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You Asked. We Answered. "What's a Reverse Stock Split?"

Our occasional Q&A series answers important questions FINRA has received from investors. If you have questions, you can call FINRA at (202) 728-6964 or send an email to InvestorEducation@finra.org.

An investor recently asked: Why do some companies do a reverse stock split—and what is FINRA's role?

Stock splits—reverse or otherwise—can help a company manage the price of its shares. When a company's stock price gets higher than desired (perhaps intimidating investors who fear there is little room for growth), the company might decide to split the stock to bring its price down.

Similarly, a company with very low-priced stock might reduce the total number of shares to increase the per-share price. A reverse stock split tends to occur with small companies that believe their stock price is too low to attract investors. Companies also may do reverse splits to maintain their listing on a stock market that has a minimum per-share price or to appeal to certain institutional investors who may not buy stock priced below a certain amount.

More often than not, a reverse split involves a company that trades in the over-the-counter markets (OTC). Reverse stock splits are less common among seasoned companies that trade on one of the major U.S. stock exchanges. If a reverse split is announced and actually occurs (more on that below), proceed with caution. Reverse splits tend to go hand in hand with low-priced, high-risk stocks. This is especially true with reverse splits that result in a post-split share price that is many times the price of the stock's current price.

Here's how a reverse split works. Say a company announces a 200:1 reverse split. Once approved, investors will receive 1 share for every 200 shares they own. So, if you owned 5000 shares of stock at a price of 10 cents per share ($500) before the reverse split, you would own 25 shares at a price of $20 each after the reverse split ($500). As you can see, the amount of money you have invested doesn't change, just the number of shares you own.

As the Securities and Exchange Commission (SEC) explains in a glossary entry on reverse stock splits, "state corporate law and a company's articles of incorporation and by-laws generally govern the company's ability to declare a reverse stock split and whether shareholder approval is required." If a company is required to file reports with the SEC, it may notify its shareholders of a reverse stock split in a number of ways, including on Forms 8-K, 10-Q or 10-K. These can be viewed on the SEC's Edgar website. If you have questions about shareholder notification with regard to a reverse stock split, contact the SEC.

What is FINRA's role?

FINRA does not approve reverse splits, but it does process reverse stock splits as part of its functions related to company corporate actions in the OTC market. OTC companies must submit notice to FINRA 10 days prior to the record/effective date of the corporate action. Once a corporate action submission is successfully processed (which may take longer than 10 days), it will be posted to the OTC Daily List. The Daily List is a place investors can learn about reverse stock splits and other company corporate actions, such as a merger or acquisition, payment of dividends or a company dissolution or liquidation.

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