Going Dark: The Harsh Reality of Voluntary Deregistration
By John Deysher
aaii.com
Investors weren’t the only ones fleeing the stock market last year. Companies also headed for the exits. And a growing number of investors are taking the hit as hundreds of small companies “go dark” or voluntarily deregister their shares. The result is often a falling share price and investors left in the dark about the firm’s finances and prospects.
What does it all mean?
When a firm “goes dark” it deregisters with the Securities and Exchange Commission (SEC) and delists its shares. Deregistered firms are no longer required to make SEC filings such as annual reports, proxies, 10-Ks, 10-Qs and other important documents. And they’re no longer required to have annual meetings or elect outside directors.
To deregister, a firm files Form 15-12G (Securities Registration Termination) with the SEC stating its intent to deregister, usually by a certain date. Once that date arrives, the stock exchange or NASDAQ prohibits future trading in the shares. The firm’s shares are then relegated to the pink sheets, where liquidity is usually much lower. Although the actual process takes some time, the firm’s share price typically will decline immediately after the “going dark” announcement, since many institutions are prohibited from owning shares of firms that don’t file with the SEC or trade on the exchanges or NASDAQ.
Who Approves?
Unfortunately, the going dark process does not require shareholder approval. As long as a firm has less than 300 shareholders of record, the board of directors can make the decision.
Although you may think even small firms would have more than 300 shareholders, the key phrase is “shareholders of record”—meaning the number of shareholders the firm has on its books. Often times this vastly understates the number of true owners. For example, Acme Widget may have 299 shareholders of record. But the shareholders of record may include firms like Merrill Lynch, AG Edwards and Morgan Stanley who hold shares on behalf of thousands of customers who chose to hold their securities in “street name” instead of taking physical delivery. In other words, a brokerage firm owning a million shares on behalf of thousands of individual customer-shareowners is actually treated as one shareholder of record, the same as an individual owning a thousand shares.
A better measure of the actual number of shareholders is “beneficial owners,” which includes all shareholders—including those holding shares in street name. Using this measure, many firms that delist would be prohibited from doing so because the number of beneficial owners exceeded 300.
Some institutional investors have petitioned the SEC to close the loophole, arguing that the definition of “shareholders of record” is obsolete. When the law was originally written in 1965, most investors took physical delivery of their shares. Nowadays, most investors hold their shares in street name, so “shareholders of record” probably understates the number of actual owners in many cases. The SEC is now holding public hearings on this and will analyze their findings in due course.
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