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
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