A reverse stock split sounds like an incredibly complex, sophisticated concept. In fact, it is simply a way for corporations to reduce the total number of shares on offer and increase the price in proportion. A reverse stock split does not affect the value of shares you already own.
Reverse Stock Split Explained
On any stock exchange, share prices rise and fall. From time to time, a stock's price may drop to a point the company feels is too low to attract investors. A reverse stock split is a way to raise the share price, the better to pull in new investors. In a reverse stock split, the company consolidates shares to reduce the number of shares outstanding. For example, in a two-to-one reverse split, you would receive one new share for every two old shares you owned, and the new share would be worth twice as much. Depending on state law and company bylaws, a reverse stock split may not require shareholder approval. The company's board of directors can decide to effect the split on its own.
Once the board of directors has resolved to effect a reverse stock split, the company's legal counsel swings into action. Counsel must prepare a series of documents to file with the exchange on which the stock is traded. He must also file documents with the state in which the company is incorporated. Further, the company has to request a new security identification number from the Committee on Uniform Security Identification Procedures (CUSIP), an entity that provides a unique number to every stock traded in the U.S. and Canada.
Once a stock split is proposed, the company has to amend its state certificate of incorporation. The amendment statement includes the following information: The number of shares outstanding, the new par value of the stock and the date the split is expected to become effective. The company must wait for the state to approve the amendment. It then conveys the approved amendment to the exchange on which its stock is traded.
The exchange must also approve any reverse stock split request. Company counsel must provide to the exchange the board resolution, the new CUSIP number and proof that the state has approved the incorporation amendment. The state also needs documentation that the company has engaged what is termed a "transfer agent" to effect the re-issuance of the split shares. Further, the company has to relate the share-exchange ratio. A reverse stock split may have a ratio of 2:1, 5:1 or 10:1, for example.
Responsibility to Shareholder
A company has to let shareholders know about a reverse stock split once it has been approved by the exchange. It can do this by conveying to stockholders the same forms it files with the SEC. These include Form 8-K, used to announce major events; Form 10-K, the annual report; and Form 10-Q, the quarterly report.