In July, Virtu Financial, a financial services company and market maker, filed a rulemaking petition with the SEC, asking the SEC to adopt rules that “would prohibit National Securities Exchanges from listing high risk ‘penny stocks’ and mandate additional disclosures from issuers that would facilitate investors’ ability to assess the risks typically inherent in such stocks.” While “penny stocks” are subject to rules designed to prevent fraud and safeguard against potential market manipulation, Virtu said, exchange-listed securities are exempt from those rules “on the premise that exchange listing standards are stringent enough to weed out the riskiest issuers.” According to Virtu, “Main Street investors are being exposed to significant risk from issuers that have the imprimatur of being listed on an exchange when they are no different from penny stocks listed on the OTC market.” In recent years, Virtu contended, the number of companies at risk of delisting because of failure to meet the minimum price of $1 per share, primarily on Nasdaq, has spiked—a problem that has been exacerbated by the increasing use of reverse splits to avoid delisting, potentially resulting in problems for brokers and investors.  While, in the last several years, Nasdaq has taken some steps to address the situation, Virtu contended that “minor tweaks to Nasdaq’s listing rules are insufficient to address the problem.” To that end, in the petition, Virtu requests “a more substantial overhaul.”  The petition appears to have given Nasdaq a big nudge: we now have a new rule proposal from Nasdaq aimed at accelerating the delisting process for companies with shares that trade below $1. Briefly, under the proposal, a company would be suspended from trading on Nasdaq if the company has been non-compliant with the $1.00 bid price requirement for more than 360 days.  In addition, any company that has effected a reverse stock split within the prior one-year period but becomes non-compliant with the $1.00 minimum bid price requirement would immediately be sent a Delisting Determination without any compliance period. A spokesman for Virtu told the WSJ that the proposed changes were “a step in the right direction. ‘While we are encouraged by Nasdaq’s efforts here, there remains more room for improvement across all markets,’ he said.”

According to Virtu, “[h]istorically, there were only a handful of companies at any one time that were at risk of being delisted for dipping below $1.  As noted in a recent Wall Street Journal report, there were fewer than a dozen such companies in early 2021.  In recent years, however, that number has spiked substantially.” As of Thursday, the WSJ reported, there were “509 stocks listed on U.S. exchanges that closed below $1 a share, of which 421 were listed on Nasdaq, according to Dow Jones Market Data.” This should not be surprising, Virtu asserted, given Nasdaq’s “more lenient listing standards.” As noted above, to avoid delisting, companies are increasingly relying on reverse stock splits; the WSJ “reported that there were 495 reverse splits of exchange-listed stocks in 2023, up from 288 in 2022 and the largest annual number in the past two decades.” The WSJ reported that some of these companies engage in multiple reverse splits and sometimes experience wild trading surges and fluctuations in price.  

Under current Nasdaq listing standards, a company with equity securities listed on the Nasdaq Global Select, Global and Capital Markets is required to maintain a closing bid price of at least $1 per share.  If the company fails to satisfy the bid price requirement for a period of 30 consecutive business days, the company is promptly notified and automatically given a period of 180 calendar days from the notification to achieve compliance. Subject to certain requirements, including notifying Nasdaq of its intent to cure this deficiency, a company listed on, or that transfers to, the Nasdaq Capital Market may be provided with a second 180-day compliance period. If not, or if the company does not resolve the bid price concern during the second compliance period, Nasdaq will issue a Delisting Determination under Rule 5810, which can be appealed to a Nasdaq Listing Qualifications Hearings Panel. That Panel can provide up to an additional 180 days to regain compliance. Although there are some exceptions to the availability of these extended compliance periods (such as the 2020 Rule exception described in the SideBar above), the result is the potential for lots of grace time. Under the current rules, “a company may be continuously deficient with the Bid Price Requirement and continue trading on Nasdaq for more than 360 days (but not more than 540 days).”

Based on Nasdaq’s “experience with the rules, Nasdaq is proposing two changes to the bid price requirements for listed companies to better protect investors.”

360-day limit. First, Nasdaq believes that providing two consecutive grace periods adding up to 360 days should do it. Under the rules, Nasdaq provides a company with a second bid price compliance period “if the company reviewed its circumstances and notified Nasdaq that it intends to cure the bid price deficiency by effecting a reverse stock split within the second 180-day compliance period.” But in these circumstances, if the company then appeals to the Hearings Panel, Nasdaq no longer considers it appropriate for a company to continue to trade on Nasdaq during the pendency of the Hearings Panel review process.  Accordingly, where a company that was afforded the second 180-day compliance period but failed to regain compliance with the minimum bid price requirement during that period, Nasdaq proposes to amend Rule 5815 to remove the stay provision in these situations so that the company’s securities will be suspended from trading on Nasdaq during the pendency of the Hearings Panel’s review. (Generally, regaining compliance means meeting the applicable standard for a minimum of 10 consecutive business days.)  While a suspended company could still appeal the Delisting Determination to a Hearings Panel, its securities would trade in the OTC market while that appeal is pending.  The Hearings Panel would still have authority to provide exceptions.

Excessive reverse splits. The automatic 180-day period to achieve compliance with the bid price requirement “is designed to allow adequate time for a company facing temporary business issues, a temporary decrease in the market value of its securities, or temporary market conditions to regain compliance with the Bid Price Requirement.  However, Nasdaq has observed that some companies, typically those in financial distress or experiencing a prolonged operational downturn, engage in a pattern of repeated reverse stock splits,” which Nasdaq believes is “often indicative of deep financial or operational distress within such companies rendering them inappropriate for trading on Nasdaq for investor protection reasons.”  Often, Nasdaq observes, these challenges are not temporary, as these companies continue to waver between compliance and non-compliance. In addition, “a pattern of recurring bid price non-compliance can be a leading indicator of other listing compliance concerns.”

Notwithstanding the 2020 Rule change, Nasdaq has observed the continuation, for some companies, of the pattern of “effecting consecutive reverse stock splits, which are often accompanied by dilutive issuances of securities.” To address this issue, Nasdaq is proposing to amend its listing rules to provide that, “if a company’s security fails to meet the continued listing requirement for minimum bid price and the company has effected a reverse stock split over the prior one-year period,” the security would be delisted; the company would “not be eligible for any compliance period specified in Rule 5810(c)(3)(A) and the Listing Qualifications Department shall issue a Delisting Determination under Rule 5810 with respect to that security.”

As described by Nasdaq in the proposal, the cumulative impact of the proposal and the 2020 Rule would be as follows:

• “A company that effected a reverse stock split of any ratio will be subject to delisting if it falls out of compliance with the Bid Price Requirement within one year of the previous reverse stock split.
• A company that effected one or more reverse stock split[s] 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).”

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