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What are the legal issues of an IPO in the United States?

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The most stringent legal rule in the world overseeing IPOs is found in the United States. In fact, the federal securities law for IPOs is not for the United States alone, but also applies to an IPO in the world that may affect a significant quantity of U.S. investors. Therefore, numerous IPOs are ordered and timed in accordance with U.S. legal requirements even if the IPO is not occurring in the United States or with a U.S. company.

The IPO process is governed under U.S. law by the Securities Act of 1933 along with the stipulations of the Securities and Exchange Commission. (Individual stock exchanges have specific rules that listing companies must follow.) IPOs smaller in nature have the possibility of being affected by a state's blue sky laws. A state's laws tend to be pre-empted by federal law if the stock is going to be listed on a major exchange or NASDAQ, but will reign over particular medium-scale offerings on the local level.

Prior to the IPO beginning, a prospectus must be drafted by the issuer. This is an exhaustive synopsis of the company's finances, history, operations, products, risk factors, industry environment, and other information. Each IPO prospectus is intensely watched by the Securities and Exchange Commission (SEC). Major law firms are often deep in the drafting process.

Until an IPO is recorded by the SEC, under the Securities Act, no public offerings may be made by issuer or underwriters. (If an offering is made during this time, it is called "gun-jumping.") After the IPO is registered, the issuer and underwriters can advertise the IPO with a simple "tombstone" advertisement that lists the name of the company, the amount of stock being offered, the underwriters' names, and some other basic information. Concealed placement conversations and restricted press releases are allowed. If a written offer is made to sell stock, it must be given with a copy of the prospectus as it was submitted to the SEC. The copy of the official prospectus is stamped with a warning of non-final status in red lettering and is called a "red herring."

When the SEC gives final approval to the prospectus, the price of the shares is settled. The IPO then engages in a "free riding" period where shares are for sale and offered in a number of ways, such as telephone calls, "road shows" and institutional visits. These offers must also be joined with a copy of the prospectus. Any false or misleading statements are forbidden while offerings are shared.

If any statements are misquoted or omitted in the prospectus, the issuer is held liable. If a "reasonable investigation" is not held or if there is reasonable ground to believe the statement was true or the omitted section was irrelevant, the directors, officers, and underwriters may also be held liable. To defend against liability, underwriters complete a due diligence investigation of the issuer which involves lawyers and accountants outside the issuers domain.

Next Page: Where do IPOs fall in the business cycle?

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