JOBS Act Opens Path to Deregistration

Delisting from a stock exchange and deregistering from the SEC are no longer death knells.
Vincent RyanMarch 12, 2013

Small-cap public companies are finding that over-the-counter stock markets are no longer a backwater, and neither is deregistering with the Securities and Exchange Commission. Indeed, some are voluntarily moving to OTC trading platforms from exchanges, making OTC stock markets no longer just the domain of issuers under financial strain, near bankruptcy, or plagued with scandal.

At the forefront of the movement are community banks, which are taking advantage of a provision in the Jumpstart Our Business Startups (JOBS) Act that lets companies have as many as 2,000 stockholders of record, up from 500, without filing with the SEC.

Since it now fits under the shareholder threshold, Coastal Banking Co., a Florida bank with $475 million in assets, deregistered its securities on May 2, 2012. As a result, it’s saving $150,000 to $200,000 a year on such costs as converting filings to XBRL, paying attorneys to review them, filing a Section 16 form every time an insider trades stock, and meeting some of the provisions of Sarbanes-Oxley. “The cost savings keep compounding,” says Paul Garrigues, Coastal Banking’s CFO.

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Brendan McGill, CFO of $802 million in assets Harleysville Savings Financial, says that after delisting from Nasdaq on December 27, the company has saved about 6 cents per share and as a result was able to increase its fourth-quarter dividend.

Coastal Banking’s and Harleysville Financial’s securities trade on OTC marketplaces created by OTC Markets, which offers five tiers of trading marketplaces based on the quality of the issuer’s business and financial-reporting standards. The OTCQX marketplace, seen as just a level below being traded on an exchange, added 86 companies in 2012 and now has issues from 400 companies trading electronically among broker-dealers. The aggregate market capitalization of the securities reached $1.2 trillion last year, says OTC Markets.

The key thing about OTC Markets’s platform is that, unlike another OTC market, the OTC Bulletin Board, OTC Markets combines a company’s financial results with its stock pricing and trading information, letting broker-dealers and investors find the data in one place. “The integration of all financial [performance] data with trading activity is not something we would have had on the [OTC] Bulletin Board,” says Garrigues. On OTC Markets, “we can continue to provide current meaningful financial information and not negatively impact the liquidity or value of our stock,” he says.

Coastal Banking’s average trading volume is actually up to 2,000 shares a day from 400 a year ago, and its stock price has doubled, although some of that is because the bank’s performance has improved, says Garrigues.

The key to succeeding on the OTC Market platform is transparency, says R. Cromwell Coulson, the company’s CEO. OTC stock markets like the so-called pink sheets have always been opaque, with companies providing limited information on their performance. Many are also viewed as the place equity issuers end up when they can’t meet the listing requirements of Nasdaq or the New York Stock Exchange, most often because they miss an SEC filing or are in distress. Many investors — exchange-traded funds, for one — only buy listed securities.

But Coulson insists that a lot of companies don’t get the benefit of being listed that they expect. “Many small companies think they will go on an exchange and have all these big investors buy their stock, but investors don’t,” he says.

The true value of a public listing is transparency to investors, Coulson says. So he is trying to encourage companies on his platform to be as transparent as an SEC-registered or exchange-listed issuer. For example, Harleysville Savings’s CFO McGill plans to continue to release quarterly financial information and compare it against the last four quarters. The bank also will release important banking benchmarks such as return on equity, efficiency ratios, loans held on the balance sheet, and the makeup of deposits. It will also publish insider-ownership information on an annual basis.

Unregistered issuers can even make their financial filings more readable. Garrigues’s team creates the equivalents of a 10-Q and a 10-K and posts them to the OTC Markets’s site, but these documents are less onerous than SEC filings, the CFO says. “We provide the same information but have halved the number of pages in the disclosures,” he says. “In a 10-Q or 10-K you have to repeat yourself many times, and include eight pages of risk factors and disclosure of all the new accounting rules. Nobody reads the things.”

For companies in some industries, amassing all that financial data might reduce the savings harvested from deregistering or delisting. But community banks and other industries are already heavily regulated, so they have the data at hand. American depository receipts of non-U.S. companies are highly suited to the OTC markets, and 1,500 of these securities from large international firms trade on OTC Markets’s platform. Foreign companies already report to their domestic securities regulator, so they can provide the same deep financial data as if the securities were registered with the SEC.

OTC issuers do have one problem related to transparency, however: while the information may be of high quality, it may not be as readily available to investors as it is for listed companies. “It becomes harder for certain subsets of investors to get the company’s disclosures,” says Coulson. OTC Markets does address this: it has a news service for issuers that is affiliated with PR Newswire. Once published on the OTC Market website, some company data is distributed to such financial portals as Yahoo Finance. Issuers can also arrange for information to go to Regulation FD–compliant news portals and professional databases.

What about secondary offerings? Because of the JOBS Act, more companies may begin issuing securities, such as private placements, that can be traded on platforms like OTC Markets’s. For one, the JOBS Act lifts the prohibition on the general solicitation and advertising of Rule 144a and Regulation D Section 506 placements, meaning they can be marketed widely. Investors will then be able to trade the shares on OTC platforms. (In the case of Rule 144a placements, this will happen immediately.) Second, the JOBS Act increases the amount of capital companies can raise in Regulation A offerings. An underused form for small-cap companies, Regulation A securities will also be allowed to trade immediately on secondary-market OTC platforms.

Raising the Regulation A limit to $50 million will cause more companies to use this kind of offering, Coulson says, because previously companies couldn’t justify the cost of doing the “miniregistration” filing Regulation A deals require.

Garrigues says the JOBS Act changes related to capital raising were crucial to Coastal Banking’s migration to OTC Markets. “When we get to the point where we want to expand again, we could do a secondary offering and still be deregistered,” he says.

The SEC has yet to propose rules surrounding these registration-exempt offerings, so all of the changes are in limbo. But once they do take effect, they will help companies expand their pool of investors — without being on an exchange, Coulson says. “Investors will pay a higher premium if the securities they invest in are free trading from day one,” he says. In addition, “it’s easier to raise capital if your shares are traded, because investors have a choice: they can sell if they disagree with something.”

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