Simulation auction for public offering

Abstract

The invention provides a method and system to estimate demand, pricing, allocation and aftermarket demand for public offerings via a simulation auction using collaborative forecasting. The simulation auction incorporates features to enhance participant knowledge about a particular company and its proposed auction. The simulation auction may be used to collect information regarding likely or equilibrium pricing of actual offerings, as well as to generate demand curve provides for different types of participants (e.g. retail and institutional investors).

Description

CROSS-REFERENCE TO RELATED APPLICATION(S) [0001] This application claims the benefit of U.S. Provisional application No. 60 / 589,328, entitled “SIMULATION AUCTION FOR PUBLIC OFFERING”, filed on Jul. 20, 2004, the subject matter of which is hereby incorporated by reference herein in its entirety.FIELD OF THE INVENTION [0002] This invention relates generally to a method and system for simulating a public offering of securities. More specifically, the invention relates to a method and system to estimate demand, pricing, allocation and aftermarket demand for public offerings via a simulation auction of securities using collaborative forecasting. BACKGROUND OF THE INVENTION Price Discovery [0003] Investment securities may be sold to institutions or to individuals and sold in public or private offerings. Companies with certain profiles can raise significant financing by public offerings. The amount of money raised depends on the unit price of the securities sold and the number of units so...

AI Technical Summary

Benefits of technology

"The patent describes a computer method for simulating a securities auction using collaborative forecasting. The method involves selecting a real-world securities offering for a simulation auction and providing information about the offering to stimulate bids for simulated securities. Participants are offered to make bids, with a fee increasing with the value of the securities. The method also involves determining a simulated clearing price for the securities and providing feedback to participants on whether their bid was rejected. The method allows for data exchange after the actual offering of securities is completed to compare the collective forecast with the actual outcome. The technical effect of the patent is to provide a way to simulate securities auctions and collectively analyze and improve the forecasting process."

Problems solved by technology

This makes pricing of securities difficult in an IPO.

However, also for other kinds of offerings, investors may be uncertain about an appropriate price offer, and the offering party may need information about demand and appropriate pricing.

The conventional price discovery methods have limitations affecting both investors and underwriters, for several reasons.

The methods lack transparency.

That is, investors have no opportunity to review the aggregated source bid data or the rationale upon which final pricing its based by the book-runner.

Further, there are barriers inhibiting pricing feedback between the offering syndicate and the investing community, so that communication of pricing information is not truly real-time.

During the course of the roadshow there are many layers of communications among the syndicate, their respective distribution networks, and potential investors, each of which can create a timing lag, as well as potential for miscommunication.

Another limitation on communication is created by SEC regulations.

SEC regulations strictly limit the information a broker / dealer involved in a securities distribution may provide—the information is limited to the delivery of a prospectus.

Thus, by law, underwriters may not show investors any other data, no matter how valuable the market might deem it, lest such information be deemed a prospectus subject to SEC review.

Trying to provide the marketplace with additional information beyond a traditional prospectus creates an unworkable paradox because of the regulations placed on the broker / dealer community.

Providing the data would require adjusting the prospectus, which would take time.

Thus, no market equilibrium is reached, and with multiple adjustments the final pricing could theoretically be delayed substantially.

This can hurt the issuer, underwriter and the efficiency of the capital markets.

Alternatively, a disproportionately large “pop” often means there was large unfilled demand.

Such underpricing may deprive the issuer of useful incremental capital.

The book-build process has inherent limitations.

As a result, it is subject to time-lags, miscommunication and disinformation.

Time-lags and inefficiency of information collection also arise because the syndicate suffers the same vagaries of human interaction that exist in a typical vendor / customer relationship.

A given salesperson / broker may not have a strong enough relationship with his / her customer to elicit timely feedback, or may decline to make further follow-up calls requested by the book-runner on any specific securities transaction in the short-term, for fear of upsetting the long-term customer relationship.

Miscommunication can result from simple verbal or body language miscues, interpretive mistakes in converting oral instructions to written, or a misunderstanding by the broker / salesperson or customer of the issuer or its proposed transaction terms and conditions.

Such miscommunications increase the risk of erroneous data being factored into the pricing.

These tactics often lead to a rush of bids and price changes at the end of the process—such a change in price or demand can catch a book-runner unprepared.

If the change is large enough, the issuer may need to file an amendment to its registration statement to capture the increase in demand or pricing (also creating a time-lag), or accept that such unfulfilled demand and price flexibility from customers will result in potentially lower proceeds than justified and an excessive aftermarket “pop.”

Another limitation of the book-build process lies in allocations.

Other general securities underwriting challenges include allocation issues where it is frequently difficult for a small investor to obtain shares of a “hot” issue, and pricing quandaries based on the tradition that the underwriting process is a closed process where only the underwriters know the demand price and overall interest level in a given offer (i.e. asymmetric information) and there is no real-time feedback to investors about their bid price or potential allocation before the auction closes, which permit them to refine their bid to the benefit of all parties.

While more fair and democratic to a broader spectrum of investors than a book-build offering in the sense that those at or above the clearing price receive allocations irrespective of their investment “pedigree”, the open offering process is not necessarily more “open” or transparent to all participants.

Firstly, the underwriters may choose to prohibit participation of certain parties based on their own review and qualification criteria so it is not truly open to all bidders.

Secondarily, because the bids for an open offering are only known to the underwriters (again the asymmetric information quandary), it is impossible for bidders or potential bidders to know whether their bid is likely high enough to purchase shares until after the auction process is completed, thus there is no more transparency in a dutch auction than a book-build.

For example, in an IPO, retail investors may get caught up in the frenzy of an IPO and overbid for the offering.

Thus, all investors may lose money if the price subsequently drops.

The rules to determine what constitutes “manipulative” are typically not defined to the public and an investor bidding too high may find itself disqualified from the offering.

There is no mechanism for participants in advance to review the demand curve of the open offering to determine whether their bid level is likely to be viewed as manipulative.

There are issues for institutional investors with regard to maintaining an optimal investment position size for any given issuer in their portfolio.

Thus if the institutional investor were to receive too small of an allocation due to a unilateral clearing price reduction by the underwriter and / or issuer, the institutional investor would either need to purchase more shares in the aftermarket or would consider “flipping” their sub-optimal sized allocation back to the syndicate—creating an unattractive dilemma for either underwriter or investor.

Further, conflicts of interest arise among underwriters with retail distribution networks (i.e. individual investors) in a dutch auction securities offering.

There is difficulty in determining how to protect the privacy of a broker's accounts while qualifying such retail investors.

This creates concerns of privacy among underwriters, because one underwriter may not want to share the bid data and the qualifications of a list or particular investor.

Currently there is no equivalent for transparently developing the fair price of financial securities to be issued in an underwritten offering.

Generally, the public cannot acquire objective research regarding the offered security until they have already purchased the security.

However, there is a dearth of public websites that provide indepth information and tools relevant to a detailed analysis of a transaction.

However, voting and online offshore gaming are less likely to produce useful information about interest level and pricing on an upcoming offering.

Voting is not effective for a securities offering as small and large investors carry the same weight which can be misleading given the different bid sizes that occur in an offering versus the vote.

Lack of financial risk and strict dependence on user trustworthiness are significant weaknesses—there is no penalty for being wrong or misleading.

Online offshore gaming does not provide transparency between institutional and individual investors, and is not legal in the U.S. Neither system is appropriate to provide the relevant feedback and analysis for a securities offering and likely provide inaccurate or suspicious results.

Thus, participants may place irrational wagers such as selecting volatile stock options or “voting” a very high or low value for an upcoming IPO, because there is no financial deterrent to a participant for placing wild guesses as to the securities pricing or post-IPO market performance given the “all-or-none” nature of those types of data collection systems.

The absence of realistic participation rules means that participant behavior and, thus, the process results lack realism.

However, there is considerable information missing from the results produced in such systems.

For example, it is not possible to differentiate between the demand curves for institutional investors and for retail investors.

Also, such simulations do not offer simulation participants a full range of bid sizes.

Thus, there is no means for an institution to simulate the results of a $20 million bid in a large public offering.

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