but it isn't the type of line that you had at the movies in high school. In this line, each time you strike out the teacher sends you to the back and makes you do it over again until you can get it right. So until the first step is done correctly the queue doesn't even accept you, it is only when you submission is considered acceptable that you allowed to be in line.
This is extraordinarily import because your underwriter has created a calendar of IPOs and has scheduled them based on when he is best able bring them to market and more important when he has room in his stable for another issue. If an issue is delayed by Washington for an unreasonably long period of time, for any number of reasons, the issuer may suffer two simultaneously adverse events. The first is that the SEC queue line has begun without him other event that could make it a really bad hair day is that the offeree's place in line with the underwriter now runs the risk of becoming usurped by another IPO because of scheduling problems. There may not be are recovery from this problem because as the longer the clock fails to tick, the more the risk that the submissions have become "stale" (outdated) and the SEC, like Mother Nature does not abide stale offerings.
With the each tick of the clock, the substantial costs of registration run like an runaway whirling dervish. Pity the poor issuer that had deficient advise to begin with, the lawyers and accounting fees may soon make up an unacceptably high percentage of the deals "use of proceeds " and both the SEC and the underwriter could determine that they are no longer interested in a public offering, the proceeds of which are primarily dedicated to paying off the professionals. Sage advice would have mandated that the professionals agree in advance to a set fee in taking the deal all the way through to completion. Many Wall Street accountants and lawyers would agree in advance to a lessor fee, or hopefully no charge at all, if the deal aborts because of uncontrollable developments such as very poor market conditions and problems in the issuers industry that did not antedate the filing.
One of the pet peeves of the SEC in reviewing a registration statement is that of inferior readability. In other words, the lawyers are really trying to strut their stuff and draft the registration in legalese rather than readable English. The SEC would view that as not being able to be read by the average investor and would send it back to the issuer to start again.
There are times when underwriting are popular and other times when you couldn't give one away. The staff that works on these things at the SEC remains fairly constant during both periods so that as a generally rule delays in busy periods produce a wait in back of a longer line than one when things are quiet. Actually, the person assigned to walking your project through the commission will have much more time to be of assistance during quiet periods.
The use of EDGAR and other electronic filing devices have improved turnaround time, but in spite of that, more deals than ever are being perused by the commission and very often it is liking trying to go cross town in Mexico City during the rush hour. On the other hand, if when making the original submission, a well written transmittal letter is furnished the commission with all material matters discussed in workmanlike manner the commission would also attempt to live with a realistic underwriting timetable if it is possible. Remember that coming out of the SEC to early and you underwriter might not be ready for you and the data you have in your registration statement may have to be updated, the market could collapse in the meantime or even worse the broker could go out of business. I mean it has been known to happen.
Competent lawyers are well aware of the preceding but sometimes local attorneys attempt to practice on their client because it doesn't so hard to do and I've got something similar in the word processor. Down deep in my heart, I believe that the SEC looks a lot closer at stuff submitted by lawyers that have not practiced before the commission previously. Kind of an initiation to the big leagues. Man, if it were my deal, I wouldn't want an hazing taking place at my expense. Additionally, the pro knows how to work with the underwriter and they have undoubtedly had other deals in the past together. The natty young graduate who is just spreading his wings and attempting to impress his client will antagonize the commission, not get the cooperation of the accountants and give the underwriter agita. Although we know some reasonably intelligent young lawyers, they are intelligent because they are aware that they have much to learn about the system and are also in a queue of sorts, a learning one. But, alas, for a little less money you can wind up with a wet faced kid who will get you into more trouble than you can shake a stick at.
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