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December 13 2010| Filed Under Investing Basics, IPOs
When stocks are soaring and initial public offerings (IPOs) are raking in the
money, it can seem like a bull market will never end. Nevertheless, market
downturns are inevitable and when the fall from grace occurs - as it has many
times in the stock market's history - textbook conditions for delisting can be
created. Here we examine how and why delisting occurs and what this change in
status means - for both the company being delisted and the individual investors
that hold its stock.
Getting Listed
You can think of major stock exchanges such as the New York Stock Exchange
(NYSE) and the Nasdaq as exclusive clubs. To get listed on a major exchange
like the Nasdaq, a company must meet the minimum standards required by the
exchange. On the Nasdaq Global Market, for example, a company must pay a
$25,000 application fee in 2010 before its stock can even be considered for
listing, and it can expect to pay between $125,000 and $225,000 in listing fees
if successful.
As for other requirements, companies must meet minimum standards such as
minimum stockholder's equity and a minimum number of shareholders, among many
other things. Turning again to the Nasdaq Global Market as an example, a
company must have at least 1.1 million public shares outstanding worth a total
of at least $8 million and a share price of at least $4 per share before it can
be considered for listing on the exchange. There are numerous other rules that
apply, but until a company reaches these minimum thresholds, it has no chance
of being listed on the Nasdaq. Similar requirements exist for the NYSE and
other reputable exchanges around the world.
Why the Prerequisites?
Stock exchanges have these requirements because their reputations rest on the
quality of the companies that trade on them. Not surprisingly, the exchanges
want only the cream of the crop - in other words, the companies that have solid
management and a good track record. Thus, the minimum standards imposed by
major exchanges serve to restrict access to only those companies with a
reasonably credible business and stable corporate structure. Any top university
or college has strict entrance requirements; top exchanges work the same way.
(For further reading, try Getting To Know Stock Exchanges and The Tale Of Two
Exchanges: NYSE And Nasdaq.)
Staying Listed
However, an exchange's duty to maintain its credibility isn't over once a
company becomes successfully listed. To stay listed, a company must maintain
certain ongoing standards imposed by the exchange. These requirements serve to
reassure investors that any company listed on the exchange is a suitably
credible firm, regardless of how much time has passed since the firm's initial
listing. To fund their ongoing scrutiny, exchanges charge periodic maintenance
fees to listed companies. On the Nasdaq Global Market, annual listing fees in
2010 range from approximately $30,000 to $100,000 (higher fees are charged to
companies with more shares outstanding). To extend the university analogy,
these ongoing requirements are much like the minimum grade point averages
students must maintain once admitted, and the annual listing fees are like
paying tuition.
For stock exchanges, the ongoing minimum standards are similar to the initial
listing standards, but they're generally a little less stringent. In the case
of the Nasdaq Global Market, one ongoing standard that a listed company must
meet is to maintain 750,000 public shares outstanding worth at least $1 million
- anything less could result in a delisting from the Nasdaq.
In other words, if a company messes up, the exchange will kick the company out
of its exclusive club. A stock that has experienced a steep price decline and
is trading below $1 is very risky because a relatively small price movement
could result in a huge percentage swing (just think - with a $1 stock, a
difference of $0.10 means a change of 10%). In low volume penny stocks, the
fraudsters flourish and stocks are much more easily manipulated; major
exchanges don't want to be associated with this type of behavior, so they
delist the companies that are liable to be affected by such manipulation. (To
learn more, see The Lowdown On Penny Stocks and Catching A Lift On The Penny
Express.)
How Delisting Works
The rules for delisting depend on the exchange and which listing requirement
needs to be met. For example, on the Nasdaq, the delisting process is set in
motion when a company trades for 30 consecutive business days below the minimum
bid price or market cap. At this point, Nasdaq's Listing Qualifications
Department will send a deficiency notice to the company, informing it that it
has 90 calendar days to get up to standard in the case of the market value
listing requirement or 180 calendar days if the issue is regarding the minimum
bid price listing requirement. The minimum bid price requirement, which is $1,
and the market value requirement (minimum $5 million, provided other
requirements are met) are the most common standards that companies fail to
maintain. Exchanges typically provide relatively little leeway with their
standards because most healthy, credible public companies should be able to
meet such requirements on an ongoing basis.
However, while the rules are generally considered to be written in stone, they
can be overlooked for a short period of time if the exchange deems it
necessary. For example, on September 27, 2001, the Nasdaq announced that it was
implementing a three-month moratorium on price and market value listing
requirements as a result of the market turbulence created by the September 11,
2001, terrorist attacks in New York City. For many of the approximately 400
stocks trading under $1, the freeze expired on January 2, 2002, and some
companies found themselves promptly delisted from the exchange. The same
measures were taken in late 2008 in the midst of the global financial crisis,
as hundreds of Nasdaq-listed companies plunged below the $1 threshold. The
Nasdaq makes other exceptions to its rules by extending the 90-day grace period
for several months if a company has either a net income of $750,000,
stockholders' equity of $5 million or total market value of $50 million.
What Delisting Means for the Company
When a stock is officially delisted in the United States, there are two main
places it can trade:
Over the Counter Bulletin Board (OTCBB) - This is an electronic trading service
offered by the Financial Industry Regulatory Authority (FINRA, formerly the
NASD); it has very little regulation. Companies will trade here if they are
current in their financial statements.
Pink Sheets - Considered even riskier than the OTCBB, the pink sheets are a
quotation service. They do not require that companies register with the
Securities and Exchange Commission (SEC) or remain current in their periodic
filings. The stocks on the pink sheets are very speculative.
Delisting doesn't necessarily mean that a company is going to go bankrupt. Just
as there are plenty of private companies that survive without the stock market,
it is possible for a company to be delisted and still be profitable. However,
delisting can make it more difficult for a company to raise money, and in this
respect, it sometimes is a first step towards bankruptcy. For example,
delisting may trigger a company's creditors to call in loans, or its credit
rating might be further downgraded, increasing its interest expenses and
potentially even pushing it into the red.
How Does It Affect You?
As a shareholder, you should seriously revisit your investment decision in a
company that has become delisted; in many cases, it may be better to cut your
losses. A firm unable to meet the listing requirements of the exchange upon
which it is traded is quite obviously not in a great position. Each case of
delisting needs to be looked at on an individual basis. However, being kicked
out of an exclusive club such as the NYSE or the Nasdaq is about as disgraceful
for a company as it is prestigious for it to be listed in the first place.
Even if a company continues to operate successfully after being delisted, the
main problem with getting booted from the exclusive club is the trust factor.
People lose their faith in the stock. When a stock trades on the NYSE or
Nasdaq, it has an aura of reliability and accuracy in reporting financial
statements. When a company's stock is demoted to the OTCBB or pink sheets, it
loses its reputation. Pink sheet and OTCBB stocks lack the stringent regulation
requirements that investors come to expect from NYSE and Nasdaq-traded stocks.
Investors are willing to pay a premium for shares of trustworthy companies and
are (understandably) leery of firms with shady reputations.
Another problem for delisted stocks is that many institutional investors are
restricted from researching and buying them. Investors who already own a stock
prior to the delisting may be forced by their investment mandates to liquidate
their positions, further depressing the company's share price by increasing the
selling supply. This lack of coverage and buying pressure means the stock has
an even steeper climb ahead to make it back on to a major exchange. (See, What
happens to my shares of a company that just received a delisting notice?)
The Bottom Line
Some argue that delisting is too harsh because it punishes stocks that could
still recover. However, allowing such companies to stay listed would result in
the major exchanges simply diluting the caliber of the companies that trade on
them and degrading the respectability of the companies that maintain the
listing requirements. Therefore, if a company that you own is delisted, it may
not spell inevitable doom, but it is certainly a black mark on that company's
reputation and, if the company can't recover, a sign of diminishing returns
down the road.
by Cory Janssen
Cory Janssen is a co-founder of Investopedia.com and currently oversees the
company's internal operations.