October 25, 2024

The U.S. Securities and Exchange Commission (the "SEC") recently approved rule changes by the Nasdaq Stock Market, LLC ("Nasdaq") relating to the minimum bid price requirements for listed companies and the use by listed companies of reverse stock splits to maintain compliance with Nasdaq's continuing listing requirements. In addition, the SEC has announced proposed rule changes by both Nasdaq and the New York Stock Exchange ("NYSE") which would make it more difficult for companies to utilize multiple reverse stock splits to maintain compliance with the bid price criteria of each exchange. These changes, if adopted in full, are particularly noteworthy given that failure to maintain the minimum bid price is the most common cause for public companies' noncompliance with stock exchange continued listing standards.

Nasdaq Final Rules Relating to Reverse Split Unintended Consequences

Nasdaq Rule 5550(a)(2) provides that a listed company is subject to delisting if its "minimum bid price" falls below $1.00 per share for 30 consecutive trading days ("Bid Price Requirement"). Companies facing delisting for failure to satisfy the Bid Price Requirement most often elect to seek stockholder approval for a reverse stock split in order to increase the per share trading price. Following a reverse split, companies will regain compliance once the trading price per share exceeds $1.00 for at least 10 consecutive trading days.

Easy enough, right? Not so fast. Beware of the unintended consequences.

For example, following the consummation of a reverse split, the number of outstanding shares is reduced. Typically, the number of stockholders is also reduced because holders of less than one share are customarily cashed out. As a result, in seeking to regain compliance with the Bid Price Requirement, a company could inadvertently fall out of compliance with the Nasdaq listing standards requiring minimum numbers of publicly-held shares or stockholders. Prior to the rule change, a company that regained compliance with the bid price requirement by implementing a reverse stock split could be granted additional time of up to 180 calendar days to regain compliance with newly created deficiencies.

The recent SEC approval of an amendment to Nasdaq Rule 5810I(3) provides that if a company consummates a reverse stock split to regain compliance with the minimum bid price requirement, but in doing so violates another continued listing requirement then: (1) the company would not be considered to have regained compliance with the minimum bid price requirement; and (2) no new 180-day compliance period will be granted for the additional violation.

Nasdaq August 2024 Proposed Amendment to Excessive Reverse Stock Split Rule

In 2020, Nasdaq amended its rules to require the issuance of a Delisting Determination if a company falls out of compliance with the Bid Price Requirement after completing one or more reverse stock splits resulting in a cumulative ratio of 250 shares or more to one over the two-year period before such non-compliance (the "2020 Rule").

Nasdaq's recent proposal would immediately initiate the delisting process (rather than providing a 180-day compliance period) for any company's security that becomes non-compliant with the Bid Price Requirement if, in the prior one-year period, the company conducted a reverse stock split regardless of the ratio.

As a result:

• A company that effects a reverse stock split of any ratio will be subject to immediate delisting if it falls out of compliance with the Bid Price Requirement within one year of the previous reverse stock split.
• A company that effects one or more reverse stock splits with a cumulative ratio of 1-for-250 or higher will be subject to delisting if it falls out of compliance with the Bid Price Requirement within two years of the reverse stock split(s).

Comparable NYSE October 2024 Proposed Amendments

The SEC also recently posted notice of NYSE rule proposals which closely mirror Nasdaq's August 2024 proposals.

Section 802.01C of the NYSE Listed Company Manual provides that a listed company will be considered to be out of compliance if the average closing price of a security as reported on the consolidated tape is less than $1.00 over a consecutive 30 trading-day period (the "Price Criteria"). The NYSE provides for a cure period of not less than six months.

NYSE's proposal would amend Section 802.01C to limit the circumstances under which a listed company may utilize a reverse stock split to regain compliance with the Price Criteria. Specifically, NYSE proposes that, if a company's security fails to meet the Price Criteria and (i) the company has effected a reverse stock split over the prior one-year period or (ii) has effected one or more reverse stock splits over the prior two-year period with a cumulative ratio of 200 shares or more to one, then the company will not be eligible for any cure period specified in Section 802.01C.

What Now?

Years ago, at an SEC Forum for Small Business, one of the speakers representing the SEC's Division of Corporation Finance suggested that some smaller companies simply 'shouldn't be public.' The crowd erupted in disagreement. Here we are, at least 20 years later and the staffs of the SEC and the exchanges continue to seek new ways to regulate smaller reporting companies. These final rules and proposed rule changes (if approved) could imperil continued exchange listings by severely limiting the effectiveness of the reverse stock split as a tool to regain compliance with the Nasdaq minimum bid price requirement and NYSE Price Criteria. Although some delisted companies will continue to maintain their registration under Section 12 of the Securities Exchange Act of 1934 (the "Exchange Act") and trade on the OTC Markets Group or the so-called "pink sheets," other companies losing the privilege of listing on a national securities exchange may decide to completely "go dark" (i.e., delist their securities from a national exchange and deregister their securities under the Exchange Act).

So what now? Nobody likes a reverse split. The stock price often settles down to the price it saw before a reverse split. Nevertheless, it has been the tool of choice for issuers to maintain listings with declining stock prices. With the new rules, it is imperative that listed companies pay close attention to their market value of their publicly held shares, number of shares outstanding, stockholders' equity, and any other considerations related to continued listing criteria, ahead of approaching the $1.00 red line. Smaller reporting companies must work proactively to monitor their trading price, capitalization and number of stockholders. We may begin to see "prophylactic" reverse splits at trading prices well above $1.00 per share to avoid the unintended consequences mentioned above (while paying careful attention to the risks arising from the amendments to the excessive reverse stock split rules). The days of figuring out what to do 'over the next 12 months' after a dip below a dollar may be behind us for many issuers.

In future analyses, we will explore various alternative strategies that listed companies are implementing to preserve compliance.