Question

1.) What is the difference between an underwriting and a “best-efforts” sale of securities? Who bears the risk associated with each sale? If the investment banker overprices a new issue of securities, who sustains the losses?

Answer 1

In an underwriting, the investment bank assumes risk and buys the issuing shares at certain price from the issuing company. In case of best effort basis, the risk is with the issuing company and the investment bank doesn't buy the shares but attempts to maximize sale of shares at determined price.

If the investment bank overprices the issue and there are not many buyers, if it underwrites the issue, it will bear the risk. Else, if it doesn't underwrite, the higher price may cause not many buyers in the 1st place. Therefore the issue may have to be dropped. If it still manages to sell the shares, on the day of the IPO listing or on subsequent days, the overpriced issue will anyway crash causing losses to retail investors who have bough the IPO.