Freeze-Out Tactics: The Reverse Stock Split
Majority shareholders use various time-tested methods to freeze out minority shareholders. One such these tactic is the reverse stock split. It works like this: The Board of Directors, acting within the company bylaws, votes to issue single shares of stock to replace some multiple outstanding shares, such as one-for-five or one-for-ten. The new share will be five or ten times the value of the old one.
There are some legitimate reasons to do this. A stock price may fall so low in value that an exchange threatens not to trade it. The board may want its company considered a “penny stock,” so they vote to consolidate shares. The share price rises and the stock keeps its listing. However, a reverse split rarely helps a company’s reputation with investors.
There are also nefarious reasons for reverse splits. Often, a reverse stock split is used to reduce the number of shareholders as well as shares. For example, suppose a minority shareholder owns 25 shares, while three shareholders representing the majority each have 40 shares. The majority controls the board and the board declares a one-for-forty split along with a recapitalization plan to buy back all fractional shares. The split leaves the majority with one share each, but the minority owner only has five-eighths of a share. The minority owner must then sell that fractional share back to the company, and loses her stake.
Because a company’s board of directors may declare a reverse stock split without shareholder approval, minority shareholders have little recourse. The Securities and Exchange Commission has authority over much corporate activity, but state law and the company’s articles and bylaws typically govern reverse splits. Simply complaining that the board was motivated by greed won’t impress a court. The oppressed shareholder must show actual harm that triggers “dissenter’s rights” or clearly indicates business oppression. This usually happens when the company offers to repurchase the fractional shares for less than fair value. Unfortunately, fair value does not necessarily mean fair market value, but rests upon a more complex formulation.
At Schwartz & Kanyock, LLC, our corporate litigators represent owners in many types of business oppression actions in state and federal court, including shareholders in corporate disputes. To learn how you can put our 50 plus years of combined experience to work for you, call us at 312-436-1442 or contact our Chicago office online.