Over the last 12 months, we have seen an increase in the number of community banks interested in generating liquidity for their shareholders. The reasons for this increase vary: some banks want to create a more liquid stock to use as currency in a merger, while others need exit opportunities for a group of shareholders or aging directors. A common thread among these banks is that they are now looking at the recession in their rear view mirrors, and their boards are anxious to get back to creating value for their shareholders.
In the last issue of Banking Notes, we talked about the most basic form of shareholder liquidity for community banks – the president’s “desk drawer.” In this issue, we will discuss the next logical step for many community banks in search of liquidity – the Over-the-Counter (OTC) market. In future issues, we will discuss other ways to increase liquidity, such as stock repurchases, stock splits, dividend reinvestment plans, and new platforms like SecondMarket.com.
Private Banks on the Over-the-Counter Market
In order to use an established market like the New York Stock Exchange or NASDAQ, a company must first go through a costly and time-consuming process to become public, one that requires underwriting and registration with the Securities and Exchange Commission (SEC). After this initial process, the company must stay current with ongoing SEC filing and Sarbanes-Oxley requirements, which even for the smallest company can cost upwards of $200,000 per year.
For most companies that are not public SEC-filers, there is only one available OTC market on which their stock can trade, OTC Pink, formerly known as the pink sheets. With little oversight and controls, the pink sheets are considered by many to be a lower-tier market, and fraudulent companies are sometimes found to be using OTC Pink. The OTC Bulletin Board or OTCQB is generally considered a step-up from the pink sheets because, in order to trade on the Bulletin Board, a company must file reports with the SEC. OTCQB companies are traded on “OTC Link,” which is an electronic trading platform for broker-dealers, and stock trades through the OTCQB in a manner nearly identical to that of the NYSE or NASDAQ. Banks and bank holding companies are unique among American companies because they can trade on the OTCQB even if they are not SEC filers, so long as they are current with their bank regulatory reports.
Challenges to Using the Over-the-Counter Market
For most community banks, the OTC market will not be a magic cure for liquidity woes. The volume of trades on the OTC market, even on the Bulletin Board, is usually low, and stocks can sit for weeks at a time without a single trade. With low trading volume, some banks may be forced to watch their stock prices fall by several dollars with only a small number of trades, and then stay at that depressed price for a considerable time. As a result, banks with stock listed on the OTCQB generally trade at a discount to book value and at a ratio lower than their counterpart banks with stock listed on more established markets.
Nevertheless, many community banks use the OTC system. According to the OTC’s website, approximately 650 community banks are traded in the OTC marketplaces, with the majority trading on the Bulletin Board. As a comparison, 440 banks currently trade on NASDAQ.
Many banks have successfully coupled a stock repurchase plan or dividend reinvestment plan with over-the-counter trading to boost shareholder liquidity while providing a barrier against overly depressed stock prices. Other banks have created intentional processes to provide information to the marketplace in an effort to bolster liquidity, such as issuing quarterly press releases, creating robust annual reports, and providing other information on the bank’s financials on the investor relations section of the bank’s website.
Beware of FINRA Rule 6490
Every bank or bank holding company with stock trading in the OTC market should be mindful of Rule 6490 of the Financial Industry Regulatory Authority (FINRA), which requires a company with exchange-traded stock to give the agency advance notice of certain events that can impact the value of the stock, like dividends, stock splits, rights offerings, mergers, and the like.
The rule exists so that FINRA can notify the market of the “ex-dividend” or “ex-rights” date associated with traded securities (i.e., the date on or after which a security begins trading without the dividend or right included in the price). Because failure to notify the marketplace timely of a significant pricing event could result in harm to an unknowing buyer, companies are subject fines up to $5,000 for submitting a Rule 6490 filing even one day late. Every issuer with OTC stock should become familiar with these requirements.
Community bankers are sometimes surprised to learn that brokers can make a market in a bank’s stock using the OTC marketplaces without the bank’s permission or even its knowledge. Even if the bank’s stock is traded on the OTC market without its permission or knowledge, the bank is still required to comply with Rule 6490.