Université De Montréal Prospectus Essay

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A prospectus is a document that provides detailed information about an investment. The prospectus first arrived in the investment arena with the Securities Act of 1933, which was created to improve investor confidence, prohibit fraud and misrepresentation in securities, and facilitate the creation of the Securities and Exchange Commission (SEC). The Securities Act emerged after litigation showed that investors did not have access to reliable information on which to make an informed decision regarding the investment. Thus, a prospectus has two purposes. First, it acts to protect investors from unreliable, fraudulent, or missing information. Second, a prospectus also acts to protect investment firms from dishonest investors claiming that they were not informed about the investment.

In the United States, a prospectus is considered a legal and binding agreement between a firm and its investors. This document must contain information on the public offering, the firm, its industry, financial statements, management, legal agreements, risks, and concerns. If any of this information is missing or incorrect, the prospectus becomes null and void. The SEC also requires that the prospectus be written in clear and concise language. Highly legal or technical language is discouraged. The SEC requires that all publicly traded firms and investments (such as mutual funds, bond funds, and real estate investment trusts) have a prospectus on file and sent to investors. Firms that are not publicly traded are not required to file a prospectus. It must be updated annually or with any significant change in the investment’s strategy or structure.

When an investment is initially placed for sale to the public (such as initial public offering or IPO), the firm representing the investment is required to write a prospectus. A preliminary prospectus (also known as a red herring because of the color of some of the print on the cover) is written before the stock sale goes into effect. It provides all of the information required in a final prospectus except the offer date and price, because those may not be known at the time. When the sale of the investment is made effective and the offer date, price, and final number of shares offered is known, a final prospectus is written and filed. The final prospectus supersedes the preliminary prospectus.

Similar to investments into public firms, the SEC also requires that a prospectus be filed by the managers of mutual funds and provided to their investors. Mutual fund investors also must be provided a prospectus upon investing. The regulations regarding mutual funds differ slightly from those for public firms. For example, investment companies of closed-end funds (which are created with a fixed number of shares and investors are allowed to purchase shares either during the fund’s first round or on a secondary market) are required to provide the fund’s prospectus only to the investors in the first round. Investors purchasing shares of a closed-end fund on the secondary market may not receive a prospectus since the purchase is through another investor and not the fund.

Mutual fund and closed-end fund prospectuses must contain information about three main areas: the logistical information of investing, the fund’s strategy and performance, and its management. The logistical information of investing includes details about the date of issue, fees, expenses, pricing, and share purchase and redemption. The strategy and performance information includes details about past performance, the investment’s objectives, investment strategies, risks of investing in the fund, and past performance. It will also contain a bar chart showing the total returns for the fund at the end of each of the last 10 years, or the life of the fund if it was issued within the last 10 years. The bar chart will be followed by a table summarizing the before and after tax returns for the past one, five, and 10-year periods. Management information includes the identities of fund managers and advisers and will often include biographical information as well. Last, the fund’s SEC file number will be provided on the back page.

The laws surrounding prospectuses vary by country and each stock exchange has differing regulations regarding the content and review of prospectuses. For example, firms in the European Union must abide by the EU Prospectus Directive. Those seeking admission to the Hong Kong Stock Exchange abide by the Hong Kong Companies Ordinance, the Securities and Futures (Stock Market Listing) Rules of Hong Kong, and the Hong Kong Listing Rules. The Australian Stock Exchange is governed by the Corps Act, which requires a security’s prospectus to be reviewed by the Australian Securities and Investments Commission. The Singapore Stock Exchange requires that the Monetary Authority of Singapore review each prospectus under the Listing Manual & Securities & Futures Act.

Bibliography:

  1. Luis de Carlos Bertrán, Raising Capital in Europe: The Legal Framework Following the EU Prospectus Directive (Richmond Law & Tax, 2005);
  2. Harvey E. Bines and Steve Thel, Investment Management Law and Regulation (Aspen, 2004);
  3. SEC Handbook, Securities Act of 1933 and the Edgar Rule (R. R. Donnelley, 2001);
  4. Securities and Futures Commission (Hong Kong, China), A Consultation Paper on Possible Reforms to the Prospectus Regime in the Companies Ordinance (Securities and Futures Commission, 2005);
  5. Dirk van Gerven, Prospectus for the Public Offering of Securities in Europe (Cambridge University Press, 2008).

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