For any new offering of securities, a corporation must file a registration statement with the SEC that contains the following information:
- A description of the corporation.
- A concise biography of the officers and directors of the corporation.
- Financial stakes of all insiders, the directors and officers (control persons) in the corporation, and a list of anyone holding more than 10% of the corporation’s securities.
- Complete financial statements.
- What securities are being offered for sale, and how will the money be used.
- Any legal proceedings that may have a material impact on the company.
The SEC will review the registration to be sure that everything is in compliance with the law, and that there is full disclosure. If it is, then the SEC will approve the registration, and allow the company to sell its securities on a specified date—the effective date. However, SEC approval is not an endorsement of the issue, but only that there has been proper disclosure.
If there is any problem with the registration, then the SEC will send a deficiency letter to remedy the problem. Generally, the underwriting manager handles the deficiency letters quickly, because deficiency letters delay the effective date. No securities can be sold or even offered for sale before the effective date.
The time between filing and the effective date is known as the cooling-off period. During this time, no reports, recommendations, or sales literature may be sent to anyone. The underwriters may, however, send a preliminary prospectus—often called a red herring, because of the red lettering on the title page—that provides potential investors with all the necessary information that an investor would need to make an intelligent decision, which includes a description of the company and its business, income statement and balance sheets, any pending events that could have an impact on the business, such as mergers or acquisitions, its competition, and the agencies that regulate it. What it does not contain, however, is the public offering price of the new securities and the effective date for the sale, since the effective date would not yet be known.
A preliminary prospectus is published to generate and gauge interest among investors in the new securities, but it cannot offer them for sale until the registration has been approved by the SEC. The indication of interest will be used by the investment bank to price the new securities.
SEC Rule 134 does permit 1 other type of publication during the cooling-off period—the tombstone ad. The tombstone ad must be clear that it is an announcement only, and not an offer to sell nor a solicitation to buy.