Prospectus law deals with a legal document given to prospective shareholders of a stock's initial public offering before they can invest. The prospectus lists the company's complete financial details as well as any related risks of the investment. This is also a requirement for mutual funds and regulated securities.

What is a Prospectus?

Contents of a prospectus are regulated under federal law. It's a document or publication that is issued by, or on behalf of, the corporation. The prospectus goes into great detail about the nature, character, and purpose for the issuance of shares, debentures, or any other corporate securities, and extends an invite to the general public to buy them. Federal law requires that a prospectus contains any and all material facts that relate to the company and its operations, so the potential investor has all the documentation to make an informed decision as to the merit of the specified investment.

A prospectus must be delivered to a prospective investor before any purchase is made. It is required any time the corporation is issuing stock to the general public. The Federal Securities Act also requires the prospectus be filed with the Securities and Exchange Commission (SEC), and it must have the SEC's approval prior to any major stock issuance. State laws regarding stock issuance may require corporations to complete similar documentation for some issuances or when it offers stock within the state.

Limited partnership interests that are offered to the public may also require a prospectus and needs to be delivered to each investor.

What Details Does a Prospectus Include?

The prospectus includes a variety of specific details:

  • Financial status
  • Corporate officers
  • Plans
  • Corporate obligations, like a lawsuit
  • Recent performance

It should include any other matters that would be important for a prospective investor, or their adviser, to evaluate the stock's merits and company's prospects for profit, growth, and loss. They discuss the amount and type of securities being offered and how many shares are available.

Even though the prospectus can be rather difficult to decipher, it is still required for each purchaser to receive a copy.

Preliminary versus Final Prospectuses

You may also see multiple prospectuses too. A preliminary one is prepared for the first offering, and the final prospectus has finalized background details like the number of shares being issued and the specific offering price. This is prepared once the deal is effective. There are also requirements that dictate what details a final prospectus must contain:

  • Business history
  • Offer description
  • Management information
  • Price
  • Date
  • Any selling discounts
  • How proceeds are used
  • Underwriting description
  • Financial information
  • Buyer risks
  • SEC Disclaimer
  • Any legal opinions on the formation of the company

Clients who expressed interest during the cooling-off period can place orders with brokers once the final prospectus is complete. A copy of the final prospectus must accompany or precede all confirmed sales.

Mutual Fund Prospectuses

For mutual funds, a prospectus will have specific information that relates to the fund:

  • Objective details
  • Risks
  • Performance
  • Investment strategies
  • Distribution policy
  • Fund management
  • Fees and expenses

It will talk about whether the offering is public or private and how much the underwriters are earning for each sale. Because fees from mutual funds reduce investor profits, you'll see the fees listed in a table near the start of the prospectus. The fees for sales, purchases, and moving between funds are included.

This makes it simple to compare costs of different mutual funds. High-cost funds will have fees that exceed 1.5 percent while low-cost funds are below one percent.

Different Types of Prospectuses

There are also other types of prospectuses that are used for different purposes:

  • Ph.D. students in Humanities are asked to prepare dissertation prospectuses for a committee.
  • Many research grant applications require prospectuses.
  • Academic job candidates typically include brief prospectuses with their application documentation.
  • Some publishers require them to use in the process to evaluate a manuscript.
  • Journal and essay volume editors may also want a prospectus with a writer's proposed article.

Why is a Prospectus Important?

The main purpose of the prospectus is to ensure potential investors are aware of the risks of the investment. Without any information, they would be making an investment “sight unseen.” That could have disastrous results. The prospectus disclosure also protects the corporation from any claims that it did not fully disclose adequate information about the securities or the company itself.

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