The report contains important details about the business, but does not contain specific details about the IPO itself, such as proposed share price and number of shares for sale.
Red Herrings and the IPO Process
Red herring submissions are used in the preliminary phase of the IPO process to prepare the IPO for approval from the SEC.
The process may only involve one red herring submission, but generally contains multiple submissions as the SEC attempts to gain a comprehensive view of the company’s operations to determine if it is prepared to be listed on the public markets.
The SEC will often request additional information that the company must submit as a red herring.
All the information contained in the red herring submissions is checked by the SEC to ensure that it is accurate and that there are no purposeful omissions of critical information.
Once all regulatory requirements are met, the company can file its final prospectus with the SEC, which contains the precise details of the IPO itself, as well as key company information intended for investor use.
Red Herring Content
The content of a red herring submission can vary substantially, but they generally contain information about the company that is relevant to the proposed IPO.
Some examples of the content of a red herring submission include intended use of proceeds from the offering, financial statements, market potential for its product/service, details regarding pertinent current major shareholders and management personnel, pending litigation and any other pertinent details.
Red Herrings and Investors
Red herrings have an alternate purpose beyond fulfilling a regulatory requirement: advertising to potential investors.
Arguably this alternate purpose to red herrings has come to dominate their production and distribution over their original purpose.
Originally investors would seek out red herrings as a potential source of information about an upcoming IPO, whereas now companies will distribute their red herrings among potential investors as a means of generating interest.
As the main audience of the red herrings transitions from regulators to investors, the content and presentation of the red herrings have changed as well.
Red herrings often contain a wide variety of additional information that is not required by regulators, but which is intended to make the company more attractive to potential investors.
Many companies now hire professional investment bankers to write their red herrings for them, as the importance of the red herring in the investor relation process has increased dramatically.
Red Herrings and Trading
A red herring submission can be an excellent source of information for traders looking to trade on an upcoming IPO or on a stock in general.
IPOs represent an excellent source of trading opportunities for both fundamental analysis and price action. The first few hours and days of an IPO see some of the biggest volatility anywhere in the equity markets, and traders can reap substantial returns if they have a comprehensive view of the underlying company.
Traders can use red herrings for further insight into a stock even long after the IPO has been completed.
In addition, by following the process of information disclosure, traders with a keen analytical mind can identify potential problem areas in the company, as managers attempt to cover up or whitewash certain aspects of the company during the IPO process.
Traders who specialize in shorting companies with possible internal problems use red herrings extensively in their evaluations of the internal workings of companies.
Red herring submissions are a key element in the regulatory requirements of the IPO process that have a growing importance in the generation of investor interest in an upcoming IPO.
Red herrings contain critical information that both investors and traders can use to trade an upcoming IPO, or even to evaluate a company long after the IPO process is complete.
Short sellers in particular often use red herring submissions to identify companies that may be trying to hide or whitewash shortcomings.
Red herrings can contain red flags that stand out to short sellers and signal candidates that are worthy of further investigation for possible fraud or poor management practices.