What is a Reverse Stock Split? Securities Lawyer 101

Reverse Stock Split

Securities Lawyer 101 Blog

Reverse stock splits are often used by public companies to reduce the amount of securities outstanding.  A reverse stock split can also be used by private companies in corporate restructurings.  Typically in a reverse split, a company reduces the number of its outstanding shares in proportion to the ratio of the reverse stock split so that each stockholder the same percentage of the company’s outstanding shares immediately prior to and after the reverse split.  If approved and effected, the reverse stock split will be realized simultaneously and in the same ratio for all of the company’s common stock. The reverse stock split will affect all holders of the company’s common stock uniformly and will not affect any stockholder’s percentage ownership interest in the company.  Unfortunately, there is typically no limit on the amount of shares a company may issue after a reverse split which would dilute investors.  The reverse split reduces the shares outstanding thereby facilitating the issuer’s ability to issue more shares. Immediately upon a reverse split becoming effective, issuers often commence issuing new shares and diluting investors.  Shares of issuers enacting reverse splits rarely hold the stock price seen upon effectiveness of the split.

Why do companies do reverse stock splits?

Companies do reverse stock splits for a variety of reasons.  Reverse Splits are frequently used in reverse merger transactions particularly where illegal custodianship or receivership actions are used. Upon taking control of a shell, corporate hijackers enact large reverse stock splits to eliminate the interests of legitimate shareholders and investors.

Despite the use by shell hijackers and reverse merger purveyors, there are legitimate reasons that companies effect stock splits.  These include that a reverse stock split might:

♦ make the company more appealing to investors because the company will have fewer shares outstanding and may have a higher stock price;

♦ improve the trading price of its common stock; and

♦ allow the company to issue more shares in the future because there are fewer shares outstanding.

How does a reverse stock split affect a stock’s share price?

A reverse split reduces the number of a company’s shares outstanding and increases its share price proportionately.  For example, if a shareholder owns 1,000 shares of a company’s stock and it declares a one for ten reverse split (1:10), the shareholder will own a total of 100 shares after the split.

Are the company’s existing shares outstanding diluted when a company enacts a reverse stock split?

If a company does not reduce its authorized shares in proportion to a reverse split–and it can elect not to do so–the company will be able to issue more shares in the future which will dilute the existing shares that were reduced as a result of the reverse stock split.

What is required should an issuer choose to do a reverse stock split?

Generally, a public company can declare a reverse split if it obtains the approval of its board of directors.  Most often shareholder approval is not required.

What law governs reverse stock splits?

State corporate law and a company’s articles of incorporation and by-laws govern reverse stock splits.

How do companies notify their shareholders of a reverse stock split?

Companies may issue press releases notifying the public of a reverse split.  If a company is required to file reports with the SEC, it may notify its shareholders of a reverse stock split on Forms 8-K, 10-Q and 10-K.  A non-reporting company is required to notify the public through its current report filings on the OTCMarkets website.

In addition, all OTC issuers, reporting and non-reporting, that wish to do a reverse (or forward) stock split must comply with FINRA’s Rule 6490.  Generally, a company must notify FINRA of its intentions at least ten (10) days prior to the desired effective date.  A Corporate Action form must be filled out, and a processing fee will be charged. Normally, the issuer’s transfer agent takes care of the paperwork.  Click here for a fuller explanation.

Once the request is processed, FINRA will set an ex-dividend date, and the split will be noticed on the Daily List.  Issuers should avoid premature announcement of the split’s effective date; that date is only certain when the processing is complete and the dividend notice appears on the Daily List.

What happens when a reverse stock split causes a shareholder to hold a fractional share?

To avoid the existence of fractional shares of common stock, stockholders often have the opportunity of being paid the value of their fractional share.  In other instances, the fractional share is rounded up to a whole share.  The decision of rounding up or down is determined by the company.

Can a reverse stock split result in shareholders having odd lots of less than 100 shares?

The reverse stock split may result in some stockholders owning “odd lots” of less than 100 shares.  Odd lot shares may be more difficult to deposit with a broker and sell; and brokerage commissions and other costs of transactions in odd lots are generally somewhat higher on a per share basis than the costs of transactions in “round lots” of even multiples of 100 shares.

Impact of Reverse Stock Splits on Convertible or Exchangeable Securities

In a reverse stock split, proportionate adjustments are generally required to be made to the per share exercise price and the number of shares issuable upon the exercise or conversion of all outstanding options, warrants, convertible or exchangeable securities entitling the holders to purchase, exchange for, or convert into, shares of common stock.  This results in approximately the same aggregate price being paid under such options, warrants, convertible or exchangeable securities upon exercise, and approximately the same value of shares of common stock being delivered upon such exercise, exchange or conversion immediately following the reverse stock split, as was the case immediately preceding the reverse stock split.  The number of shares deliverable upon settlement or vesting of restricted and deferred stock awards and units will be similarly adjusted.

A reverse stock split can be an attractive option for a company wishing to reduce its shares outstanding while enhancing the price per share. For OTC issuers, it’s a useful strategy particularly when the company plans to move to an exchange where a higher stock price is a listing requirement.  Issuers should, however, be aware that–particularly on the OTC–reverse splits are regarded with some suspicion by investors.  They should make sure that the reverse split they have in mind is not too large, and is not one a series of splits, which could negatively impact the company’s ability to locate future investors or lead to shareholder actions against management for breach of various fiduciary duties under state law.  Going to the well too often will have long-term deleterious effects.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit www.securitieslawyer101.com.   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
101 Plaza Real South, Suite 202 North
Boca Raton, Florida 33432
Telephone: (561) 416-8956
Facsimile: (561) 416-2855