The SEC has issued a bulletin explaining Trading Suspensions, available in full here. Here’s a quick takeaway.
Why Suspend Trading?
The SEC has the authority to suspend trading in any stock for up to ten business days for investor protection purposes. The SEC typically suspends trading in a stock where there is:
- A lack of information, such as a company that has failed to make required filings,
- Questions about the accuracy of information in regulatory filings, press releases and other public information, or
- Questions about trading in the stock, including possible insider trading or market manipulation.
What Happens Next?
The expiration of the ten-day suspension is generally not the end of trouble for a company’s shareholders. There is frequently an ongoing investigation into either the company, or into certain holders or traders of the shares, or into brokerage firms that promote or trade the stock. SEC practice prohibits discussing ongoing investigations, and unless there is a formal investigation, with a notification to the subject entities (see last week’s Hedgeye Investing Ideas for the Investing Term: SEC Inquiry) so shareholders may never find out about the investigation until after its results are announced – if at all.
Brokers who wish to trade in the shares for their customers must go through a post-suspension process including an internal compliance review, updated due diligence on the company, and often a regulatory filing through FINRA, the brokerage industry self-regulatory body. Since this filing alerts FINRA that you intend to actively market the now-tainted shares, it is often the equivalent of an engraved invitation for a FINRA letter of inquiry, and perhaps an audit of the firm. This goes a long way towards answering the next question in the SEC’s Bulletin:
If the suspended stock resumes trading, why is it trading at a lower price?
Aside from the taint in the mind of the investing public, brokerage firms are reluctant to put their name alongside that of a stock if they believe there may be a regulatory investigation underway. As we have seen in recent years, fraud investigations often go beyond the civil parameters available to the SEC. No broker wants to put his customers into the stock of a company that might be raided by the FBI.
What About Shareholders?
The SEC is sensitive to the reality that current shareholders of a company will be harmed by a trading suspension. While the suspension is in force, they will not have access to their assets – they can’t liquidate their stock. After the suspension expires, the shares will likely trade at a fraction of the price at which they were bought, and trading is likely to be highly illiquid. The Commission suspends trading only when there is a palpable concern that investors may be making decisions based on incomplete, inaccurate, or deliberately misleading information, or where there is a concern about fraud, or other investor protection concerns that, in the Commission’s estimation, are more compelling going forward than the potential damage to existing shareholders.
Note that a Trading Suspension is not the same as a Trading Halt – which the exchanges impose when there is an order imbalance in a stock during the trading day. Halts can be imposed by the exchanges, or at the request of a company if they are about to release news that management considers likely to have a significant impact on the price of their stock.
News issued in the middle of the trading day can cause pandemonium among shareholders and traders. Unexpected good news – a takeover bid, for example – can cause a feeding frenzy, while unexpected bad news – oops, the merger didn’t go through after all – can cause panic selling. A trading halt can’t prevent outsized moves in the price of a stock, but it dampens volatility and permits market makers to match up orders in a more orderly process.
Give the SEC credit for trying to educate the individual investor. The more of these releases you read, the better sense you will have of what regulation can, and can not accomplish. If you don’t know what a Trading Suspension is, you should read the SEC release. The Commission thought it important enough that they posted it on Twitter.
In our experience, suspensions generally happen in the stocks of more speculative companies, often stocks you may have bought on a hot tip, or perhaps off a tout sheet from “HOTT STOXX!” that mysteriously appeared in your email in-box. By the time the Commission gets around to suspending trading, the company has probably already done lasting damage to your net worth. People who believe they know which highly speculative stocks are safe to invest in – and that they will be the only ones who know when to get out – remind us of kids who practice jumping out of the way of a speeding locomotive: isn’t it smarter not to play on the tracks in the first place?