Movin’ on Down: Firms Eye Alternative Listings

Published by Reuters Complinet
June 2009

General Motors did it. Air France expected to save $10 million by doing it. Many smaller firms have done it, too, citing cost savings averaging around $500,000 annually.

Since passage of the Sarbanes-Oxley Act in 2002, a number of companies have chosen to “de-register” and move their stocks to foreign or over-the-counter exchanges. While that number has tailed off over the past couple of years, a new rule scheduled to go into effect in December has companies increasing exploring options beyond SEC registration and the major U.S. trading exchanges.

Public companies with annual revenues of $75 million or more whose fiscal years end after Dec. 15 must become fully SOX-compliant. The deadline was pushed back from last year, but there have been no indications so far that there will not be another extension. The deadline is forcing a large number of firms to explore alternatives, experts say.

“When you amalgamate these costs – Sarbanes, litigation, D&O (directors and officers) insurance – you have to be a fairly sizable company from a market cap perspective to bear those costs,” notes Thomas C. Klein, an attorney with the Silicon Valley-based law firm GreenbergTraurig, where he represents public companies and specializes in venture capital deals, mergers and acquisitions and other transactions.

There have been a lot of recent conversations about alternatives to SEC registration with GreenbergTraurig clients, Klein said. “We’re reaching down into the 90 percent of the companies that are listed and applying the SOX 404 to them, and there’s a cost concern for those that are already public. As for those that are not yet public, every one of them now considers … listing on another exchange.”

“We are getting more inquiries,” said Tim Ryan, director of the OTCQX, the newest, top-tier exchange created by Pink OTC Markets Inc. “We’re going to start seeing a pretty significant uptick in companies over the next couple of months as they start figuring out what they want to do.”

The cost of complying with SOX regulations, particularly section 404, create a difficult financial burden for small companies, particularly when sales are soft. That’s why the directors of Proxim Wireless Corp., a maker of broadband network and Internet devices, chose to de-register and move its shares to the relatively new OTCQX market, according to Dave Renauld, the company’s chief financial officer.

The North Andover, Mass.-based firm with a market cap of around $3.5 million left the Nasdaq and began trading over-the-counter on April 23. “The primary rationale for making the change was saving expenses,” Renauld said. “We did a careful analysis of the expenses we expect to save. And it totaled multiple hundreds of thousands of dollars.”

Proxim intentionally moved to the top-tier OTCQX market where the reporting requirements are similar to those it was already meeting. The company has reporting and compliance systems in place that will serve it well on the new exchange, and it intends to continue quarterly financial reporting and an annual, third-party audit.

Despite a report by the Advisory Committee on Smaller Public Companies to the U.S. Securities and Exchange Commission in April 2006 that recommended a scaled approach to the application of SOX provisions to smaller companies, SEC officials have made it clear that’s not likely to happen.

In a speech to the American Institute of CPAs’ National Conference on Current SEC/PCAOB Developments last December, citing the likelihood of increased financial fraud that tends to accompany recessions, then-SEC Chairman Christopher Cox said the regulatory agency is in “no mood to soften accounting rules in an effort to firm up financial reports,” according to

SOX was enacted in response to the very public failures of several large companies like Enron and WorldCom. But those big public companies make up only a fraction of public companies in the United States.

Fifty-two percent of U.S. public companies are considered microcap firms with market caps of less than $128 million and accounted for just 5 percent of all U.S. market capitalization in 2006; 78.5 percent are considered smaller public firms with market caps of $787.1 million or less and account for 6 percent of U.S. market capitalization, according to the SEC Office of Economic Analysis report “Background Statistics: Market Capitalization and Revenue of Public Companies.”

In the past decade, over-the-counter markets have proliferated, gone electronic, and tried to clean up their images. “Alternative market centers are maturing, electronic trading is proliferating and market participants are adapting trading strategies to operate in the new environment,” wrote Thomas M. Joyce, chairman and CEO of Knight Capital Group Inc. in the company’s “2008 U.S. Market Structure Update.”

Knight Equity Markets is one of the most active market-makers in the OTC exchanges. Knight is not alone. Most of the major players, including UBS Securities, Archipelago Trading Services and E*Trade Capital Markets are among the largest-volume traders active in the OTC markets today.

“Second-generation ECNs are pursuing exchange status to compete on the same playing field with the NYSE and Nasdaq and realize the financial benefits of registration,” Joyce wrote.

Perhaps the most prominent example is the market once known simply as “the pink sheets.” The pink sheets exchange has had a reputation for years of being the Wild West of stock trading, a place where penny stocks with questionable prospects and management with suspect motives pushed shares on unsuspecting investors.

In recent years, Pink OTC Markets has worked hard to improve the exchange’s image. Those efforts have included introducing an electronic trading platform, tiering the market, providing more information about the companies it lists, and adding reporting and compliance tools.

Just 80 companies are included in the OTCQX market, according to Ryan. Many are foreign firms like Air France that found the OTC markets a less-expensive alternative to full SEC registration and listings on the NYSE or Nasdaq.

“One of the things that created a bad rap on pink sheets … is the companies that trade there,” Ryan admits. While most of the news is about the bad pennies, “The majority of our trading volume is done in international companies that are exchange-listed, companies that may be just coming off of exchanges, or distressed companies, as GM is.” General Motors moved from the Big Board to the OTC on June 2, and 207 million shares changed hands that day, Ryan said.

“We wanted to provide a way to identify companies that have a strong culture of compliance and are engaged with investors” and separate them from shady firms more traditionally associated with pink sheets, those that don’t report financial information or have credible management teams in place, Ryan said. “What’s interesting is the trading volume in those securities we’ve designated as having no information represent less than 2 percent of our total dollar volume in the OTC even though they’re about 60 to 70 percent of the companies.”

The exchange uses symbols to denote how current a company’s fining are, even a skull and crossbones on those companies where there’s a public interest concern, he said.

The OTCQX has partnered with Blue Sky Data to help its listed firms identify the states where the company meets listing requirements and its shares are eligible to be traded, Ryan said. OTC firms can use a service provided by Standard & Poors that will verify its shares meet requirements for trading in about 38 states; Blue Sky determines whether they are compliant with the requirements of the remaining 12 states, and offers a service that tells broker-dealers in which state each stock can be sold.

Klein notes that foreign exchanges, in particular the London, Hong Kong and Toronto exchanges, have become more competitive and are aggressively seeking listings from U.S. companies. And liquidity is better on foreign exchanges than it was a few years ago, he said. The largest institutional investors have a presence on most of the major global exchanges.

Klein stresses that every company’s situation is different. But foreign exchanges, even with their own versions of Sarbanes-Oxley laws, have less stringent reporting requirements, especially in areas such as executive compensation. “In London, the reporting is twice yearly instead of quarterly. There are options in many of these exchanges to not do certain disclosures and merely explain why you’re choosing not to do them,” Klein said.

“We operate in that globally competitive environment,” he said. GreenbergTraurig boasts 1,800 employees in 32 global offices. “So we might say everyone who wants to get from point A to point B in the US has to travel in a Rolls Royce, whereas other exchanges are saying, ‘We’ll allow Ford Escorts and Pontiacs and even scooters on our exchanges’.”

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