Reverse Stock Split Trading Confusion Eased by NYSE Rule Change

The New York Stock Exchange adopted new regulatory halt procedures in connection with reverse stock splits to enhance investor protection in cases where market participants might make ill-advised trades because they were unaware that the subject security had undergone a reverse stock split.

The NYSE amended NYSE Rule 123D, which became effective May 11. The amendments provide for a mandatory regulatory halt to trading on the NYSE before the end of post-market trading (at 7:50 p.m. ET) on the day immediately before the market effective date of a reverse stock split and a delayed opening of the security (at 9:30 a.m. ET) on the market-effective date.

Reasons for the NYSE Amendments

In a reverse stock split, a company decreases the number of issued and outstanding shares by a specified ratio without affecting its total market capitalization. Reverse stock splits are frequently used by public companies to increase the per-share range at which their common equity is trading, including to prevent the delisting of their shares due to the failure to satisfy the minimum share price requirements of the securities exchange.

The NYSE is adopting the amendments in light of the increase in completed reverse stock splits among exchange-listed companies in recent years. While reverse stock splits have been more prevalent on Nasdaq—which adopted similar amendments in November 2023—than on the NYSE, the NYSE introduced the amendments in response to the requests of market participants seeking consistency across exchanges with respect to regulatory halt rules.

Before the amendments went into effect, the NYSE processed reverse stock splits overnight and the affected security would be available for trading on a split-adjusted basis on other markets at 4:00 a.m. ET. Market participants expressed concerns that trading on an adjusted basis during early morning trading sessions could adversely affect investors, market participants and the issuer. Market participants claim that early trading sessions post-reverse stock split may result in unnoticed and remedied system errors that could harm market participants.

Potential errors include the incorrect adjustment of securities post-reverse stock split or entry of orders. These and other issues could arise due to various factors, including market participants’ misunderstanding of the impact of a reverse stock split on the quantum or value of the adjusted security post-reverse stock split.

For example, in connection with a reverse stock split, an investor could unwittingly sell shares it doesn’t hold positions in (due to the issuer’s reduction in shares outstanding) based on frothy market sentiment and a misunderstanding regarding the effects of a reverse stock split on their holdings. Such sales could result in significant losses to an investor, who could have limited recourse to address the situation after the trade.

Additionally, processing errors in connection with a reverse stock split could result in a broker executing trades for the sale of more shares than customers held in their accounts, resulting in a temporary short position. A brokerage that is forced to cover short positions by completing open market purchases at prices that are greater than the prior short sale will be at risk of suffering financial losses.

Potential Impact

The NYSE believes that the amendments “remove impediments to and perfect the mechanism of a free and open market and national market system.” Among the desired effects, the NYSE believes the updated procedures for the halt of trading and delayed opening for trading post-reverse stock split will reduce the possibility that market participants will transact in securities without knowledge of a reverse stock split and experience the unanticipated financial consequences of such an uninformed transaction.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Thurston J. Hamlette is of counsel at Morgan Lewis and focuses his practice on corporate and securities matters.

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