Wednesday, June 3, 2015

Protecting Shareholders: Accounting and the Risk of Delisting



Stock markets exist to allow companies to raise capital. In many cases, an initial public offering is performed for a business that doesn’t generate consistent sales and earnings. That’s to be expected.

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However, once a stock is trading on an exchange, there are some minimum expectations. Timely financial reporting is one of those expectations. If a company does not meet these minimum requirements, the firm runs the risk of delisting. Delisting means that the stock is removed from trading on an exchange.

SEC Acts of ’33 and ‘34
After the stock market crash of 1929, Congress found two major problems that needed to be corrected. First, companies issuing stock in the 1920s had virtually no rules on financial disclosure. Investors were not fully informed of the company's financial condition. 

The SEC Act of ’33 requires companies to sell shares by prospectus. Businesses are also required to file quarterly reports with the SEC- and to submit additional filings for any major change in the business between quarters.

The SEC Act of ’34 governs stocks once they start trading. This rule address fairness in stock trading, among other issues.

In addition to reporting requirements, a stock exchange may have other expectations. The NASDAQ exchange, for example, has a $1 rule. “Failure of a company to meet a minimum closing bid price of at least $1 for 30 consecutive trading days can trigger delisting.” 

A slippery slope
Unfortunately, an accounting issue can lead to delays in issuing financials. That delay can cause investors to lose confidence- which drives down the stock price. A lower stock price puts a company at risk of violating the $1 delisting rule. As you can see, it’s a slippery slope….

Auditor resignation
The Sacramento BusinessJournal provides an example of the slippery slope concept. Ernst & Young resigns as auditor for Cesca Therapeutics. The auditor cites material weaknesses in the internal controls for financial reporting. Essentially, the auditor is saying that accounting controls are so lax that we can’t rely on the account balances we’re auditing- serious stuff.

Because of the lack of financial controls, the quarterly reporting required by the SEC and NASDAQ is delayed. This hurts the stock price. The share price goes below $1. Now, there’s a process to avoid a delisting- but will investor confidence ever recover?

These rules are in place to protect shareholders. Investors need timely financial reporting. If a company has run completely off the rails financially, they should lose the ability to trade on a large exchange. Keep in mind that the slippery slope begins with an internal control issue.

Have you dealt with or worked for a company that has had this issue? I’d love to hear from you.

Ken Boyd
St. Louis Test Preparation
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
Co-Founder: accountinged.com
 (website) www.stltest.net


Image: Wall Street, Sue Waters CC by SA-2.0