Risk

Going Private Confuses Bank’s Shareholders

When First Advantage Bancorp announced it was delisting from Nasdaq and moving to SecondMarket, a private exchange, equity holders scratched their ...

Many an equity holder would rejoice if the private company in which they held shares announced that it would be using a private-share exchange to give them some pre-IPO liquidity. In 2010, one such platform, SecondMarket, helped buyers and sellers trade $40 billion of pre-IPO shares in Facebook. 

But what if the issuing company is already public, delists from a stock exchange, and then put its shares on SecondMarket or another platform that gives the issuer greater control over the trading in its shares?

First Advantage Bancorp recently announced it was doing just that and the announcement produced investor confusion and some negative reaction. This occurred despite the fact that First Advantage made the move to benefit its shareholders and give them more liquidity, not less, says the bank’s chief executive.

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On April 22, First Advantage, a Clarksville, Tenn.-based bank holding company with $360 million in assets that had been publicly held since 2007, announced that it was leaving Nasdaq and deregistering  (no longer filing its financials with the Securities and Exchange Commission). Like many other companies have said, First Advantage stated that the public markets were “not ideal” for small institutions with low trading volumes, and that the bank would be eliminating an “ongoing administrative burden” and the “high costs that public companies incur.”

At the same time, First Advantage said that henceforth, after May 10, shares would trade on SecondMarket, and communications with shareholders would also take place over the platform.

On the day of the announcement, First Advantage shares dropped from $12.67 to $11.26. The next day, trading volume reached 240,000 shares as the stock rebounded a little. The day was by far the bank’s most active trading period in five years.

A handful of investors sounded off on the stock’s Yahoo! message board. One investor posted  that the move was a “disservice” to shareholders and there was “no market in the future for this stock.” Another shareholder expressed concern because on SecondMarket the issuer controls which investors can trade and when they can trade, usually very infrequently.

Two days later, clarifying things, First Advantage noted in a press release that after May 10 its shares would also trade on the OTCQB, an over-the-counter (OTC) platform operated by OTC Markets. Institutional investors may have welcomed the news, because it meant they could trade the stock more freely after the delisting.

But First Advantage Bancorp would rather have investors trade on SecondMarket. Earl Bradley, the banks CEO says the platform suits its 554 holders of record, many of whom are local and therefore hold the stock for a long time. “They have no intentions of trading on a daily basis, but need and want a good source of liquidity if they want to sell or buy,” he told CFO.

But once going back to being private, the bank didn’t want return to the old way of acting as its own stock transfer agent. That meant that it had to match up the occasional buyers and sellers. “The [previous] CEO kept a list in his desk drawer of who wanted to buy stock,” Bradley says. The process was time-consuming, and First Advantage executives had a hard time answering investors’ questions about how much the stock was worth.

Most important in the move to going private and engaging SecondMarket, says Bradley, was getting sellers a fairer price. “I’ve watched it hundreds of times [with bank stocks],” says Bradley. If a shareholder places an order to sell a block of 20,000 shares, traders, recognizing the stock is thinly traded, bid the price down, he says. The relatively large order artificially lowers the bank’s stock price and “unwary shareholders don’t get the best value,” Bradley says.

Poor Communication
Bradley admits that First Advantage Bancorp could have handled investor communications better or provided more upfront education about the delisting event and its consequences for investors.

For example, in the press release, First Advantage used the term “going private” to “take the edge” off the terms “delisting” or “deregistering, which are largely seen as negative, Bradley says. When shareholders heard the term “going private,” though, they worried about what that would mean for the shares they held. 

Usually it means that some shareholders would be bought out. “The unsophisticated investor was scratching his head,” Bradley says. In addition, investors that held stock certificates  received an explanatory letter two weeks before those that held shares through a brokerage firm. 

The bank’s experience also raises the question of how other issuers should handle trading of their shares once they delist.

As CFO reported in March, more companies are voluntarily moving to OTC trading platforms from exchanges, instead of being forcibly delisted from an exchange. OTC platforms are thus no longer just the domain of issuers under financial strain, near bankruptcy or plagued with scandal.

Community banks are at the forefront. They are taking advantage of a provision in the Jumpstart Our Business Startups (JOBS) Act that lets banks have as many as 1,200 stockholders of record, up from 300, without filing with the Securities and Exchange Commission. (“The JOBS Act was a godsend,” says Bradley.)

Many of those banks have moved to OTC platforms — networks of broker-dealers, like those operated by OTC Markets. First Advantage Bancorp is the first to use SecondMarket. The choice is not straightforward.

From its days of just providing liquidity to Facebook employees, SecondMarket has evolved into a replacement for the big stock exchanges, Barry Silbert, SecondMarket’s CEO, told CFO. SecondMarket is a better environment for highly illiquid stocks of small companies, he explains.

“By having a stock that trades 2,000 or 3,000 shares a day, a company [like First Advantage Bancorp] gets none of the benefits of being publicly listed but is paying all the money to be so,” he says.

On SecondMarket, the issuer restricts trading to certain events or time periods (every three months, for example) and decides who can sell shares and how many. Buyers have to be accredited investors (those permitted to invest in high-risk securities), but sellers do not.

Compressing the trading days means small orders (1,000 shares, for example) do not move the stock’s price by several percentage points, as can happen on an exchange, Silbert explains. In addition, SecondMarket uses a sealed-bid auction, which prevents an investor’s bid from being telegraphed to the market. Traders can put in multiple offers, and the shares get matched up and cleared at one price.

If a company does not engage a firm like SecondMarket after delisting, the only trading in the shares may be on OTC markets on which it’s difficult to successfully trade any “meaningful” block of shares, Silbert says. “There are very few market makers that know anything about [a company or bank] to help you in any way,” he says. “It’s a bad trading dynamic.”

But OTC trading platforms are actually much more sophisticated than they were a few years ago.

On Friday, the Financial Industry Regulatory Authority qualified First Advantage’s shares for trading on one of the five marketplaces run by OTC Markets, according to an OTC Markets spokesperson.

OTC Markets’ electronic platforms combine a company’s financial results with its stock pricing and trading information. The company offers different market tiers based on the quality of the issuer’s business and its 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 OTCQB, on which First Advantage Bancorp shares will trade, is the next level down from the OTCQX. The OTCQB does not have any financial reporting standards, but issuers have to be current in their reporting with a U.S. regulator, as banks usually are.

It remains to be seen which platform — the OTCQB or SecondMarket — most First Advantage equity holders will use to trade the bank’s shares.

The OTC platforms are not inadequate, Bradley says, they are just not the right place for his local shareholders. “The large institutional investors may or may not want to go through that source,” he says.

SecondMarket’s Silbert says investors that choose to trade in between the quarterly periods set by First Advantage will come to realize they are better off doing business on SecondMarket. Meanwhile, First Advantage is planning its first “liquidity event” on the platform. That will probably take place after the bank publishes its financial information for the second quarter, possibly the end of July or first part of August, says Bradley.