AI, Biotech Companies at Risk in Nasdaq’s Penny Stock Crackdown

Artificial intelligence and biotech startups are among the smaller businesses vulnerable to a new proposal from Nasdaq Inc. that would kick companies off the exchange more quickly for trading under $1.

Take ENDRA Life Sciences Inc., which is developing medical ultrasound technology to diagnose liver disease. The Ann Arbor, Mich.-based company’s stock traded at more than $100 in December. As of Wednesday, it was trading around 50 cents.

Nasdaq has proposed rules that would speed up the delisting process for many companies like ENDRA whose shares have broken a buck. The proposal, published Aug. 19, is the latest move by the exchange to tighten its listing regulations.

Supporters of the rule change, including brokerage Virtu Financial Inc., argue it will protect investors from risky penny stocks. Others worry it will restrict access to capital for small companies, including many early-stage biotech and AI businesses.

“This would appear to be investor versus company in a battle that the SEC needs to step in and stop,” said Olshan Frome Wolosky LLP partner Spencer Feldman, who represents small companies.

Investor Protections

Nasdaq, like other major stock exchanges, requires companies listed on the exchange to maintain a minimum share price of $1. Failure to do so can trigger delisting, although companies are given various grace periods, which can extend over a year, to bring the stock price back up.

Virtu in July asked the Securities and Exchange Commission for new rules around the listing of penny stocks on exchanges. Such stocks are often tied to market manipulation, including pump-and-dump schemes, Virtu argued.

“The bottom line is that current SEC rules that allow high-risk penny stocks to be listed on major stock exchanges present serious investor protection concerns,” Virtu said in its letter.

As of Wednesday, there were 430 stocks trading on the Nasdaq that were listed below $1, according to Bloomberg data. That is almost six times as many as on the same date in 2021, when there were 72, the data show.

Nasdaq’s proposed rule change would suspend companies from trading during a review process if they haven’t met the $1 requirement for more than 360 days. Additionally, the exchange would immediately send a delisting notice to any company whose stock price falls under the $1 within one year of a so-called reverse stock split.

“You could be more quickly delisted than you are currently,” said Dechert LLP partner Anna Tomczyk, who advises companies on securities offerings.

The SEC, which oversees Nasdaq and other stock exchanges, must approve the rule proposal.

Reverse Stock Splits

The proposal is the latest from Nasdaq to target reverse stock splits, a maneuver some companies use to climb over the $1 threshold. The splits involve combining multiple outstanding shares into a single share, resulting in a higher price per share.

More companies are carrying out reverse splits. Nasdaq processed 196 such stock splits in 2022, compared to 31 the previous year, the exchange reported.

Worsening market conditions likely account for much of the increased activity, attorneys said. Delaware, where most companies are incorporated, also changed its law last year to make it easier for companies to do a reverse stock split, requiring approval from a majority of votes cast, rather than a majority of the outstanding shares.

Under a separate proposed rule change, Nasdaq wouldn’t give companies extra time to fix new deficiencies caused by the company carrying out a reverse stock split. A final rule, approved by the SEC last year, requires companies planning such a split to give investors more notice.

Nasdaq in its latest rule proposal said it has observed some companies engaged in a pattern of repeated reverse stock splits.

“Nasdaq believes that such behavior is often indicative of deep financial or operational distress within such companies rendering them inappropriate for trading on Nasdaq for investor protection reasons,” the exchange said.

Searching for a Home

Companies delisted from the major exchanges are sent to the over-the-counter market, where they’re effectively removed from many investors’ radar screens. Some institutional investors refuse to trade stocks in the OTC market.

While some research supports the $1 mark as an appropriate cutoff point for screening stocks, there are attorneys who question whether kicking companies off the exchange based on a stock drop is the right move.

The market for initial public offerings remains lukewarm, Bloomberg News reported last month, while private markets face their own headwinds.

“In the current financial environment, this is a very harsh and very hard way to deal with companies whose prices have dropped,” Feldman said.

Biotech and artificial intelligence companies, whose businesses require heavy research and development costs, could be among the most impacted by Nasdaq’s rule proposals.

Bloomberg data show 40% of the companies trading under the $1 threshold are health companies, like ENDRA, which announced last week it plans a 1-for-50 reverse stock split to increase the bid price.

Others include Conduit Pharmaceuticals Inc., which is developing autoimmune and infertility treatments; Amarin Corp., maker of heart medicine Vascepa; and Jet.AI Inc., a private jet charter AI company. Each company has reported receiving a delisting notice in recent months.

Marc Indeglia, president of the Small Public Company Coalition, said the group wants small companies “to have a home.”

“In our view the answer here is not necessarily to keep more companies on Nasdaq,” he said. “It’s to have a quality exchange available for issuers who don’t meet those requirements.”

The pool of capital available on the OTC markets, already smaller than the major exchanges, has retracted as of late, Indeglia said. The SEC’s novel legal push to classify certain convertible note lenders as dealers has also made it harder to raise money, he said.

“We want to see that capital formation happening,” Indeglia said. “We don’t want it restricted artificially because some people don’t like lower priced stocks or think they’re inherently higher risk.”