We’ve received dozens of calls from distressed investors, all with the same complaint: “I woke up today, saw that my stock is trading at a much higher price, but when I went to sell, I had a fraction of the shares I had yesterday. Help! My broker stole my stock!”
There are certainly examples of rogue brokers running off into the night with their clients’ investments in hand. Happily, though, outright theft like that is a rare thing. So what happened when the number of shares you had yesterday disappeared overnight? In nearly every instance, you experienced what’s called a “negative split.”
Before going further, a reminder of how stocks are valued is useful. Each share of stock represents an ownership in the issuer, including its net assets and profits. We could go on at length about how stocks are valued, but in an ideal world, they’re priced based on an equal division of the net value of the company across the number of shares outstanding, modified by the market’s expectation of how the company will do in the future. If there are 100 shares, the value is divided by 100; and if there are 1,000 shares, the value is divided by 1,000. While this is an incredibly simplistic view of things, it’s necessary to understand how splits affect stock prices.
The news is certainly full of reports of stock splits – Apple comes to mind – where a number of new shares are issued for every old share held. Apple recently announced a four-for-one split. Thus, an investor who had 100 shares of Apple before the split would end up with 400 shares afterwards. Since the number of outstanding shares grows four-fold under that example, you’d expect the new per-share price to be ¼ of what it was before the split. But, since stock splits are typically a good sign of a company’s health, the markets tend to apply premiums to the post-split shares and they’ll often trade for more.
The Reverse Split
What, then, is a “reverse split?” It’s the opposite of a split. Instead of issuing more shares, the company issues less.
So, for example, a one-for-ten split would result in a situation where an investor who had 100 shares of Company X before the split would end up with 10 shares afterwards.
In that example, one would expect that a 10 – 1 reverse split would cause a 10x jump in the price of the stock (since there would be a tenth of the number of shares outstanding after the split). But reverse splits are often a negative sign of the issuer’s health.
Where the market often applies a premium on newly split shares, it tends to apply a discount on shares of companies undergoing a reverse split. Thus, the post-reverse split shares certainly trade higher than they did immediately before the split, but at a discount compared to the pure mathematical expectation. Thus, the per-share price after the reverse split might only be 9x instead of 10x.
Which brings us back to the start: the investor (or you) saw a higher per-share price with a lower number of shares. There was no theft involved.
If the investor checks the total value of their investment, it will likely be similar to what it was immediately before the split. But, and that said, the discount often applied to post reverse split stocks will result in the total investment value dropping to some degree.
How to Check for a Reverse Split
If you’re reading this because it seems your stock is valued much higher than it was yesterday, but you have far fewer shares than you did, do a quick Google search for the name of the issuer. If you see reports of the issuer having undergone a reverse split, you’ll know that nobody stole your stock. Instead, you simply have fewer shares in what’s likely a struggling company. The total investment value is almost certainly close to what it was yesterday.
But, if there are no reports of a reverse split, and a review of your statement shows that your shares were transferred elsewhere, there could well be a problem. If you didn’t authorize the transfer, it’s possible you have a claim against your financial advisor. We’re here and ready to help: please don’t hesitate to give us a call to discuss your experience and we’ll see what we might be able to do to help you recover your losses.
Hugh Berkson is a Securities Attorney with McCarthy, Lebit, Crystal & Liffman, Co. LPA. Hugh is rated AV® Preeminent™ by Martindale-Hubbell®.
He obtained a business degree in Finance from the University of Texas at Austin in 1989, and is a 1994 graduate of Case Western Reserve University School of Law, where he was a member of the Order of the Barristers and received both the American Jurisprudence Award, (National Mock Trial) in 1993 and the Jonathan M. Ault Mock Trial Prize for 1993-1994.