What is a Red Herring?


Welcome to the Investors Trading Academy talking
glossary of financial terms and events. Our word of the day is “Red Herring”
A red herring is something that misleads or distracts from a relevant or important issue.
It may be either a logical fallacy or a literary device that leads readers or audiences towards
a false conclusion. When a security is offered to the public for
the first time, the underwriter prepares a preliminary prospectus, called a red herring.
While the name may refer to the parts of the document printed in red ink, the implication
is that the document has been written to present the company in the best possible light. The
reference is to the rather distinctive odor of the fish in question, which, the story
goes, fleeing fugitives sometimes used to throw bloodhounds off their scent. Although
the preliminary prospectus contains important information about the company, its offerings,
financial projections, and investment risk, it is customarily revised before the final
version is issued. The red herring prospectus contains substantial
information on the company, including use of proceeds from the offering, market potential
for its product/service, financial statements, details of officers, directors and major shareholders,
pending litigation, etc. The red herring prospectus is used to solicit
expressions of interest in the issue. Once the registration statement becomes effective,
a final prospectus that contains the final IPO price and issue size is disseminated.
Expressions of interest are then converted to orders for the issue at the buyer’s option.
The minimum period between the time a registration statement is filed and its effective date
is 20 days. Note that the SEC does not approve the securities but simply ensures that all
relevant information is disclosed in the registration statement.

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