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In this lesson, we're going to talk about initial public offerings also known as IPOs.
What are the procedures that govern those and then also liability when things go wrong.
So let's start with some important terms.
Term number one, issuer.
An issuer is a company that sells stock to the public.
Now they could be selling stock for the very first time or it could be a company that has
sold a lot of stock to the public before but they're
selling newly created stock to the public.
Either way they are an issuer.
Second important term, initial public offering.
We've already mentioned it also known as an IPO.
This is when an issuer sells new stock to the public.
It's called an initial public offering.
Then the third term we need to define here is called an underwriter.
An underwriter is an organization usually an investment bank.
So you think like J.P. Morgan's of the world,
the Goldman Sachs of the world,
they're usually an investment bank and what
the underwriter does is it creates a market for the stock.
They basically are salespeople.
So if I'm a company and I want to engage an initial public offering,
the first thing I have to do is find some people who are willing to buy my stock, right?
That's when I engage an underwriter,
the underwriter goes on what's called a road show
and markets my stock to institutional investors,
pension funds, retirement funds, that kind of thing.
The underwriter doesn't do this for free.
They keep a percentage of the stock that they sell to
the public and it's exceptionally lucrative.
This is why investment banks like Goldman Sachs make
a ton of money when it comes to initial public offerings.
So what's the process if you want to engage in an IPO.
There's actually a really stringent process you have to
follow and if you break these rules you expose yourself to liability.
So, first step in the process.
From the first moment you think about engaging in
an IPO up until the time that you file your registration statement,
this is called the prefiling period.
During the prefiling period you're not allowed to sell any securities to anybody.
Now during the prefiling period you will be probably
engaged in drafting this document called the registration statement.
The registration statement is
a gargantuan document that
contains all the relevant info about your company's management,
your finances, risks, all sorts of things
and the registration statement gets filed with the Securities and Exchange Commission.
It's a public document you can search for it on the SEC's website.
Once the registration statement is filed,
that begins what's called the quiet period.
The quiet period goes from the time of filing of
the registration statement until the time the SEC approves the registration statement.
During the quiet period your company is actually not allowed to
communicate certain information to the public or investors or anyone on the market.
Now the company is allowed to market its securities but it can't finalize any sales.
So we can say hey we're selling stock and it can
actually come to agreements to sell stock to people but
it can't finalize the sale until the SEC
approves the registration statement which starts the post-effective period.
In the post effective period the registration statement has been approved and now
the company can actually sell stock to the public or other forms of securities.
Now when a company engages in an IPO,
there's always the risk that people will be harmed.
Maybe the price of the stock goes down instead of up or other things happen.
When that happens people who have suffered
damages will try to figure out who's responsible and sue them.
Now when individuals or businesses suffer damage as a result of the IPO process,
the issuer and also other people involved in
the drafting of the registration statement and
the selling of the stock can sometimes be exposed to liability.
Now specifically in the 33 Act sections
11 and 12 govern the liability to which they might be exposed.
Section 11 of the 33 Act creates liability for
anybody who makes a false or misleading statement in a registration statement.
So if the company includes a false statement in its registration statement,
it's liable if people suffer damage as a result of that statement.
Section 12 of the 33 Act creates liability for anybody who sells
securities and those securities are
the subject of a false or misleading registration statement.
Now it doesn't matter who wrote the registration statement it matters who sold them.
So Section 11 creates liability usually for the issuer,
section 12 creates liability usually
for the underwriter and other people engage in selling the stock.
So if a registration statement is false or misleading,
usually the issuer and the underwriter and anybody else
involved in the sale of that stock can be held liable.
Then finally the 33 Act also imposes
criminal liability on anyone who willfully violates the Act.
So if you include a false statement on accident there's
no criminal liability there but if you purposely try to mislead your investors,
that is actually a criminal act under the 33 Act.
Now if a company or individual is subject
to a lawsuit for liability pertaining to an IPO,
they actually have some defenses in some instances.
A first offense that a defendant might raise is that
the other party knew the statement was false or misleading and this makes sense right.
If I put a false statement in a document and you suffer
harm as a result because you didn't know it was false, then that's my fault.
But if I put a false statement in a document and you know it's false,
then I shouldn't be held responsible for that.
So that's one defense to an IPO claim.
Second defense is that the statement might have been false or
misleading but it didn't concern a material fact.
Maybe what the statement was in there maybe
the address of our company's headquarters was wrong.
That's not a material fact.
So even though the registration statement could contain
a false statement if it's not a material fact you can't sue me for it.
Then the final defense to an IPO claim is if I the defendant who's being sued did
my due diligence and I have a reasonable belief that the statement
is accurate then I will not be held liable if the statement turns out not to be accurate.
Now this defense is only available to parties other than the issuer.
The issuer is always liable for its inaccurate statements but if
I'm the underwriter or an adviser to the issuer or someone else
besides the issuer and I did my due diligence and I tried to ascertain if
the statement was true and it turned out not to be
true but I reasonably believed it to be true,
well in that case I will be held liable for that statement.
Professor Michael R FrickeTeaching Assistant Professor
