The first reference of Investment banks was made in the Glass-Steagall Act of 1933. This act separated the insurance companies, commercial banks and investment banks. The senators who proposed this bill had opinion that the 1929 market crash was the result of the investment banks operating as merged entity with investment banks.

They felt that the banks failed because their security operations were not foolproof and the commercial banks used their lending knowledge to do the insider trading on the securities. Thus, traditionally many investment banks operated in partnership mode like Goldman Sachs, Morgan Stanley, Soloman brothers etc. However, the partnership mode is gradually disappearing.

Change of Approach on the Operation of Investment Banks

One study conducted by Prof Benston showed that the failure rate is lower in case of unregulated banks. Similarly, various countries like Germany, Switzerland etc have allowed the universal banking instead of separate operations of Investment Banks. Thus, in 1990s, regulators in US allowed the commercial banks to operate on certain securities and finally Graham Leach act rescinded the Glass Steagall act.

The Graham Leach act triggered the merger of various insurance companies, commercial and Investment banks. For example, Traveler Group, an insurance company, merged with Citicorp, a commercial bank, to produce Citigroup. Chase Manhattan Bank acquired investment bank, JP Morgan.  Similarly, UBS Switzerland bought Paine Webber, a brokerage firm.

How Does Security Underwriting Happen

The underwriting of securities happens by issuance of shares and through varied corporate debt instruments. The organisation may choose to come out with the seasoned issue or IPO. The underwriter of the security provides the advice for issuing, distribution of securities, sharing of the risk and aftermarket stabilization. The reputation of the underwriter is also at stake as the underwriting company “certifies” the issue.

There Are Two Types of Offerings Provided By the Underwriters –

• Bought Deal or firm commitment offering – In this situation the underwriter agrees to buy all unsold shares
• Best Efforts – The underwriter keeps the deal collapse option open if the issues are not sold

Underwriting Process

The process flow of on type of the underwriting process is as given below –

• The period for pre-filing
• The advices are given to the issuers about the various choices they have
• The agreement is reached amongst designate managers, underwriters on various aspects including fees
• The registration filing statement with the securities board of the country, thus triggering the cooling off period
• The red herring prospectus is distributed in the cooling off period

Another Type of Underwriting Process Has Following Flow –

• The prospective clients are called for interest indication
• The due diligence meeting happens between the corporation and underwriters
• The offering price is decided
• The agreement of the underwriter is formed and which underwriter sells which security is agreed upon
• Effective date of the issue is decided
• Finally, the price is supported in the open market

The underwriter may also manipulate market in a certain way to induce stabilization in the market around the time of issue of security.