two stages in a US prospectus: preliminary and final

As long as I’m writing about IPOs, I thought I should make a comment about prospectuses.

hire an investment bank; prepare a prospectus

In the US, the first step on the road to offering securities to the investing public (“going public”) is to hire an investment bank to act as lead underwriter.  The underwriter will, among many other things, help the firm create the prospectus, an offering document that discloses to potential investors all material and relevant company information.

There are two stages in the life of a prospectus:  the preliminary and the final.

file the preliminary prospectus with the SEC

Once the prospectus is completed, it’s marked as preliminary and submitted to the SEC for approval, in a form S-1, or registration statement. 

Here’s the one LNKD filed. If you scroll down past the cover page of the S-1 to the prospectus itself, you’ll see that the first page has a lot of blanks, where the offering price and number of shares will eventually be filled in.  As well, there’s a narrow band of bright red print at the top.  It’s the following notice:

“The information in this preliminary prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

PROSPECTUS (Subject to Completion)

Issued January 27, 2011”

becoming “effective”

The SEC staff reviews the preliminary prospectus for compliance with the disclosure requirements of US securities laws.  It may ask the filing company for further detail or clarification.  Once the agency is satisfied, it declares the prospectus as “effective,” or in legal compliance.  When this happens, the prospectus may be distributed to potential investors.  But it’s still preliminary and contains the red warning notice.

the sales campaign

The preliminary prospectus is the main sales tool for the IPO.  One or more teams of top company management members may tour the country meeting investors, either one-on-one or in large groups.  There may be “virtual” meetings through audio or video conference, as well.  But these events tend to be heavily rehearsed and scripted.  The issue?  The prospectus is supposed to contain all material information about the offering.  So the last thing the firm’s legal advisers want is for some company representative to make an off-the-cuff remark that’s not in the prospectus, that someone later on tries to construe as relevant.

the IPO date; the final prospectus

Investors give their indications of interest.  The underwriter buys the issue from the company and resells it to clients (this is a more convoluted process than it seems, but that’s a topic for another day).

Only then does the final prospectus appear.  It’s distributed to investors after they’ve already bought stock.

Here’s the final prospectus for LNKD.   Note that the blanks have been filled in and that the red warning label, which includes the key statement:”is not complete and may be changed” has been removed.

the significance of “final”

In my experience, everyone does analysis of an offering using the preliminary prospectus.  When the final comes, it’s just stuck in a file–unread.  Legally, however, the final prospectus is important.  It is the official, complete disclosure of all facts relating to the offering.  Technically, investors have a short period of time in which to read the final.  They can return the stock to the underwriter if they don’t like what they see.

I’ve never heard of a case of an investor exercising this right.  My impression is most investors are unaware they can do so.

preliminary and final aren’t always the same

Nor do they know that last-minute changes to the prospectus can be inserted into the final that aren’t in the preliminary.  I’ve only seen this happen once.

Armand Hammer, the corporate buccaneer who was CEO of Occidental Petroleum years ago, decided to spin off IBP, a meatpacking subsidiary, in 1987.  The final prospectus revealed that Occidental had allocated to IBP an extra $1 billion in corporate debt above what was stated in the preliminary.  The move made the deal worth about 10% less, by my reckoning, than the preliminary prospectus made it seem.

Not a nice thing to do.  Not something calculated to make you ever trust anyone associated with the deal again, ever.  But, however ethically suspect, legally permitted.  This would have been a famous incident, and might have spurred regulatory changes, had the IPO not come in mid-October, the week before the crash on Black Monday.

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