Successfully reported this slideshow.

Investment Banking and Securities Law


Published on

  • Be the first to comment

Investment Banking and Securities Law

  1. 1. Prepared by Ken Hartviksen INTRODUCTION TO CORPORATE FINANCE Laurence Booth • W. Sean Cleary Chapter 17 – Investment Banking and Securities Law
  2. 2. CHAPTER 17 Investment Banking and Securities Laws
  3. 3. Lecture Agenda <ul><li>Learning Objectives </li></ul><ul><li>Important Terms </li></ul><ul><li>Conflicts between Issuers and Investors </li></ul><ul><li>Securities Legislation in Canada </li></ul><ul><li>IPOs and Investment Banking </li></ul><ul><li>Post-IPO Regulation and Seasoned Offerings </li></ul><ul><li>Summary and Conclusions </li></ul><ul><ul><li>Concept Review Questions </li></ul></ul>
  4. 4. Learning Objectives <ul><li>You should understand the following: </li></ul><ul><li>That the core problem in raising capital is information asymmetry, which, in extreme cases, can to lead to fraudulent activities </li></ul><ul><li>The importance of securities laws and regulations in financial markets </li></ul><ul><li>The basic steps included in the initial public offering (IPO) process </li></ul><ul><li>What is included in a prospectus and why it is critical for IPOs </li></ul><ul><li>Why continuous disclosure requirements are important for investors, and how they affect secondary offerings. </li></ul>
  5. 5. Important Chapter Terms <ul><li>Agency theory </li></ul><ul><li>Asymmetric information </li></ul><ul><li>Banking (or dealer) syndicate </li></ul><ul><li>Bearer bonds </li></ul><ul><li>Best efforts offering </li></ul><ul><li>Bought deal </li></ul><ul><li>Continuous disclosure </li></ul><ul><li>Distribution period </li></ul><ul><li>Due diligence </li></ul><ul><li>Exempt market </li></ul><ul><li>Fair disclosure </li></ul><ul><li>Firm commitment offering </li></ul><ul><li>Greenshoe </li></ul><ul><li>Initial public offering (IPO) Investment Dealers Association </li></ul><ul><li>Lead investment dealer </li></ul><ul><li>Limit orders </li></ul><ul><li>Lock-up period </li></ul><ul><li>Long-form prospectus </li></ul><ul><li>Market or disaster “out” clause </li></ul><ul><li>Market orders </li></ul><ul><li>Offering memorandum </li></ul><ul><li>Overallotment </li></ul>
  6. 6. Important Chapter Terms… <ul><li>Ponzi scheme </li></ul><ul><li>Preliminary prospectus </li></ul><ul><li>Private equity </li></ul><ul><li>Prospectus </li></ul><ul><li>Reporting issuers </li></ul><ul><li>Securities and Exchange Commission (SEC) </li></ul><ul><li>Selling group </li></ul><ul><li>Short-form prospectus </li></ul><ul><li>Spinning </li></ul><ul><li>Spread </li></ul><ul><li>Standby or rights offering </li></ul><ul><li>Underpricing </li></ul><ul><li>Underwrite </li></ul><ul><li>Venture capital </li></ul><ul><li>Waiting period </li></ul>
  7. 7. Participants in Securities Markets Investment Banking and Securities Law
  8. 8. Issuers and Investors in Securities <ul><li>Issuers of Securities </li></ul><ul><li>Corporations 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. </li></ul><ul><li>Corporations must design securities that meet the investing needs of investors. </li></ul><ul><li>Investors in Securities </li></ul><ul><li>Investors has surplus cash at the moment, but hope to transform that cash into larger sums in the future by investing in appropriate securities </li></ul><ul><li>Some investors have long investment time horizons and have the capacity to accept risk (for example a large pension fund) </li></ul><ul><li>Other investors have short investment time horizons, require a liquid investment and do not have the capacity to accept risk </li></ul>
  9. 9. Other Participants in the Markets for Securities <ul><li>In addition to issuers and investors there are other participants in the financial markets including: </li></ul><ul><ul><ul><li>Financial intermediaries that bring buyers and sellers of securities together (brokers) </li></ul></ul></ul><ul><ul><ul><li>Underwriters (that help issuers bring new security issues to market) </li></ul></ul></ul><ul><ul><ul><li>Speculators </li></ul></ul></ul><ul><ul><ul><li>Arbitrageurs </li></ul></ul></ul><ul><li>Given the diversity of parties, interests, goals, skills and access to information, the financial marketplace is an attractive target for scam artists who seek to try to take advantage of others. </li></ul>
  10. 10. Information Asymmetry Investment Banking and Securities Law
  11. 11. Conflicts Between Issuers and Investors The Basic Problem of Asymmetric Information <ul><li>Information asymmetry occurs when one party to a transaction has information that the other party doesn’t. </li></ul><ul><li>Superior information creates a situation where one party can use that information for their own benefit at the expense of the other. </li></ul>
  12. 12. Conflicts Between Issuers and Investors Real-World Examples of Fraudulent Activities <ul><li>William E. Lyons attempting to sell US $220 million in fraudulently issued zero coupon bonds to Bear Stearns, Merrill Lynch, Goldman Sachs Group and Chase Manhattan </li></ul><ul><li>Common use of bearer bonds in Europe </li></ul><ul><li>Ponzi schemes </li></ul>
  13. 13. Conflicts Between Issuers and Investors Some Canadian Examples of Fraudulent Activities <ul><li>Broker-dealers (securities dealers) dealing in penny stocks known as “bucket shops” </li></ul><ul><ul><li>Issuing shares in highly speculative mining and real estate companies </li></ul></ul><ul><ul><li>Use of ‘ wash sales’ and high pressure sales tactics </li></ul></ul><ul><li>The case of Norbourg Asset Management Inc. where founder Lacroix was accused of stealing $84 million of investors money from the firm he controlled. </li></ul>
  14. 14. Implications of Financial Fraud for Financial Markets <ul><li>If investors are not convinced that the markets are reasonably fair, they will not invest. </li></ul><ul><ul><li>Societies where individuals do not respect the rule of law, or where law breakers are not found and punished, find that financial markets cannot develop </li></ul></ul><ul><ul><li>In these cases, legitimate businesses operating those countries lack access to capital, cannot invest, cannot create jobs and cannot compete in international markets for their products and services. </li></ul></ul><ul><ul><li>In the end, the standard of living in countries with no respect for the rule of law is extremely low, and they are often plunged into political turmoil. </li></ul></ul><ul><ul><li>In such places, people bury their funds or hide them under their pillow cases…and everyone loses! </li></ul></ul>
  15. 15. Primer on Securities Laws in Canada Investment Banking and Securities Law
  16. 16. Primer on Securities Legislation in Canada Basic Responsibilities <ul><li>Provinces are responsible under the Canadian Constitution for securities regulation. </li></ul><ul><li>Many argue that a national regulator would improve the efficiency of Canadian financial markets by harmonizing laws and their enforcement. </li></ul><ul><li>Provincial regulators (like the Ontario Securities Commission) meet regularly to coordinate efforts through the CSA (Canadian Securities Administrators) </li></ul><ul><li>The CSA among other things: </li></ul><ul><ul><li>Issues National Policy statements that provide recommendations for Provincial regulators to follow </li></ul></ul><ul><ul><li>Maintain (System for Electronic Data Access and Retrieval) which is a website that maintains all information for publicly-traded companies in Canada. </li></ul></ul>
  17. 17. Primer on Securities Legislation in Canada What is a Security? <ul><li>A security includes “ any document, investment or writing commonly known as a security” </li></ul><ul><li>In determining whether a security exists, the following are factors that are considered: </li></ul><ul><ul><li>Whether the promoter raises money and leads the investor to expect a profit </li></ul></ul><ul><ul><li>Whether the investor has any control on how the money is spent </li></ul></ul><ul><ul><li>Whether there is risk involved. </li></ul></ul>
  18. 18. Primer on Securities Legislation in Canada Ontario Securities Commission (OSC)Oversight <ul><li>Given that the markets for stocks are concentrated in Ontario (TSX, TSX Venture Exchange) the OSC has considerable responsibility and influence over securities regulation in Canada. </li></ul><ul><li>The OSC is involved in five major areas in which securities are transferred or traded: </li></ul><ul><ul><li>Primary market offerings </li></ul></ul><ul><ul><li>Secondary market trading </li></ul></ul><ul><ul><li>Activities of investment professionals </li></ul></ul><ul><ul><li>Insider trading </li></ul></ul><ul><ul><li>Takeover bids </li></ul></ul>
  19. 19. Securities Offerings Investment Banking and Securities Law
  20. 20. Security Offerings The Prospectus Versus Offering Memorandum <ul><li>Prospectus </li></ul><ul><ul><ul><li>A disclosure document in support of public offering of securities </li></ul></ul></ul><ul><ul><ul><li>Must provide “full, true and plain disclosure of all material information pertaining to the security being issued” </li></ul></ul></ul><ul><ul><ul><li>Consists of two parts: </li></ul></ul></ul><ul><ul><ul><ul><li>Long-form prospectus – contains information about the corporate issuer, directors, financial performance, operations, etc. </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Short-term prospectus – contains information pertaining to the particular securities that are being offered including price, type of security, intended use of the proceeds, etc. </li></ul></ul></ul></ul><ul><li>Offering Memorandum </li></ul><ul><ul><ul><li>A disclosure document in support of an offering of securities in the exempt market </li></ul></ul></ul><ul><ul><ul><li>Has the same objectives of disclosure as a prospectus, however, offers significantly less information because of the nature of exempt /sophisticated investors </li></ul></ul></ul>
  21. 21. Public Offerings of Securities IPOs and Seasoned Offerings Investment Banking and Securities Law
  22. 22. IPOs and Investment Banking <ul><li>IPO – Initial Public Offering </li></ul><ul><ul><li>Primary offering of securities to the public ( a first-time distribution by the issuer) </li></ul></ul><ul><ul><li>Difficult to ‘value’ or price because there is no prior history of trading in the securities by unrelated parties in arms length trading </li></ul></ul><ul><ul><li>Must be accompanied by a prospectus. </li></ul></ul>
  23. 23. IPOs and Investment Banking Motivation for IPOs <ul><li>Going public requires the firm to incur significant changes and costs including: </li></ul><ul><ul><li>Costs of meeting market listing requirements including the costs associated with information disclosure requirements expected of public companies </li></ul></ul><ul><ul><li>Underwriting and distribution costs associated with the public offering including prospectus and underwriters spread and potentially underpricing costs associated with the IPO </li></ul></ul><ul><ul><li>Listing fees </li></ul></ul><ul><li>The motivation for going public include: </li></ul><ul><ul><li>Access to capital </li></ul></ul><ul><ul><li>Greater public visibility (perhaps increasing the market demand for the firm’s products and services) </li></ul></ul><ul><ul><li>Ability for venture capital firm and/or entrepreneur to ‘harvest’ their investment </li></ul></ul><ul><ul><li>Ability to reward managers through options that will now have a market value </li></ul></ul>
  24. 24. IPOs and Investment Banking The Stages of the IPO Process 17 - 1 FIGURE Discussion triggers IPO Preliminary prospectus: three to five months Waiting period and road shows: one to two months Pricing, distribution, and after-market stabilization: one-month Initial filing: red herring Final clearance
  25. 25. IPOs and Investment Banking Types of Public Offerings <ul><li>Best efforts offering </li></ul><ul><li>Firm commitment offering </li></ul><ul><li>Bought deal </li></ul><ul><li>Standby or rights offering </li></ul>
  26. 26. IPOs and Investment Banking IPO Underpricing <ul><li>Underpricing of an IPO occurs when the price of the IPO is less than its market value </li></ul><ul><ul><li>Measured as the difference between the initial offering price and the price on the first day of trading. </li></ul></ul><ul><li>There is evidence of systemic underpricing in most OECD countries (see Table 17 -1 on the following slide) </li></ul><ul><li>Reasons for underpricing and the various degrees of underpricing in different capital markets include: </li></ul><ul><ul><li>Degree of competition for underwriting business </li></ul></ul><ul><ul><li>Litigiousness of the investors in the country </li></ul></ul><ul><ul><li>‘ Spinning’ where the underwriter allocates IPOs to favoured clients knowing that they will make a large profit on the first day of trading. </li></ul></ul>
  27. 27. IPO Underpricing Evidence
  28. 28. Post-IPOs Regulation and Seasoned Offerings The Post-IPO Market <ul><li>Following the IPO a quiet period is required before the investment dealer’s research analysts can initiate coverage on the company. </li></ul><ul><ul><li>The prospectus is assumed to provide sufficient information during the distribution phase. </li></ul></ul><ul><li>Misleading research reports were identified in the U.S. during the internet bubble and analysts from major U.S. underwriters were charged for providing such reports. </li></ul><ul><ul><li>These practices were found to be encouraged and rewarded by the underwriting firms as a form of ‘self-dealing’ where the underwriter had a financial interest in the success of the security offering, and therefore, had it’s analysts write overly positive reports on the security. </li></ul></ul>
  29. 29. Post-IPOs Regulation and Seasoned Offerings Continuous Disclosure Requirements <ul><li>Following the IPO investors do not receive the prospectus when investing in securities </li></ul><ul><li>Public companies are expected to become reporting issuers and provide continuous disclosure including: </li></ul><ul><ul><li>Quarterly and annual financial statements </li></ul></ul><ul><ul><li>Annual information forms (AIF) </li></ul></ul><ul><ul><li>Proxy and information circulars </li></ul></ul><ul><ul><li>Press releases on any material information </li></ul></ul><ul><li>All required information for public issuers in Canada is available at </li></ul>
  30. 30. Post-IPOs Regulation and Seasoned Offerings Seasoned Offerings and Short-Form Prospectuses <ul><li>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. </li></ul><ul><li>The short-form prospectus system has given rise to the use of the ‘bought deal’ in Canada. </li></ul><ul><ul><li>In a bought deal, the underwriting contract is signed even before the drafting of the preliminary prospectus </li></ul></ul><ul><li>The underwriting market in Canada has become extremely competitive as information requirements have been decreased through the POP system. </li></ul><ul><li>(See Table 17 -2 on the following slide for recent Canadian underwriting trends.) </li></ul>
  31. 31. Canadian Financings
  32. 32. Summary and Conclusions <ul><li>In this chapter you have learned: </li></ul><ul><ul><li>The basics of securities law </li></ul></ul><ul><ul><li>About information asymmetry and the impacts of this on financial markets, market participants and the occurrence of financial fraud </li></ul></ul><ul><ul><li>The role of securities regulators and securities regulation and the costs associated with regulation, monitoring and enforcement. </li></ul></ul>
  33. 33. Concept Review Questions Investment Banking and Securities Law
  34. 34. Concept Review Question 1 Asymmetric Information <ul><li>How does the existence of asymmetric information lead to market inefficiencies? </li></ul>
  35. 35. Copyright <ul><li>Copyright © 2007 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (the Canadian copyright licensing agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these files or programs or from the use of the information contained herein. </li></ul>