Who is underwriters or Investment Banking .. what is playing?

An investment banking firm negotiates the terms of the underwriting deal with the company planning to go public and then acts as the managing underwriter of a group of underwriters collectively known as the underwriting syndicate.

The managing underwriter spells out the basic terms of the underwriting and issues a letter of intent to the issuing corporation in which the risks to and obligations of each side are spelled out. The underwriter relies on a market-out clause, which explains that certain unforeseen events will allow the underwriter to back out of the deal. If the company's drug making facilities are shut down by the FDA due to contamination, for example, the underwriter can back out of the underwriting engagement.
This topic may related to SIE exam.

For municipal securities and for some corporate securities offerings, a potential managing underwriter submits a bid or responds to an RFP (request for proposals). This is known as a competitive bid as opposed to a negotiated underwriting.

In a competitive bid, the syndicate who can raise the money at the lowest cost to the issuer wins.

 In a negotiated underwriting, the managing underwriter negotiates the terms of the deal with the issuer, and then forms a syndicate of underwriters.

Even though firms like Morgan Stanley and Goldman Sachs are fiercely competitive, they also routinely work with each other when underwriting securities. Sometimes Goldman Sachs is the managing underwriter; other times Goldman Sachs is just one of many underwriters in the syndicate. Depends which firm brought the deal to the table.

The syndicate often gives an issuer a firm commitment. This means the underwriters bear the risk of any unsold securities and make up the difference by buying them for their own accounts. That's a last resort, though. The whole point of doing the underwriting is to sell all the securities as fast as possible at the highest price Possible.

Underwriters act as agents for the issuer when they engage in a best efforts, (all-or-none,) or (mini-max) underwriting. Here, if the minimum amount is not raised, the underwriters are off the hook.

In a best-efforts underwriting, the issuer will accept what the underwriters raise. In the other types, money is returned to investors if the minimum amount is not raised during the offering period.

Broker dealers involved in either type of contingency offering (all-or-none, mini-max) must place customer payments in an escrow account so that if the offering is canceled, investors receive their money plus their prorate share of any interest payments. If the underwriter were to place such payments into its own account, this would be a violation of FINRA rules.

The firms in the syndicate usually handle different amounts of an offering, and their liability for any unsold shares is spelled out in an agreement among the underwriters. Not surprisingly, the agreement among underwriters is called the agreement among underwriters, sometimes referred to as the syndicate letter.

Syndicate members in a firm commitment have their firm's capital at risk, meaning they act in a principal capacity. The syndicate manager, therefore, often lines up other broker-dealers to help sell the offering. This group of sellers is referred to as the selling group.

The selling group acts in an agency capacity for the syndicate, trying to sell shares but bearing no financial risk for the ones they can't. They have customers who might want to invest the syndicate is happy to share part of the compensation with these firms.

So, in a firm commitment underwriting the syndicate members have capital at risk, but selling group members never do in any type of underwriting.

❑ Underwriter Compensation
Securities regulators are concerned with protecting investors. Investors can be defrauded when an issuer pulls most of the value out of the company and gives it to the underwriters either in the form of cash or generous warrants to buy shares at fractions-of-a-penny.

Why would an issuer want to do that?
 Maybe they don't want to pay for the services with money and would rather just take it out of the value of the investors' shares by letting the warrants dilute their equity.

Or, maybe the issuer owns a percentage of one of the underwriters. Moving money from this company over to that one would be a neat trick for the issuer, so why not just pay top dollar for the underwriting both in terms of fees and underwriter options/warrants?

Promoters are people who founded the company or have a big ownership interest in it. If the offering doesn't pass the smell test in terms of underwriter or promoter compensation, the regulators will shut it down through legal action.

For a good example of underwriter compensation, we can pull up the prospectus for Facebook's IPO. When we do, we see that the shares were sold to investors at a POP of $38, with the spread to the underwriters at about 42 cents per share.

FINRA insists the terms of the offering among the various underwriters be spelled out clearly:

[Selling syndicate agreements or selling group agreements shall set forth the price at which the securities are to be sold to the public or the formula by which such price can be ascertained, and shall state clearly to whom and under what circumstances concessions, If any, may be allowed.]


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