Sometimes I get the feeling that the two biggest problems in America today are making ends meet—and making meetings end.
—Robert Orben
Rolfe and I knew that meetings would be a major part of our existence as bankers. We never imagined, though, just how absurd the meetings could get. Banker meetings are a lot like the Ebola virus. They start out small, but they grow quickly. And they don’t stop growing until they’ve consumed everything around them. At times, when it came to meetings, Rolfe and I felt like we were trying to play two-on-two basketball with twenty-five people on each team. We never really nailed down why banking meetings always seem to end up out of control, but we think it has something to do with how the new generation of bankers was hatched.
In the early days of banking, bankers were a lot like drug dealers. They told the potential customers, “My shit’s the best, man, it’ll really do the job for you.” The customers told themselves, “This guy’s dressed nicely, he’s smooth, he must have the goods.” They bought some of his shit and they took it home. They smoked it down, they shot it up, or they put it into their portfolio, and then they waited. Nothing happened. They weren’t getting high. They weren’t getting rich. Sometimes they even got a headache or, if they were really unlucky, they got some really bad shit that killed them. That was the nature of the beast.
Before the Great Crash of 1929, bankers were selling all kinds of bad shit to the public. They called the bad shit “securities.” It was like the bankers were packaging up little dime bags of flour and telling the customers that it was high-grade cocaine. The customers didn’t care, because they never tried it and didn’t know what it was. There was always some bigger fool that was willing to pay them even more for their little bags of flour than they’d paid themselves. And then, one day, some random guy tried snorting up some of the flour and he realized that it wasn’t cocaine at all. He realized it was crap. He sold his little bags of flour and told two friends what he’d figured out. Each of them, in turn, called their brokers, sold their bags of flour, and told two more friends about what was going on. Before long, everybody was trying to sell their flour, nobody wanted to buy it anymore, and the Great Crash had arrived. The game was up.
In the wake of this scandal, the federal government decided that somebody had to reign in the freewheeling bankers and their errant sales forces, who’d foisted the little flour bag scam upon the unsuspecting public. With this goal in mind, President Roosevelt’s regulators jammed reforms through the legislative branch under the guise of the Securities Act of 1933 and the Securities Exchange Act of 1934. Among other things, these Acts created the Securities and Exchange Commission, or SEC, which is now responsible for the monitoring and administration of most aspects of securities issuance in the United States.
The SEC is pure government bureaucracy. Its policy is never to approve any aspect of a new securities issuance; its only “approval” of a given deal comes in the form of a “failure to disapprove.” In other words, when a company and their investment bank come to market with a deal, the SEC doesn’t give a seal of approval that the deal’s OK, it merely states, “We’re not saying that this deal’s not OK.” It’s one of those double negatives that guys use to fool their girlfriends after they’ve done something wrong.
One of the requirements for securities issuers is that they make a filing with the SEC every time they intend to sell new securities to investors. The filings contain very specific information about the company issuing the securities and the nature of the securities themselves. These filings, which generally have to be made available to the investing public, go by a number of different names: S-1, S-3, S-4, the list goes on and on. The type of filing depends on what kind of securities are being issued. The important thing to remember is that the filings are required by law, which means that the bankers don’t have any choice but to put these documents together before they can go out, sell the securities, and earn their fees. They can no longer just tell the buyers that their shit is the best and the companies they are representing are high fliers, now they have to put it in writing. That presents a problem for the bankers, because it creates a paper trail. When things go awry, the buyers know where to point the finger and where to go looking for payback.
For the ever optimistic bankers, the filing requirements have created an opportunity. The bankers have decided that if they’re going to be forced to create this public filing, then they’re going to do it on their own terms. They’re going to turn it into a sales brochure, complete with color pictures and promotional material about what a fantastic, once-in-a-lifetime investment opportunity the securities being sold represent. They’re going to take that filing, print it up in a neat little package, and mail it out to all the potential buyers. Once it’s in the buyers’ hands, the bankers will take the smoothest, best-looking, most presentable members of company management, trot them out to all the big potential buyers, and put on a show. It’s called a road show, and it’s in the best tradition of the traveling medicine shows. Instead of traveling around and putting on the show off the back of a covered wagon, though, the bankers and the members of management use private jets. They stay in the best hotels, and put the show on in fancy restaurants, so that the buyers can have a nice meal while they hear about how wealthy they’re going to get by purchasing the company’s securities. It’s critical to maintain the image of big money. The buyers have to believe that the management team knows how to make coin. They have to believe that this is the team that’s going to make everybody rich.
Before the show can begin, the bankers and the company have to give birth to that sales brochure. It’s called the prospectus. It’s a tricky job, because at the same time that the prospectus tells the buyers what a great opportunity exists, it also has to cover everybody’s ass and meet the letter of the law on SEC filing requirements.
A long time ago, somebody figured out that if he came up with an important-sounding name for these meetings where the prospectus is created, people wouldn’t focus so much on what a waste of time they were. They decided to call them “drafting sessions.” All associates experience their fair share of drafting sessions. Rolfe and I were no exceptions.
Drafting sessions involve a big cast of characters. Everybody gets together in a room. They spend long days disagreeing with each other on what should be in the prospectus.
The bankers are always there. They only want to say good things. The better they can make the company sound, the easier it will be for them to sell the securities. The easier it is for them to sell the securities, the more certain they’ll be that the clients will be happy. That means fees. Fees are important.
The bankers have their lawyers there—the underwriters’ counsel. The job of an underwriters’ counsel is to make sure that the bankers don’t put any lies into the prospectus that are going to get them into trouble later. They have to twist the language in the document around so that if the prospectus ever gets brought up as evidence in a court of law the judge and jury will be so confused that they won’t have any idea what the language is claiming, or trying to claim, or maybe not even claiming at all. They have to be crafty.
Representatives from the company are there. The CFO almost always shows up; he’s usually in charge from the company’s side. Sometimes, depending on how important the transaction is to the company, the CEO may show up as well. If it’s the company’s first trip to the public markets for money the CEO usually comes in for lunch one day during drafting. There’s almost always somebody more junior from the company there also, usually somebody from the investor relations department. The CFO needs to have somebody to pin the blame on in case things get fucked up.
The company has its lawyers there also. Similar to the underwriters’ counsel’s role, it’s the company counsel’s job to make sure that any half-truths that go into the prospectus aren’t going to get the company into trouble. Sometimes company counsel is on the same side of the fence as underwriters’ counsel; more often than not they’re arguing with one another. If there’s ever going to be trouble, the company and the underwriters both want the other guy to take the fall. That’s usually why their lawyers end up arguing with each other.
The company’s accountants are there. Their job is to provide a fair and impartial rendering of the company’s financial health. The prospectus contains a lot of detail on the company’s historical financial performance, and it’s the accountants’ job to make sure it’s accurate. Before the prospectus gets finalized, the accountants have to provide “comfort” on the numbers. They usually spend a lot of time arguing with the company about what the right numbers should be, so their provision of professional comfort is generally accompanied by acute feelings of personal discomfort. At the end of the day, the company can fire the accountants if it doesn’t like the position they’re taking. This means that the accountants tend to come around to the company’s point of view if they want to keep the business. Usually, they want to keep the business.
If there were only one representative from each participating organization at the drafting sessions, things would probably go pretty smoothly. Five or six people could get together in a room and hammer out the prospectus in a couple of days. The problem is that each organization sends its own small army. An army girded for war.
The lawyers show up with the managing partner on the account, an associate, and a paralegal. The managing partner’s job is to argue, the associate’s job is to make a lot of pencil marks on the master draft of the document, and the paralegal’s job is to make copies and faxes. As junior bankers, whenever we were feeling low, we’d watch the junior lawyers and start feeling better. They worked just as many hours as we did, they made a lot less money, and their work was even more boring than ours. Three strikes, they were out.
The bankers show up with a managing director, a vice president, an associate, and, sometimes, an analyst. Having lots of bankers at the drafting sessions conveys strength and power. The clients are supposed to believe that with such an impressive array of financial talent, there’s no way the deal can fail. If there is more than one investment bank underwriting the deal, which there usually is, each of the banks will send its own representatives. Only the lead manager will send the full array of bankers. The co-managers figure that they’re not getting paid enough to have the whole cast show up. Sometimes the co-managers will each send only an associate, but usually they will send at least a couple of bankers.
There has to be at least one banker from each underwriter. There are two reasons for this. First, each underwriter wants to be absolutely positive that their firm’s name is printed correctly on the prospectus cover. This is a major concern for all associates. The junior banker’s most important job is to make sure that the firm’s name is spelled and displayed correctly on the prospectus cover and that the colors on the cover and inside the cover are accurate and vibrant. Second, a co-manager has to send at least one banker to the drafting session just in case the other underwriters decide that they’re going to try to get that co-manager evicted from the deal. Allowing a drafting session to pass without at least one banker from your bank being present is more dangerous than letting a hungry weasel into a nudist farm hot tub.
On the first day of drafting, everybody meets at the company counsel’s office. The company counsel keeps control of the document. Everybody meets up in a conference room that has a big table in the middle of it. Usually, there are twenty to thirty people there. Everybody stands around drinking coffee, adjusting themselves, and billing their clients.
As associates, our first order of business on the opening day of drafting was to seek out the associates from the other investment banks. We’d find them, introduce ourselves, and size each other up. It was like two dogs meeting in the park and sniffing each others’ asses to determine whether they were compatible. All the associates fell into one of two camps; those who got it, and those who didn’t. You could look into any of the other associates’ eyes and determine immediately which of the two species they were a member of. The ones who got it understood the game. They knew that an associate was little more than a yes-man, and that our role was to be as humble and subservient as a geisha girl. They were our allies, and we’d commiserate with each other throughout the deal process. The ones who didn’t get it believed that they were hotshots and deal magicians. They thought they were driving the wagon train when in fact they were being ridden like an inbred pack mule. They didn’t see themselves for what they were—street punks learning the business. They carried Mont Blanc pens in their front pockets so that everybody could see them. They had new Coach briefcases and shiny leather shoes. They shook everybody’s hand in the entire room and told them how glad they were to make their acquaintance. It was embarrassing to watch. In our minds, they were there to be tormented and, if the right opportunity presented itself, terminated. They were the enemy.
In preparation for the first day of drafting, company counsel usually puts together a rough draft of the prospectus. The rough draft provides a reference point from which to begin working. It’s easier than beginning work with a blank sheet of paper, but this rough draft is really rough, like that institutional toilet paper that feels like a sheet of sandpaper in your ass. The rough cut normally just includes a brief description of the company up front, and then a bunch of section titles in the back as placeholders. It costs the company a few thousand dollars, and by the time the final draft rolls around not a single word from the original will remain.
When it comes to drafting, there’s no such thing as pride of authorship. The normal rules of literary law and etiquette do not apply. This is probably because the rules of literary law that address plagiarism only apply to prose worth stealing, and there’s never been any text in a prospectus worth stealing. Bankers aren’t known for their vivid imaginations, so the chances of them breaking any new ground in their descriptions of a company’s business are slim. Furthermore, whatever mildly compelling prose any banker has managed to create to describe a company’s business has inevitably gotten watered down by paranoid lawyers. There’s no prime rib in the process; hamburger goes in, horsemeat comes out.
The various sections of any given prospectus are dictated both by tradition and regulatory mandate. The sections may differ slightly, depending on the nature of a given deal, but there are certain sections that are included in nearly all prospectuses. What follows here is our guide to prospectuses. For the uninitiated it will hopefully serve as a road map if you ever decide, against your better judgment, to actually sit down and read one.
Prospectus Summary—This is always the first section. It’s what the drafting team spends 75 percent of their time working on, and it’s often the only thing that prospective investors ever read. It’s supposed to give the reader all the key information in two to three pages. It’s supposed to tell the reader why the company doing the offering is the best, most successful competitor in its industry, why they’re the ass kickers who take no prisoners. It’s supposed to tell the reader how the company is going to take over its industry, and then its country, and then the world, so that an investment in the company will eventually represent pro-rata ownership in world domination. This section usually contains more bullshit than any other section.
Reversion to the mean dictates that most companies have to be average. There can only be a few standouts in any given industry. This principle works against the goal of presenting every company engaged in an offering as the industry leader. Since, therefore, it is impossible to present facts that actually support most companies’ claim to be the standout in their industry, the prospectus summary generally tries to confuse the readers through obfuscation. Those drafting the prospectus believe that if they can layer in enough nonsensical prose, readers will become so confused that they’ll be unable to realize how mediocre the company actually is.
Risk Factors—This section is a lawyer’s wet dream. It describes all of the things that could go wrong with the company. Years ago, the bankers, the lawyers, and the company all used to spend a lot of time fighting about what went into this section. The bankers and the company didn’t want to put too much in here, because they thought that people might get scared and not buy into the offering. The lawyers, though, were scared shitless and just wanted to cover their asses. The fights raged on and on. Then, one day, folklore has it, a brilliant young lawyer came up with a most Machiavellian strategy. He decided that if he overloaded this section with a bunch of irrelevant drivel, people would give up in frustration and neglect to read any of it or, at the very least, stand a good chance of missing the really important points. The strategy was pure genius. Today, there are maybe one or two risk factors that are relevant, really relevant, for any given deal. The rest is window dressing, but there’s so much of this extraneous window dressing that the relevant risk factors get ignored. The lawyer, the one who invented the strategy, has been immortalized as a charter member of the Prospectus Drafting Hall of Fame.
Use of Proceeds—Not too many people pay attention to this section, but they should. A careful reading of this section will tell you where the hell all the money from the offering is going. If it’s not going into the company coffers to help grow the company, but instead is going to pay out existing owners and management, then stay away. If owners are cashing out, there’s no reason for you to be cashing in.
Selected Financial Data—This section is also known to insiders as “Creative Presentation of the Company’s Financial Performance.” In it, the bankers and accountants put all their efforts into figuring out a way to make the company look like a real money machine. If a company’s got good cash flow but no earnings, you’ll see a cash flow line presented in a fat, bold font. If a company’s got neither cash flow nor earnings, but it’s growing like a weed, then you can bet that there’s going to be a bold line at the bottom showing year-over-year revenue growth or unit growth or employee growth. The only situation that’s difficult for even the most talented bankers and accountants to contend with is one where there’s no revenue at all. Even Houdini can’t mask the vacuum that a revenue line equal to zero creates. In this situation, the company is effectively fraternizing with the professional beggars on New York’s subway lines—“Please, I need money right away. It’s not for crack, I swear. Just soup and a sandwich.”
Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)—MD&A is the place where dreams are made, and mistakes justified. While the tables in the Selected Financial Data section can be spun and recrafted to focus attention on and present results in the best possible light, a good huckster needs a real soapbox to get out the vote. This is where MD&A comes in. In MD&A management gets the opportunity to justify its mistakes and take credit for its successes. In a painstaking narrative the management team explains just how things got to be the way they are. Revenues have dropped by 20 percent. Here’s why. Costs are spiraling out of control? There’s a valid explanation, and here it is.
Business—This section is an exact replication of the prospectus summary, but with twice as many meaningless adjectives and even more excruciating detail. If it wasn’t boring enough the first time around, it’ll become so in the Business section.
Management—This section presents biographies of both the management team and the board of directors. Members of management and/or the board of directors generally get only two to three sentences each to make themselves seem important, so they maximize the balderdash per sentence. The Management section also presents the reader with an opportunity to assess just how inbred the board of directors is. A good way to figure out how likely it is that the directors are sucking money out of a company is to draw a chart with each director’s name in a box. Read through the Management section, and each time that you identify a professional or personal connection between two directors, connect their boxes with a line. If you also happen to know about other relationships between directors, for instance one director is married to another director’s daughter, or one director is an old college buddy of another director, you can draw a line in there as well. If, upon completion, the chart looks like a spider web, then hold on to your wallet.
Principal and Selling Stockholders—This section describes who owns big pieces of the company and, if it’s an equity offering, whether any of them are selling their stock. If there are relatively few stockholders, each of whom owns a large piece of the company, that’s good because they’re probably going to be just as pissed off as the minority shareholders if the value of their holdings starts going down the toilet. It’s good to have a group of people channeling their fear, frustration, and greed to maximize the value of your investment.
If any of the large holders are selling their shares in the offering, stay away. As junior bankers, when institutional buyers would ask us why insiders were selling their stock in the offering, we’d volunteer numerous glib responses:
“Oh, it’s a liquidity issue.”
“Estate planning, nothing more.”
“Diversification, they don’t want to have all their eggs in one basket.”
In general, if the people who know the most about the business are taking their money out, it’s a safe bet that you shouldn’t be putting yours in.
Underwriting—This section will indicate which banks or brokerage houses are getting allocated a portion of the offering to parcel out to their preferred accounts. Effectively, the relatively small number of investment banks that underwrite the deal (the managers) sell the entire deal to a much larger group of brokerage houses (the syndicate), which in turn sell the deal to investment institutions and individuals. Now it’s much more lucrative to be a manager of a deal than it is to merely be a member of the syndicate, but a crummy free lunch is better than no free lunch at all. The syndicate is like the Treehouse Club—only the really bad boys don’t get to be members. The investment banks all fight tooth and nail up front to be given the mandate to manage a deal, but there’s an unspoken understanding among all the players that even those who lose out on the management mandate will get to be a part of the syndicate at selling time. Participation in the syndicate is the ever present booby prize of the public offering world.
Financial Statements—This is the real meat and potatoes of the prospectus. This is the section that should be up front. The problem is that this is the section with the least room for creative input, since disclosure in the financial statements is dictated by a well-defined set of independent accounting principles. The bankers don’t get a vote here; it’s the timid little bean counters who make the final decisions on what makes it into Financial Statements. In fact, it’s not so much the fact that the bankers don’t get to make the decisions on what goes into this section that drives them mad. It’s that the guys who do get to make those decisions are the accountants. If a big hitter like a CFO were responsible for the decisions it would be one thing, but it’s the frigging accountants. Call it the accountant’s revenge, and chalk one up for truth and justice.
For the investor, the financial statements are the only unadulterated statement of historical fact that can be used as a justification for taking on risk. The prospectus should be read like a Chinese newspaper, start at the back and work your way forward.
The entire drafting process can take anywhere from five to ten full working days. With a working group of twenty to thirty people, that translates to somewhere between one hundred and three hundred equivalent work days. That’s about a year’s worth of work for the creation of a document that hardly anybody reads. If one were to add up all the man-hours that go into the drafting of prospectuses in a given year there might be enough to develop a cure for cancer. The cure probably wouldn’t pay as well as writing prospectuses does, though.
As associates, our responsibilities at the drafting sessions were a function of the senior banker on the deal. Some senior bankers didn’t want us to do anything but sit quietly. We were just there to provide a presence, and as long as we didn’t fall asleep or wet ourselves we were doing our job. Other senior bankers gave us marginally more responsibility. They would stand up to leave the room and announce, “I have to go make a few phone calls. My associate here will lead the drafting while I’m gone.” That meant that if the group spent more than ten minutes arguing about how a single sentence should be worded, it would be our responsibility to state loudly, “OK, let’s keep things moving here.” It was an impressive skill to be developing.
The associate’s other responsibility once the document begins taking shape is to conform it to the bank’s formatting style. Every investment bank has a style manual. It’s a book that details every element of prospectus formatting—what size fonts to use in which locations, where headings should be placed, which lines in the financial tables should be underlined. This is important stuff, and being on style duty at the drafting sessions was exactly the sort of intellectually challenging work Rolfe and I had always dreamed that we’d be doing one day as investment bankers. We were determined to become the best damned style managers Wharton and Harvard had to offer.
Drafting sessions are utterly forgettable. They are slow, painful, and excruciatingly boring. Usually, the most difficult aspect of the drafting sessions is striking a reasonable balance between the amount of coffee one has to drink to stay awake and the number of trips one takes to the bathroom to mitigate the diuretic effects of the caffeine. Mealtime provides the only break in the insufferable monotony. I once asked Rolfe whether he’d ever enjoyed himself at a drafting session. He thought long. He thought hard. I began to worry that his brain might crack. After much reflection, he said no, he’d never actually enjoyed himself.
Rolfe and I had been to drafting sessions in Dallas, Los Angeles, Washington, D.C., Montreal, and New York. We could have had drafting sessions on the beach at Maui, or while flying in a hot air balloon high over the Amazon. It wouldn’t have made a difference. They still wouldn’t have been memorable.
The associate never knows for how many weeks the drafting sessions are going to drag on. Each drafting session ends with the scheduling of the next session. The associate understands that drafting is a lot like chemotherapy. There are no guarantees that the drafting will eventually lead to a completed deal, but without it there’s no chance for success. Each session is a necessary step in an evil, painful process. At the end of each session, the associate yearns for some indication that the process is drawing to a close. One day, he gets it.
The senior banker on a deal is the one who pulls the trigger and decides when the drafting sessions are done. This determination is not an objective process. The members of the drafting team don’t dot the last “i,” cross the last “t,” look around at each other, and exclaim “by God, we’re done!” It’s much more subjective than that. The lead banker uses an internal productivity gauge, developed over years of experience with both human nature and the tendency of attorneys to generate as many billable hours as possible. The lead banker assesses each drafting session’s accomplishments. When the number of accomplishments per dollar of billable legal time for a given drafting session falls below some minimum threshold the lead banker pulls the trigger. The banker decides that the time has arrived to light a fire under everybody’s ass. The time has arrived to start making it really expensive to continue wasting time. The lead banker decides to crank up the momentum, and take the drafting team to a place where dillydallying is not allowed. The lead banker speaks the words:
“It’s time to go to the printer.”