BULLS & BEARS: Sarbanes-Oxley leads to small-company delistings

May 9, 2005

While many view an initial public offering of stock the mark of a fast-growing company, a stark contrast has begun to emerge. There has been a marked increase in the number of small, publicly traded companies voluntarily opting to remove their shares from the markets.

The main reason expressed for doing this is the financial burden associated with complying with the Sarbanes-Oxley Act of 2002. The new regulations mean increased expense in audit and legal fees. The requirements consume company time and resources, as new internal control systems need to be implemented.

These additional costs are significant to small, publicly traded companies and can swallow up their profit. As a result, an increasing number of small companies is undertaking the steps to go private or "go dark."

In a typical going-private transaction, the management of the company, and/or a private equity firm make an offer to existing shareholders to acquire their shares for cash. This was the avenue taken by Quality Dining Inc. of Mishawaka. It was completed last month when five shareholders led by the company's CEO offered $3.20 per share to existing shareholders.

Another method small companies are using is to "go dark" by taking steps to delist their stock from an exchange and cease their reporting requirements to the Securities and Exchange Commission. Under SEC rules, a public company may voluntarily file for deregistration if it has fewer than 300 shareholders of record, or less than $10 million in assets and fewer than 500 holders of record.

A "going dark" transaction is accomplished by a reverse stock split whose purpose is to reduce the number of shareholders. Evansville-based Fidelity Federal Bancorp completed a 1-for-30,000 share reverse stock split. Holders of fewer than 30,000 shares received $1.85 cash per share.

By eliminating these shareholders, the bank was able to drop to under 300 shareholders and cease reporting to the SEC. Last year, Keller Manufacturing Inc. of Corydon enacted a 1-for-500 share reverse-split and met the qualifications to have the stock delisted.

It is worth noting that shareholders of Fidelity Federal and Keller who still remain after the reverse split-those who held more than 30,000 shares and 500 shares, respectively-can still trade their stock in the "pink sheets, " which is a sort of quasi-stock market for illiquid securities. However, their access to company information and financial reports is generally reduced to the whims of management to divulge such details.

There are both positive and negative consequences for small companies that choose to deregister with the SEC. In addition to significant cost savings, a private company is generally relieved of the shortterm demands from Wall Street to perform quarter after quarter, and can instead take a longer-term view to building shareholder value. But the company may have diminished access to capital and no longer has a publicly traded stock that can be used as currency for acquisitions.

The SEC has announced it will hold hearings to address the effect of Sarbanes-Oxley compliance costs on small companies. In the meantime, we would expect to see more of these types of transactions until there is regulatory relief afforded to small public companies.

Ken Skarbeck is managing partner of Indianapolisbased Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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