As Trading Frenzies Grip Penny Stocks, Criticism of Nasdaq Grows

Nasdaq rules require companies to be delisted if their share price falls below $1 for an extended period of time.. REUTERS/Jeenah Moon/File Photo/File Photo (REUTERS)
Nasdaq rules require companies to be delisted if their share price falls below $1 for an extended period of time.. REUTERS/Jeenah Moon/File Photo/File Photo (REUTERS)

Summary

Bit Brother, a tiny Chinese cryptocurrency company, reached nearly 30% of U.S. stock-market volume late last year.

Nasdaq touts itself as the stock exchange for many of the world’s most iconic and successful companies. It is also the home of Bit Brother.

The China-based company focused on selling tea products until it pivoted to cryptocurrencies in 2021. Its shares have fallen more than 99% since the beginning of 2020, after accounting for the three reverse stock splits it has done.

Bit Brother drew little notice until late December when its trading volume surged to billions of shares a day for no clear reason. Volume in Bit Brother hit 3.5 billion shares, or 28% of all the shares that changed hands in the U.S. stock market, on Dec. 27. The stock was trading for about a penny a share, so the value of those trades was small. On Jan. 10, Bit Brother did an unusual 1,000-for-1 reverse split, which helped the company maintain its Nasdaq listing by getting its stock back above $1.

It has become increasingly common for stocks with a low share price to experience huge bursts of trading volume. Fueling these frenzies are individual investors who use zero-commission trading tools to pile into stocks that get buzz on social media.

When such stocks trade for pennies a share, it is easy for day traders to place enormous bets on them. Then the high volumes themselves become a source of buzz, with the stocks appearing on leaderboards of heavily traded stocks where other investors take their cues.

A growing number of market veterans say something is broken—and they point the finger at Nasdaq, the listing exchange for most smaller public companies.

Nasdaq rules require companies to be delisted if their share price falls below $1 for an extended period of time. But the grace period before delisting can last more than a year. And some companies, like Bit Brother, repeatedly do reverse splits to stay listed.

“These sub-dollar, high-volume stocks make a mockery of our stock market," said Joe Saluzzi, a partner at New Jersey-based brokerage Themis Trading. “The primary listing market, in most cases Nasdaq, needs to tighten up their standards and reduce the amount of time needed for a delisting."

Critics such as Saluzzi say Nasdaq faces a conflict of interest: The exchange makes money by listing companies, while running a regulatory arm that delists companies when they don’t follow the rules.

“At Nasdaq, our regulatory functions operate independently of Nasdaq’s business units to safeguard the integrity of our markets," a spokesman for the exchange said.

Being listed on an exchange is effectively a seal of approval for a company. Major brokerages generally allow customers to trade any stock listed on Nasdaq or the New York Stock Exchange, while restricting access to the over-the-counter market, a sort of purgatory where companies land after they get delisted.

Days after the Bit Brother frenzy eased, volumes exploded in Phunware, a software developer that developed an app for Donald Trump’s 2020 re-election campaign. This past Jan. 16, after Trump won Iowa’s 2024 Republican caucuses, Phunware’s stock price more than quintupled to 42 cents, and 1.6 billion of its shares changed hands—accounting for 12% of total market volume that day.

Phunware’s stock has been stuck below $1 for the past year. A spokeswoman said the company would do a reverse split, if needed, to comply with Nasdaq listing rules.

The number of sub-$1 stocks has swelled as many of the companies that went public during the era of rock-bottom interest rates—often via mergers with special-purpose acquisition companies, or SPACs—have struggled. As of Thursday, there were 493 stocks that closed below $1, the majority of them listed on Nasdaq, according to Dow Jones Market Data. In early 2021, fewer than a dozen stocks were trading below $1 a share.

“Historically, these companies would have been delisted and gone to the OTC market," said Ovi Montemayor, a managing director at Charles Schwab.

Reverse splits have grown more common as such companies have sought to boost their share price above $1. There were 495 reverse splits of exchange-listed stocks in 2023, according to S&P Global Market Intelligence. That was up from 288 the year before and marked the largest annual total in the two decades since S&P began recording such data. In reverse splits, companies swap multiple shares for one share, artificially boosting the price of a single share.

The flurry of reverse splits has caused headaches for some brokers. In December 2022, a tiny pharmaceutical company called Cosmos Health approved a 25-for-1 reverse split and executed it the next day. The move led to a processing error at Robinhood Markets, which said it lost $57 million, blaming the snafu on delayed notifications about the split. Fallout from Cosmos Health’s reverse split caused losses at other brokers, including Schwab, people familiar with the matter said.

After the debacle, firms including Robinhood and Schwab met repeatedly with Nasdaq to urge improvements in the handling of reverse splits, the people said. Late last year, Nasdaq implemented a rule change requiring companies to publicly disclose reverse splits at least two business days before the splits take effect.

Some market veterans say big bursts of activity in sub-$1 stocks lead to a distorted picture of total market volume. Unlike many other countries, the U.S. measures stock-market volume in terms of number of shares traded, rather than their value. So when cheap stocks like Bit Brother trade over a billion shares a day, it inflates volume data for the market as a whole.

“Notional volume and share volume are kind of growing apart," said Anna Kurzrok, head of market structure at Jefferies. “On any given day, volume and value traded can be very different things."

Bit Brother didn’t respond to a request for comment. Its website greets visitors with the grammatically challenged message: “Infinite blockchain make future simpler."

The company could finally be booted off Nasdaq soon. This month, Bit Brother disclosed that Nasdaq was planning to delist it because of “public interest concerns" about two of the company’s recent share offerings. The company is set to appeal the decision at a hearing next week. Until then, Bit Brother will still be listed on Nasdaq.

Write to Alexander Osipovich at alexo@wsj.com

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