Primary versus secondary markets

Seller, offering and trading venue

The primary market is where an issuer sells newly issued securities to investors. A company can sell new shares in its IPO or in a later follow-on primary offering. In either case, the company receives the proceeds, less offering costs. Being already public does not make its new issuance a secondary-market trade.

In ordinary secondary-market trading, existing shares or bonds pass from one investor to another, often through a broker-dealer. The seller receives the proceeds. The issuer receives no cash from that resale. A secondary-market price may influence the price of a future offering, but it does not fix every future offering price.

Keep a secondary offering separate from ordinary trading. In a selling-shareholder offering, existing holders offer their shares to the public under offering documents. Those holders receive the proceeds. An offering can include both new shares sold by the company and existing shares sold by holders. Read the seller and use-of-proceeds facts; a prospectus or an underwriter alone does not show who gets the money.

An exchange brings securities buyers and sellers together through market facilities. It can operate electronically; a physical trading floor is not required. Over-the-counter (OTC) trading occurs away from an exchange, commonly through dealers. Both unlisted and exchange-listed securities can trade OTC. Third market means listed securities traded OTC through broker-dealers. Fourth market means institutions trading directly without a broker-dealer intermediary. An electronic network by itself does not make a trade fourth market.

Registration and resale restrictions are separate questions. For a registered public offering, the general sequence is filing before offers and effectiveness before sales, subject to applicable exceptions. Some offerings and resales are exempt; existing shares are not automatically free of resale restrictions. SEC effectiveness does not approve an investment’s merits.

A riskless principal trade is still a principal trade. The firm receives a customer order, then makes an offsetting own-account trade at the same price before markup, markdown or fees. It matches that trade to the customer order instead of taking an unmatched inventory position. Riskless does not mean every business, settlement or customer risk disappears. Agent means acting for another account; principal means trading for the firm’s own account.

Price discovery is the process through which buy and sell interest helps establish market prices. Competition among orders can support it; weaker order interaction can impair it. Exchange order matching and dealer negotiation are different trading arrangements. Neither arrangement, by itself, guarantees the best price for every order or a zero bid-ask spread.

Secondary trading can take place on a physical floor or electronically. When Congress mandated a national market system in 1975, trading in US-listed stocks was dominated by exchanges with manual trading floors, where brokers met face to face. Since then trading has moved to a structure dominated by automated trading centers, and even the New York Stock Exchange added electronic execution that bypasses the face-to-face auction on its floor. Either way, a trade in shares that are already outstanding is secondary-market trading: the money goes to the selling investor, not to the issuer.

In 2008 the SEC approved the New York Stock Exchange's plan to replace its specialists with designated market makers, or DMMs. A DMM is the market maker assigned to particular stocks. It trades for its own account, with its own capital, to help keep trading in those stocks fair and orderly: it adds liquidity when there is little, quotes at the best price for part of the day, and handles the opening and closing. A floor broker is different: it represents customer orders.

Exam terms

Primary market

New securities sold by the issuer; proceeds go to the issuer.

Secondary market

Existing securities bought and sold; ordinary resales pay the selling holder.

IPO / follow-on primary offering

First public offering / a later issuer sale of new shares. An IPO can also include selling-holder shares.

Selling-shareholder (secondary) offering

Existing holders sell their shares in an offering; they receive those proceeds.

Third / fourth market

Listed securities traded OTC through broker-dealers / direct institution-to-institution trading without a broker-dealer.

Designated market maker (DMM)

The NYSE market maker assigned to a stock; trades for its own account to keep trading fair and orderly.

Compare an issuer sale of new securities with an ordinary investor resale.

Worked example

Lumen Grid Inc. sells 5 million new shares through a syndicate led by an investment bank. A week later, a retail investor buys 200 of those shares from another investor on an exchange.

1. The new-share offering is primary: Lumen Grid receives its proceeds after offering costs.
2. The later exchange purchase is an ordinary secondary-market trade: the selling investor receives the money. Lumen Grid receives none.
3. If a founder sells 1 million existing shares in a registered selling-shareholder offering, the founder receives those proceeds. If the same offering also contains new company shares, the company receives only its portion.

Check yourself

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Related practice

• Primary vs secondary market and proceedsPractice this
• Underwriting commitment and offering typePractice this
• Regulator and participant role mapPractice this