Quick Answer
An IPO is a company's first sale of stock to the public, moving it from private to public ownership. The issuer files a Form S-1 with the SEC, waits out a minimum 20-day cooling-off period, and delivers a final prospectus before shares are priced and sold. Proceeds go to the issuing company in the primary market.
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?
- Issuer selects a managing underwriter (lead investment banker)
- Due diligence is conducted on the issuer
- Registration statement (Form S-1) is filed with the SEC under the Securities Act of 1933
- SEC reviews the filing; a minimum 20-day cooling-off period begins
- 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
- SEC declares the registration effective (does NOT "approve" the offering)
- Final prospectus is delivered to investors at or before the time of sale
- Securities are priced and sold to investors
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 disclosure requirements have been met. 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?
| Document | Purpose | When Used |
|---|---|---|
| Registration statement (S-1) | Full disclosure filing with the SEC | Filed before offering |
| Preliminary prospectus (red herring) | Shares material info with potential investors; lacks final price and effective date; has red-ink disclaimer on cover | During the cooling-off period |
| Final prospectus | Complete disclosure document with final price; must be delivered to all buyers | At or before time of sale |
| Tombstone ad | Brief public notice of the offering; contains only factual information (issuer name, security type, price, underwriter) | 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.
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.
| Role | Responsibility |
|---|---|
| Issuer | 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) | 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 | An individual (natural person) representing the BD or issuer in effecting transactions; never an entity |
| Dealer | A BD acting in a principal capacity, buying and selling for its own account |
| Rating agency | 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.