In an ordinary stock split, a company doubles the number of shares outstanding in order to halve the share price. The purpose of a stock split is to make the stock more affordable for small investors. In a reverse split, the opposite happens: the number of shares decreases, and the price rises proportionally. In both cases, the value of your shareholdings remains the same.
Many institutional investors follow strict guidelines on share price. If a company’s stock price falls, it may cross a minimum price below which the bigger investors -- such as pension funds, banks, brokerage houses and mutual funds -- must sell the shares, or are prevented by their own guidelines from buying new shares. In order to avoid this scenario and retain institutional investors, a publicly traded company may consider a reverse split.
In a 10-for-1 reverse split, one new share is issued for every 10 shares you hold. If you own 100 shares of a stock priced at $1 a share, you will own 10 after the split while the price will be adjusted to $10 per share. If you own less than 10 shares and your company announces such a split, however, you will be forced to cash out if your broker doesn’t allow you to hold fractional shares. A reverse split is common and accepted practice for NASDAQ-listed companies that fall below the $1-per-share minimum, which this automated exchange system requires.
Reverse splits occur when a company’s management declares them. They take effect soon after the announcement, and in most cases the company does not request any form of shareholder approval unless the company's by-laws require it. The Securities and Exchange Commission, which regulates the markets and public trading, does not control stock splits of any kind or require a review of such actions beforehand.
The states have their own laws regarding corporate governance and the issuance of shares by public companies. By the Model Business Corporation Business Act, which has been adopted by 24 states, a company must carry out a reverse stock split by an amendment to the articles of incorporation. Under the laws of the state of Delaware, where many U.S. corporations are legally organized, a reverse split requires an amendment to the certificate of incorporation. Such actions do not normally require review by any state agencies.