Initial Public Offering (IPO)

Quick Answer

An IPO is a company's first sale of stock to the public. The issuer files a Form S-1 with the SEC and completes registration before selling shares. The final prospectus includes the final price; eligible corporate offerings can meet prospectus delivery requirements through access to the filed document. Primary-offering proceeds go to the issuer.

The rest of this lesson works through the documents and parties the exam builds scenario questions around.

What Is an IPO?

IPO: A company's first sale of stock to the public; transitions the company from private to public

Proceeds: Go to the issuing company (primary market transaction)

Registration: Must file a registration statement (Form S-1) with the Securities and Exchange Commission (SEC) under the Securities Act of 1933

Underwriter: An investment bank (the managing underwriter) manages the offering

IPO shares are sold in the primary market; subsequent trading occurs in the secondary market

What Are the Key Steps in an IPO?

1. Issuer selects a managing underwriter (lead investment banker)

2. Due diligence is conducted on the issuer

3. Registration statement (Form S-1) is filed with the SEC under the Securities Act of 1933

4. SEC reviews the filing; a minimum 20-day cooling-off period begins

5. During the cooling-off period, the preliminary prospectus (red herring) may be distributed to gauge investor interest, and the underwriter arranges a road show where company management presents to institutional investors to build interest ahead of pricing

6. SEC declares the registration effective (does NOT "approve" the offering)

7. The offering is priced, and the final prospectus (which includes the final price) is prepared

8. Securities are sold, and final-prospectus delivery requirements are met through delivery or an eligible access-based method

Exam Tip: Gotchas

An IPO is a primary market transaction. Proceeds go to the issuing company, not selling shareholders.

The SEC never "approves" an offering or passes judgment on the investment's quality. It only declares the registration statement "effective," meaning the offering may go forward and sales may begin. Effectiveness is not an SEC finding that the disclosure is true, complete, or accurate; the issuer stays responsible for that, and telling a buyer otherwise is unlawful. An exam question saying the SEC "approved" a security is always wrong.

What Happens During the Cooling-Off Period?

The cooling-off period is a minimum 20-day waiting period from the date the registration statement is filed with the SEC until it becomes effective.

During this period: indications of interest may be collected, but NO binding sales or acceptance of payment

The preliminary prospectus (red herring) may be distributed

Tombstone ads (brief public notices) may also be published

The SEC may issue a stop order to suspend the registration statement's effectiveness if material misstatements or omissions are found

Exam Tip: Gotchas

Underwriters can collect indications of interest during the cooling-off period but cannot accept orders or money. No sales occur until the effective date.

During the cooling-off period, only the preliminary prospectus, tombstone ads, and oral communications such as the road show are permitted; no sales, binding offers, or written sales literature outside those channels can occur.

What Are the Key IPO Documents?

Registration statement (S-1): Purpose Full disclosure filing with the SEC; When Used Filed before offering

Preliminary prospectus (red herring): Purpose Shares material info with potential investors; lacks final price and effective date; has red-ink disclaimer on cover; When Used During the cooling-off period

Final prospectus: Purpose Complete disclosure document with final price; When Used Before or with delivery of securities; eligible offerings may use access to the filed final prospectus

Tombstone ad: Purpose Brief public notice of the offering; contains only factual information (issuer name, security type, price, underwriter); When Used During or after the cooling-off period

Exam Tip: Gotchas

A tombstone ad is NOT a prospectus and NOT an offer to sell. It is merely a public announcement. It cannot contain recommendations or promotional language.

The SEC declaring the registration effective and the pricing are separate events. The final prospectus generally must precede or accompany delivery of the securities, rather than physically reaching every buyer before the contract of sale. Eligible corporate offerings may satisfy this obligation through access to the filed final prospectus.

How Do You Tell Broker, Agent, Dealer, and Issuer Apart?

The Series 65 frequently tests role-identification scenarios: a company is raising funds, and the answer choices list broker, agent, dealer, issuer. Knowing which party handles which responsibility prevents these from becoming guesses.

Issuer: Responsibility The company itself. Creates and sells the new securities; files all regulatory documents (Form S-1, state registration, exemption filings); receives the proceeds

Broker-dealer (underwriter): Responsibility The firm hired to distribute the securities to the public. Acts as principal/dealer when it buys the securities to resell, agent/broker when it only arranges sales

Agent: Responsibility An individual (natural person) representing the BD or issuer in effecting transactions; never an entity

Dealer: Responsibility A BD acting in a principal capacity, buying and selling for its own account

Rating agency: Responsibility A separate third party (Moody's, S&P, Fitch); assigns credit ratings to debt issues. Not listed alongside broker/agent/dealer/issuer in role-identification questions

Exam Tip: Gotchas

Role-identification questions typically list broker, agent, dealer, and issuer as answer choices. Match the responsibility to the role:

Issuance and regulatory filings: issuer

Distributing securities to the public: broker-dealer

Effecting transactions as an individual: agent

Trading for own account: dealer

Rating the securities: none of those four; the answer is the rating agency

What Should You Check on Exam Day?

Proceeds direction: IPO proceeds go to the issuer, never to selling shareholders.

The SEC declares a registration effective; it never "approves" a security.

In role-identification questions, match issuer, broker-dealer, agent, and dealer to their exact responsibility before picking an answer.