Chapter 14. Primary MarketsChapter 14. Primary MarketsChapter 14. Primary MarketsChapter 14. Primary Markets

• Traditional Process

• Regulation

• Variations in Underwriting

• Traditional Process

• Regulation

• Variations in Underwriting

BackgroundBackgroundBackgroundBackground

• all types of securities

• security being sold for the first time

• new offerings of firms with publicly held securities

-- SEO seasoned equity offering

• IPOs

• after initial offering, security is in secondary market

• all types of securities

• security being sold for the first time

• new offerings of firms with publicly held securities

-- SEO seasoned equity offering

• IPOs

• after initial offering, security is in secondary market

I. Traditional ProcessI. Traditional ProcessI. Traditional ProcessI. Traditional Process

• investment banks play key role• function performed by different

institutions• roles:

(1) advising

(2) underwriting/best efforts

(3) distribution & support

• investment banks play key role• function performed by different

institutions• roles:

(1) advising

(2) underwriting/best efforts

(3) distribution & support

(1) advising(1) advising(1) advising(1) advising

• timing of offering

• terms of security

• pricing

• regulation

• timing of offering

• terms of security

• pricing

• regulation

(2) underwriting(2) underwriting(2) underwriting(2) underwriting

• optional

• investment bank buys securities from issuer,

then resells to public

• investment bank bears the price risk

• optional

• investment bank buys securities from issuer,

then resells to public

• investment bank bears the price risk

• price set 2 days prior to issue• security floatation• firm commitment

• resale price - guaranteed price

= gross spread

= underwriter’s discount

• price set 2 days prior to issue• security floatation• firm commitment

• resale price - guaranteed price

= gross spread

= underwriter’s discount

• size of discount depends on

• type of security

-- bonds lowest, stock IPOs highest

• size of issue

-- smaller issues have larger discount

• market conditions

• .5% - 7% (table 14-1)

• size of discount depends on

• type of security

-- bonds lowest, stock IPOs highest

• size of issue

-- smaller issues have larger discount

• market conditions

• .5% - 7% (table 14-1)

group of investment banksgroup of investment banksgroup of investment banksgroup of investment banks

• several investment banks bear price risk

• lead underwriter

-- bulge bracket firm

• syndicates help underwrite

• selling group

• syndicate AND

• other firms

-- help sell issue, do not underwrite

• several investment banks bear price risk

• lead underwriter

-- bulge bracket firm

• syndicates help underwrite

• selling group

• syndicate AND

• other firms

-- help sell issue, do not underwrite

tombstonetombstonetombstonetombstone

• advertisement

• lists all of the underwriters

• details of issue

• after sale has taken place• to get more underwriting business

• advertisement

• lists all of the underwriters

• details of issue

• after sale has taken place• to get more underwriting business

26,000,000 Shares

Hartford Life, Inc.

Class A Common Stock(par value $.01 per share)

Price $28.25 Per Share

Upon request, a copy of the Prospectus describing these securities and the business of the company may be obtained within any state from anyunderwriter who may legally distribute it within such state. The securities are offered only by means of the Prospectus, and this announcement is

neither an offer to sell nor a solicitation of an offer to buy.

20,800,000 SharesThis portion of the offering is being offered in the United States by the undersigned.

Goldman Sachs International Merrill Lynch International

Morgan Stanley Dean WitterSmith Barney Inc.

Credit Suisse First Boston A. G. Edwards & Sons, Inc. Edward D. Jones & Co., L.P. Lehman Brothers PaineWebber Incorporated

Prudential Securities Incorporated Advest, Inc. Sanford C. Bernstein & Co., Inc J.C. Bradford & Co.

Conning & Company Dain Bosworth Fox-Pitt, Kelton Inc. Legg Mason Wood Walker Incorporated Incorporated

Piper Jaffray Inc.

Principal Financial Securities, Inc. Raymond James & Associates, Inc. The Robinson-Humphrey Company, Inc.

Stephens Inc. Sutro & Co. Incorporated Wheat First Butcher Singer Dowling & Partners Securities, LLC

Interstate/Johnson Lane Corporation

Janney Montgomery Scott Inc. Neuberger & Berman, LLC

5,200,000This portion of the offering is bein offered outside the United States by the undersigned.

Goldman Sachs International Merrill Lynch International

Morgan Stanley Dean WitterSmith Barney Inc.

ABN AMRO Rothschild Banque Nationale de Paris Barclays de Zoete Wedd Limited

Dresdner Kleinwort Benson Yamaichi International (Europe) Limited

June 4, 1997

IPOs typically underpricedIPOs typically underpricedIPOs typically underpricedIPOs typically underpriced

• 1980s: first day return 7%

• 1990-98: 15%

• 1999-2000: 65%

• why?• reduces risk for underwriter• issuer accepts underpricing for

prestigious underwriter

• 1980s: first day return 7%

• 1990-98: 15%

• 1999-2000: 65%

• why?• reduces risk for underwriter• issuer accepts underpricing for

prestigious underwriter

who gets “hot” IPOs?who gets “hot” IPOs?who gets “hot” IPOs?who gets “hot” IPOs?

• Lucent 1996

• Red Hat 1999 (Linux)

• “spinning”• underwriters allocate shares to

preferred customers

• Lucent 1996

• Red Hat 1999 (Linux)

• “spinning”• underwriters allocate shares to

preferred customers

(2) best efforts placement(2) best efforts placement(2) best efforts placement(2) best efforts placement

• alternative to underwriting

• investment bank promises to use “best efforts” to sell issue• but no guarantee of price

-- issuer retains price risk

• done with firms with limited market recognition

• alternative to underwriting

• investment bank promises to use “best efforts” to sell issue• but no guarantee of price

-- issuer retains price risk

• done with firms with limited market recognition

(3) distribution & support(3) distribution & support(3) distribution & support(3) distribution & support

• underwriters expected to support secondary market

• hold large inventory of securities

• underwriters expected to support secondary market

• hold large inventory of securities

who underwrites?who underwrites?who underwrites?who underwrites?

• commercial banks, insurance co.• U.S. firms restricted under Glass

Steagall until 1999• no restrictions on firms outside

U.S.

• commercial banks, insurance co.• U.S. firms restricted under Glass

Steagall until 1999• no restrictions on firms outside

U.S.

• securities houses• top ten underwriters do over 75%

of underwriting• also leading brokerage firms and

dealers

• securities houses• top ten underwriters do over 75%

of underwriting• also leading brokerage firms and

dealers

top underwriters, 2003top underwriters, 2003top underwriters, 2003top underwriters, 2003

• Equity & bonds

1. Citigroup

2. Merrill Lynch

3 . Morgan Stanley

• Equity & bonds

1. Citigroup

2. Merrill Lynch

3 . Morgan Stanley

0

500

1,000

1,500

2,000

2,500

3,000

1999 2000 2001 2002 2003

Total Debt Underwriting, Billions $

0

50

100

150

200

250

1999 2000 2001 2002 2003

Equity Underwriting, Billions $

equity IPOs

0

500

1,000

1,500

2,000

2,500

3,000

1999 2000 2001 2002 2003

Total Debt Underwriting, Billions $

II. RegulationII. RegulationII. RegulationII. Regulation

• SEC regulates primary market• disclosure of information• insider trading

• SEC regulates primary market• disclosure of information• insider trading

security registration w/ SECsecurity registration w/ SECsecurity registration w/ SECsecurity registration w/ SEC

• prospectus• nature of firm• features of security• risk• firm management• certified financial statements

• prospectus• nature of firm• features of security• risk• firm management• certified financial statements

• firms liable for incorrect info• criminal and civil

• underwriters possibly liable• must show due diligence in

reviewing info

• firms liable for incorrect info• criminal and civil

• underwriters possibly liable• must show due diligence in

reviewing info

red herringred herringred herringred herring

• waiting period for SEC approval

• firm distributes preliminary prospectus• saying so in red ink• red herring

• waiting period for SEC approval

• firm distributes preliminary prospectus• saying so in red ink• red herring

SEC approvalSEC approvalSEC approvalSEC approval

• registration is effective

• SEC determines info is complete• NOT accurate• NOT a recommendation

• investment bank now offers security for sale

• registration is effective

• SEC determines info is complete• NOT accurate• NOT a recommendation

• investment bank now offers security for sale

Shelf registration ruleShelf registration ruleShelf registration ruleShelf registration rule

• SEC rule 415 (1982)

• issuer gets prior approval for several new issues w/in 2-year period• investment grade• NOT IPOs

• allows issuer to move quickly when market conditions favorable

• SEC rule 415 (1982)

• issuer gets prior approval for several new issues w/in 2-year period• investment grade• NOT IPOs

• allows issuer to move quickly when market conditions favorable

Exempt from registrationExempt from registrationExempt from registrationExempt from registration

• U.S. government debt

• municipal debt

• commercial paper

• small offerings (< $1 million)

• intrastate offerings

• U.S. government debt

• municipal debt

• commercial paper

• small offerings (< $1 million)

• intrastate offerings

III. Variations in UnderwritingIII. Variations in UnderwritingIII. Variations in UnderwritingIII. Variations in Underwriting

• Bought Deal• investment bank presents offer to

firm to buy entire block of debt securities

-- issuer accepts/rejects w/in days

-- if accepts, issuer “bought the deal”

• Bought Deal• investment bank presents offer to

firm to buy entire block of debt securities

-- issuer accepts/rejects w/in days

-- if accepts, issuer “bought the deal”

• only 1 underwriter

-- greater risk of capital

-- issue usually presold to institutional buyers

• only 1 underwriter

-- greater risk of capital

-- issue usually presold to institutional buyers

• Competitive bidding• auction• issuer sets terms of issue,

places up for bid to competing underwriters

-- competition will lower cost• required for municipalities, utilities• no evidence that this is cheaper

• Competitive bidding• auction• issuer sets terms of issue,

places up for bid to competing underwriters

-- competition will lower cost• required for municipalities, utilities• no evidence that this is cheaper

• Pre-emptive Rights Offering• company w/ stockholders• new stock offered to existing

shareholders

-- below market value

-- prevents dillution of voting rights

• Pre-emptive Rights Offering• company w/ stockholders• new stock offered to existing

shareholders

-- below market value

-- prevents dillution of voting rights

• Private Placement• issued placed directly with small #

of buyers• no solicitation/advertising to

public• buyers are institutional investors

-- insurance co., pension funds

-- capable of evaluating risks

• Private Placement• issued placed directly with small #

of buyers• no solicitation/advertising to

public• buyers are institutional investors

-- insurance co., pension funds

-- capable of evaluating risks

• usually bonds• no registration w/ SEC

-- but must offer prospectus• PP are less liquid

-- limits on resale for 2 years

• usually bonds• no registration w/ SEC

-- but must offer prospectus• PP are less liquid

-- limits on resale for 2 years

• Growth in private placements• rule 144A (1990)

-- allows trading of PP among institutions

• Growth in private placements• rule 144A (1990)

-- allows trading of PP among institutions