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The Dirt On Delisted Stocks

2012-10-30 11:47:51

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.