What happens in reverse splits that preserve round lots?

Sometimes when announcing a reverse stock split, a company will add a line to the press release or SEC filing about preserving round lots. This small phrase can be very significant for small investors, and can sometimes lead to serious profits with little risk. So what does it mean to preserve round lots?

some background

First, let’s discuss reverse stock splits. A reverse stock split is when a company reduces its number of shares by some ratio, say 10 to 1, so that anyone holding 10 shares will now hold 1, everyone holding 100 shares will hold 10, etc. Because the company itself didn’t change, it’s worth the same amount of money, and so each new share will be worth 10 times as much as before. There are a few reasons for a stock to undergo a reverse split, but often it is a way to quickly raise share price in order to remain listed on a major exchange like Nasdaq or NYSE.

If you only had one share going into the reverse split, you’d be left with a fraction of a share after, e.g., one tenth of a share in our example. Sometimes these will be paid out in cash, but other times the fractional share will be rounded up to a full share. This new share should be worth about ten times the old price, so investors can sometimes get a 10x return, albeit one that’s limited to just a few dollars. These can be traded on some brokers for small profits.

Preserving Round Lots

Occasionally, a reverse stock split announcement will include some language regarding “special treatment” of round lot holders or “preservation” of round lot holders. What does this mean?

“Round lots” is an industry term that just means 100 shares. So when they say “preserve round lot holders” they mean “if someone holds 100 shares before the split, we might do things that will make it so that they still hold 100 shares after the split.” Here’s an example from Singlepoint Inc.’s ($SING) Form DEF 14C from January 22, 2021.

Singlepoint Inc.'s Form DEF 14C from January 22, 2021

How would round lots be preserved exactly? Singlepoint Inc. hasn’t said, and the reverse split hasn’t yet occurred so it may be clarified later. Curious, I looked up past reverse splits that preserved (or planned to preserve) round lot holders. There seem to be three ways these were handled.

Option 1: 1-Pre to 100-Post Round Up

In this example, everyone who has even 1 share pre-split gets 100 shares post-split. This appears to be what happened with Origin Agritech Ltd. ($SEED) in 2018, as evidenced by a Reddit thread about it involving some happily confused investors. A single share was converted into a tenth of a share, then rounded up to a full share worth 10 times the original investment, then rounded up again to 100 full shares worth 1000 times the original investment. It should be obvious that these are incredibly rare.

Option 2: 100-Pre to 100-Post round up

In the second example, everyone who has 100 or less shares pre-split gets the same number of shares post-split. This how the preservation is described in filings for Research Solutions ($RSSS), Saleen Automotive ($SLNN), and AtheroNova ($AHRO). Research Solutions even provided a helpful table to understand how pre-split shares convert to post-split shares:

Research Solutions Form DEF 14A, May 14 2014
Option 3: 50-Post to 100-Post

In the final example, everyone who has 50 shares after the split gets rounded up to 100 shares post-split. Those with less than 50 shares post-split would get the normal reverse split ratio plus any fractional shares from a round up to the next whole share. This was the approach described for China SLP Filtration Technology ($SLPC) in 2010 and Dolce Ventures Inc. ($DLCV) in 2006. 

To use China SLP Filtration as an example, they had a reverse split ratio of one to five. Any shareholder with 250 shares pre-split (50 share post-split would be rounded up to 100 post-split shares, for a rather significant 100% return. Anyone holding 500 shares would get no round up. This is one of the few instances with a massive incentive for those holding 500 shares to sell.

Risks

As with any trading, there are significant risks. Share price could drop while brokers  process the reverse split, an operation that can take several weeks. The company may choose to cancel the reverse split or change the terms last minute, as most of the announcements are careful to state that any special treatment to preserve round lot holders is at the board’s discretion.

A similar opportunity exists with tender offers with odd lot provisions, but over subscription by arbitrageurs seems to have resulted in these becoming less common in recent years. Reverse splits with round lot provisions may likewise become too popular.

So how can I profit from conventional reverse splits?

Say a company performs a reverse stock split at a ratio of 1 to 10. If you had bought 1 share before the split for $0.50, after the split you’d have 1/10 of a share, a fraction which historically could not be traded. To get around fractional shares, companies will sometimes pay the cash value of the fractional share, in this case $0.50. Other times, though, they will round you up to one full share. When they round up, the share you had bought for $0.50 is now worth around $5. You profit $4.50 at minimal at risk.

It’s nice, clean profit, but $4.50 is too small to get excited about. You can’t buy more shares at the same broker, as that just means you’ll get rounded up less. You can, however, purchase a single share at multiple brokers and let them all round up. There are at least 15 brokers that round up fractional shares from reverse splits. 

If you’re interested in trading reverse splits that round up, subscribe to my newsletter and Twitter to get notified of upcoming splits the day they happen. Make sure your broker is one that rounds up fractional shares (some don’t round up as policy, while others charge fees). A running list of participating brokers can be found here along with sign up links to get you free stocks. If you’re interested in recent successful trades, they are posted here. More information about trading reverse splits can be found on the homepage here.

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