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Chapter Sixteen

Securities Firms and


Investment Banks

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Securities Firms and


Investment Banks (IBs)
Investment
Investment banks
banks (IBs)
(IBs) help
help corporations
corporations and
and
governments
governments raise
raise capital
capital through
through debt
debt and
and equity
equity
security
security issues
issues in
in the
the primary
primary market
market

underwriting
underwritingisisassisting
assistingin
inthe
theissue
issueof
ofnew
newsecurities
securities
IBs
IBsalso
alsoadvise
adviseon
onmergers
mergersand
andacquisitions
acquisitions(M&As)
(M&As)
and
andcorporate
corporaterestructuring
restructuring

Securities
Securities firms
firms assist
assist in
in the
the trading
trading of
of securities
securities
in
in secondary
secondarymarkets
markets
broker-dealers
broker-dealersassist
assistin
inthe
thetrading
tradingof
ofexisting
existing
securities
securities

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Securities Firms and


Investment Banks (IBs)
The
Thesize
sizeof
ofthe
theindustry
industryisisusually
usuallymeasured
measuredby
bythe
theequity
equity
capital
capitalof
offirms
firmsrather
ratherthan
thantotal
totalasset
assetsize
size

the
thelargest
largestfirm
firminin1987
1987had
had$3.2
$3.2billion
billioninintotal
totalcapital
capital
the
thelargest
largestfirm
firminin2007
2007had
had$114.2
$114.2billion
billioninintotal
totalcapital
capital

5,248
5,248firms
firmsinin1980
1980
9,515
9,515firms
firmsinin1987
1987
5,808
5,808firms
firmsinin2007
2007

The
Thenumber
numberof
offirms
firmsin
inthe
theindustry
industryusually
usuallyfollows
followsthe
the
overall
overallcondition
conditionof
ofthe
theeconomy
economy

As
Aswith
withcommercial
commercialbanks,
banks,consolidation
consolidationhas
hasoccurred
occurred
through
throughmergers
mergersand
andacquisitions
acquisitions
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Securities Firms and


Investment Banks (IBs)
The
The largest
largest firms
firms in
in the
the industry
industry are
are diversified
diversified
financial
financial service
service firms
firms or
or national
national full-service
full-service IBs
IBs
service
serviceboth
bothretail
retailand
andwholesale
wholesalecustomers
customersby
byacting
acting
as
asbroker-dealers
broker-dealers
service
servicecorporate
corporatecustomers
customersby
byunderwriting
underwritingsecurity
security
issues
issues

The
The second
second largest
largest group
group of
offirms
firms are
are full-service
full-service
firms
firms that
that specialize
specialize in
in corporate
corporate finance
finance or
or
primary
primary market
market activity
activity (i.e.,
(i.e., focus
focus less
less on
on
secondary
secondary market
market activities)
activities)
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Securities Firms and


Investment Banks (IBs)
A
Athird
third group
group of
of firms
firms includes
includes the
therest
rest of
ofthe
the
industry
industry and
and isis further
further divided
divided into
into five
five subgroups
subgroups
IB
IBsubsidiaries
subsidiariesof
ofcommercial
commercialbanks
banks(i.e.,
(i.e.,Section
Section20
20
subsidiaries)
subsidiaries)
discount
discountbrokers
brokers
regional
regionalsecurities
securitiesfirms
firms
specialized
specializedelectronic
electronictrading
tradingfirms
firms
venture
venturecapital
capitalfirms
firms

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Securities Firms and


Investment Banks (IBs)
Investment
Investment banking
banking

first
firsttime
timedebt
debtand
andequity
equityissues
issuesoccur
occurthrough
throughinitial
initial
public
publicofferings
offerings(IPOs)
(IPOs)
new
newissues
issuesfrom
fromaafirm
firmwhose
whosedebt
debtor
orequity
equityisisalready
already
traded
tradedare
arecalled
calledseasoned
seasonedequity
equityofferings
offerings(SEOs)
(SEOs)
aaprivate
privateplacement
placementisisaasecurities
securitiesissue
issuethat
thatisisplaced
placed
with
withone
oneor
oraafew
fewlarge
largeinstitutional
institutionalinvestors
investors
public
publicofferings
offeringsare
areoffered
offeredto
tothe
thepublic
publicatatlarge
large
IBs
IBsact
actonly
onlyas
asan
anagent
agentin
inbest
bestefforts
effortsunderwriting
underwriting
IBs
IBsact
actas
asprincipals
principalsin
infirm
firmcommitments
commitments

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Securities Firms and


Investment Banks (IBs)
Market
Market making
making involves
involves the
the creation
creation of
of
secondary
secondary markets
markets for
for an
an issue
issue of
of securities
securities

agency
agencytransactions
transactionsare
aretwo-way
two-waytransactions
transactionson
on
behalf
behalfof
ofcustomers
customers
with
withprincipal
principaltransactions
transactionsmarket
marketmakers
makersseek
seekto
to
profit
profitfor
fortheir
theirown
ownaccounts
accounts

Trading
Trading involves
involves taking
taking an
an active
active net
net position
position in
in
an
an asset
asset
position
positiontrading
tradinginvolves
involvesrelatively
relativelylong-term
long-term
positions
positionsin
inassets
assets

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Securities Firms and


Investment Banks (IBs)
pure
purearbitrage
arbitrageinvolves
involvesattempts
attemptsto
toprofit
profitfrom
fromprice
price
discrepancies
discrepancies
risk
riskarbitrage
arbitrageinvolves
involvesattempts
attemptsto
toprofit
profitby
by
forecasting
forecastinginformation
informationreleases
releases
program
programtrading
tradingisisthe
thesimultaneous
simultaneousbuying
buyingand
and
selling
sellingof
ofatatleast
least15
15different
differentstocks
stocksvalued
valuedatat$1
$1
million
millionor
ormore
more
stock
stockbrokerage
brokerageinvolves
involvestrading
tradingon
onbehalf
behalfof
of
customers
customers
electronic
electronicbrokerage
brokerageoffers
offerscustomers
customersdirect
directaccess,
access,
via
viathe
theinternet,
internet,to
tothe
thetrading
tradingfloor
floor
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Securities Firms and


Investment Banks (IBs)
Investing
Investing involves
involves managing
managing pools
pools of
ofassets
assets such
such
as
as closedclosed- and
and open-end
open-end mutual
mutual funds
funds
as
asagents
agents
as
asprincipals
principals

Cash
Cash management
management involves
involves deposit-like
deposit-like
accounts
accounts such
such as
as money
money market
market mutual
mutual funds
funds
(MMMFs)
(MMMFs) that
that offer
offer check
check writing
writing privileges
privileges
Merger
Mergerand
and acquisition
acquisition (M&A)
(M&A) assistance
assistance
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Securities Firms and


Investment Banks (IBs)
Venture
Venturecapital
capital (VC)
(VC) isis aa professionally
professionally
managed
managed pool
pool of
of money
money used
used to
to finance
financenew
new(i.e.,
(i.e.,
start-up)
start-up) and
and often
often high-risk
high-risk firms
firms
VC
VCusually
usuallypurchases
purchasesan
anequity
equitystake
stakein
inthe
thestart-up
start-up
usually
usuallybecome
becomeactive
activein
inmanagement
managementof
ofthe
thestart-up
start-up
institutional
institutionalventure
venturecapital
capitalfirms
firmsfind
findand
andfund
fundthe
the
most
mostpromising
promisingnew
newfirms
firms
venture
venturecapital
capitallimited
limitedpartnerships
partnerships
financial
financialventure
venturecapital
capitalfirms
firms
corporate
corporateventure
venturecapital
capitalfirms
firms

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Securities Firms and


Investment Banks (IBs)
Industry
Industry trends
trends depend
depend heavily
heavily on
on the
the state
state of
of the
the
stock
stock market
market
commission
commissionincome
incomedeclined
declinedmarkedly
markedlyafter
afterthe
the1987
1987
stock
stockmarket
marketcrash
crashand
andthe
the2001-2
2001-2stock
stockmarket
market
decline
decline
improvements
improvementsin
inthe
theU.S.
U.S.economy
economyin
inthe
themid-2000s
mid-2000s
led
ledto
toincreases
increasesin
incommission
commissionincome
income
income
incomefell
fellwith
withthe
thestock
stockmarket
marketin
in2006-8
2006-8because
becauseof
of
rising
risingoil
oilprices
pricesand
andthe
thesubprime
subprimemortgage
mortgagecollapse
collapse

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Balance Sheets of Securities Firms


and Investment Banks (IBs) (2007)
Long
Long positions
positions in
in securities
securities and
and commodities
commodities
represent
represent 24.1%
24.1% of
ofassets
assets
Securities
Securities purchased
purchased under
underagreement
agreement to
to resell
resell
represent
represent 21.6%
21.6% of
oftotal
total assets
assets
Securities
Securities sold
sold under
underagreement
agreement to
to repurchase
repurchase
represent
represent 41.5%
41.5% of
oftotal
total liabilities
liabilities and
and equity
equity
Equity
Equity capital
capital amounted
amounted to
to 3.0%
3.0% of
oftotal
total
liabilities
liabilities and
and equity
equity
compares
comparesto
to10.1%
10.1%for
forcommercial
commercialbanks
banks
SEC
SECrequires
requiresminimum
minimumnet
networth
worthto
toassets
assetsof
of2%
2%

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Regulation of Securities Firms


and Investment Banks (IBs)
The
The Securities
Securities and
and Exchange
Exchange Commission
Commission
(SEC)
(SEC) isis the
the primary
primary regulator
regulator of
of the
the securities
securities
industry
industry
The
The National
National Securities
Securities Markets
Markets Improvement
Improvement
Act
Act (NSMIA)
(NSMIA) of
of 1996
1996 reaffirmed
reaffirmed federal
federal (over
(over
state)
state) authority
authority
even
evenso,
so,state
stateattorneys
attorneysgeneral
generalintervene
intervenethrough
through
securities-related
securities-relatedinvestigations
investigationsthat
thathave
haveled
ledto
tomany
many
highly
highlypublicized
publicizedcriminal
criminalcases
cases
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Regulation of Securities Firms


and Investment Banks (IBs)
The
The Sarbanes-Oxley
Sarbanes-Oxley Act
Act (SOX)
(SOX) of
of 2002
2002
created
created an
an independent
independent auditing
auditing oversight
oversight
board
board under
under the
the SEC
SEC
increased
increased penalties
penalties for
for corporate
corporate wrongdoers
wrongdoers
forced
forced faster
faster and
and more
more extensive
extensive financial
financial
disclosure
disclosure
created
created avenues
avenues of
of recourse
recourse for
for aggrieved
aggrieved
shareholders
shareholders
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Regulation of Securities Firms


and Investment Banks (IBs)
The
The SEC
SEC sets
sets rules
rules governing
governing underwriting
underwriting
and
and trading
trading activity
activity
SEC
SEC Rule
Rule 144A
144Adefines
defines boundaries
boundaries between
between
public
public offerings
offerings and
and private
private placements
placements
SEC
SEC Rule
Rule 415
415 allows
allows shelf
shelf registration
registration
allows
allowsfirms
firmsthat
thatplan
planto
tooffer
offermultiple
multipleissues
issuesof
of
stock
stockover
overaatwo-year
two-yearperiod
periodto
tosubmit
submitone
one
registration
registrationstatement
statementsummarizing
summarizingthe
thefirms
firms
financing
financingplans
plansfor
forthe
theperiod
period
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Regulation of Securities Firms


and Investment Banks (IBs)
Two
Two self-regulatory
self-regulatoryorganizations
organizations oversee
oversee the
the
day-to-day
day-to-day regulation
regulation of
of trading
trading practices
practices
the
theNew
NewYork
YorkStock
StockExchange
Exchange(NYSE)
(NYSE)
the
theNational
NationalAssociation
Associationof
ofSecurities
SecuritiesDealers
Dealers
(NASD)
(NASD)

The
The U.S.A.
U.S.A. Patriot
PatriotAct
Act became
became effective
effective in
in 2003
2003
firms
firmsmust
mustverify
verifyidentities
identitiesof
ofcustomers
customers
firms
firmsmust
mustmaintain
maintainrecords
recordsof
ofidentities
identitiesof
ofcustomers
customers
firms
firmsmust
mustverify
verifycustomers
customersare
arenot
noton
onsuspected
suspected
terrorist
terroristlists
lists

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Regulation of Securities Firms


and Investment Banks (IBs)
Industry
Industry isis protected
protected by
by the
the Securities
Securities
Investor
Investor Protection
Protection Corporation
Corporation (SIPC)
(SIPC)
protects
protects investors
investors against
against losses
losses of
of up
up to
to
$500,000
$500,000 due
due to
to securities
securities firm
firmfailures
failures (but
(but
not
not against
against poor
poor investment
investment decisions)
decisions)
created
created following
following passage
passageof
of the
the Securities
Securities
Investor
InvestorProtection
ProtectionAct
Act in
in 1970
1970

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Global Issues
Securities
Securities firms
firms and
and investment
investment banks
banks are
are
by
by far
far the
the most
most global
global of
of any
any group
group of
of
financial
financial institutions
institutions
U.S.
U.S. firms
firms are
are increasingly
increasingly looking
looking to
to
expand
expand their
their business
business abroadparticularly
abroadparticularly
into
into China
China an
an India
India

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