By Christina P. O’Neill
When ClearStory Systems announced last month that it would deregister its common stock, the company made a point of stating that it did so voluntarily. Companies that “delist” are often in financial distress that impacts the price and trading volume of their stock. But ClearStory, a Westboro-based enterprise digital media management developer, formerly known as INSCI, emphasized in its announcement that the primary reason for voluntarily delisting its stock was the burdensome cost of filing annual and quarterly reports with the SEC and the burdensome cost of complying with the Sarbanes-Oxley Act of 2002.
ClearStory will remain a public company, and it can re-register at any time. The catch: It would have to file all back annual and quarterly reports from which deregistration reprieves it. But its management came to the conclusion that it wouldn’t be cost-effective to keep filing quarterly and annual reports with the SEC in order to trade on the OTC Bulletin Board run by Nasdaq. The company’s stock, which was trading in the $1.20 to $1.50 range two years ago, closed at seven cents a share on June 30 – a drop likely due to the pending delisting.
Factors such as low market valuation and thinly traded shares have been longstanding reasons for smaller-cap public companies to either deregister – also known as “going dark”– or to take the company completely private, a different process that can be more expensive. While a great many of the companies that take these actions are businesses in trouble, not all of them are, notes R. Cromwell Coulson, CEO of New York City-based Pink Sheets LLC, the exchange on which ClearStory stock now trades. He says he’s seeing more small-cap firms choosing to deregister because of the costs of complying with the Sarbanes-Oxley Act.
These costs were the tipping point for ClearStory. Filing annual and quarterly reports with the SEC already costs ClearStory between $240,000 and $300,000 annually. President and CEO Henry Nelson says Sarbanes-Oxley would have cost the company an additional $200,000 in 2007, when small-cap companies will have to meet the same requirements as large ones now do.
A good reason to get out
“I take a phone call a week from somebody that wants to buy the company for whatever the market cap says on Yahoo,” Nelson says. “There’s the perceived valuation and then there’s the real valuation.” He says the real valuation is in the neighborhood of $16 million to $20 million; the market cap based on the company’s six million shares of common stock on July 1 was about $420,000. The gap has discouraged private equity firms from investing in ClearStory, and to Nelson, represents a good reason to get out of the market.
ClearStory reported $11.6 million in revenues and a $1.2 million loss for its fiscal year ended March 31, 2005, the last year for which it will report results. The company has racked up substantial losses since its inception. It recently sold its Integrated Document Archiving and Retrieval Systems unit, or IDARS, to Chelmsford-based Datawatch Corp. for an initial $4.3 million and 30 percent of the unit’s revenue stream over 18 months, for an anticipated $7.5 million total. The company will now focus on its remaining business, Digital Asset Management, where Nelson says the real growth is.
The cost savings and the lifting of disclosure requirements will make it easier for the company to focus on the business segment it wants to develop, without being forced to reveal information which might put it at a competitive disadvantage compared to its privately held competitors, Nelson says.
Other regional public companies that have deregistered in recent years are: Acton-based Pamet Systems Inc., which deregistered in January 2004; Marlboro-based Data Translation Inc., which deregistered in April 2003; and Framingham-based ASA International Ltd. They all trade on the Pink Sheets.
SarbOx refugees
It’s difficult to get a national figure for companies that are deregistering but remaining public strictly due to the burdens of Sarbanes-Oxley. The firms must file a Form 15-12G to terminate a security, but that also applies to companies that are acquired or phasing out a certain class of stock while staying registered. The anecdotal evidence suggests that an increasing number of small-cap companies will follow ClearStory into the deregistration process. Usually they are companies for which the cost/benefit of staying registered does not outweigh the need to invest the money available to them in business development – without giving away trade secrets. By 2007, when the small-cap companies have to meet the same disclosure standards as their large-cap brethren do now, people in the investment field say the number of companies deregistering to avoid Sarbanes-Oxley requirements is bound to increase.
“I agree with everything about Sarbanes-Oxley except the cost,” says R. Cromwell Coulson, CEO of Pink Sheets LLC, an over the counter stock exchange. “It’s been a Full Employment Act for accountants.” Small companies feel the brunt of it, he says, because the auditors have taken control of the process.
Coulson says that while Pink Sheets is recognized as the primary trading venue for stocks of smaller public companies, the majority of the dollar volume trading is taking place in distressed or reorganizing companies, or large international issuers. He and his company have launched a new exchange service, OTCQX (see sidebar), to tap what he sees as a growing market for companies that don’t want to be perceived as economically distressed but which don’t want the costs and constraints of SEC filings and Sarbanes-Oxley compliance. “I see some of the SarbOx refugees forming the backbone of it,” he says.
Coulson warns of companies that use Sarbanes-Oxley as an excuse to “go dark,” stripping shareholder value, and expresses the opinion that such activity should be considered just as fraudulent as dumping stocks. “Good disclosure is very hard, but not that hard,” he says. “There’s too many shysters in the over the counter space right now.”
He notes that over the next six to seven years, a wave of companies that had deregistered or gone private will likely come back as fully-registered public companies again after they’ve restructured and refocused. In these instances, “going dark” represents the brightest chance for a new future for companies in the midst of change.
Raising the price of being public
“Deregistration doesn’t suddenly change management’s ability to run the business,” says attorney Tom Hartman of Chicago-based Foley & Lardner LLP. “You either have good management or you don’t.” The big issue for small companies, he says, gets back to cost. Companies freed of the requirement to file annual and quarterly reports can presumably trim headcounts, as well as freeing up the CEO’s and CFO’s time. But traditionally, the CFO in many companies isn’t the one who’s developing the business anyway, he says.
The company’s board makes the decision to deregister, and it does not require a shareholder vote. The delicate part comes in how the minority shareholders sell their stock. Announcing the intention to deregister in advance, as ClearStory did, can depress the price of the stock – a good thing for the majority shareholders who are buying the stock, but not so good for the minority shareholders. ClearStory’s Nelson says shareholders initially expressed disappointment over the company’s decision to deregister, but did not seek to block the effort.
Sarbanes-Oxley “has raised the price for a small company to be public,” says attorney Hartman. The concern is that too many – often small, high tech companies – will decide they can’t afford to go public. If they can’t access public markets, they may not grow at all. “Many companies go out the door with an IPO at a small size,” he says. “They may fail, maybe most of them fail. But the ones that succeed become drivers in our economy.”
Christina P. O’Neill can be reached at coneill@wbjournal.com
SIDEBAR: OTCQX: bringing respectability to OTC
One executive thinks he might have the answer for emerging growth companies whose securities trade over the counter. R. Cromwell Coulson’s company, New York-based Pink Sheets LLC, is launching OTCQX, a stock trading, quotation and disclosure venue for over the counter securities in the U.S. market. Pink Sheets is now accepting applications for admission to OTCQX. Coulson says the exchange is designed to distinguish strong public companies that provide high-quality disclosure to their shareholders, through a set of defined standards and professional gatekeeper mechanisms.
To be eligible, companies must have bona fide operations – unlike many Bulletin Board companies that, in Coulson’s words, “issue press releases and shares.” They must have U.S. GAAP audited financials and, instead of a broker, they must have a Designated Advisor for Disclosure or DAD, for U.S. issuers and Proposing Advisors for Listing, or PAL, for international issuers. Individuals and organizations that will serve as DADs or PALs have to be securities attorneys, NASD-member investment banks, or an ADR (American Depositary Receipts) bank for sponsored ADRs in good standing.
Pink Sheets companies include businesses that are economically distressed, closely held or inactive, and large foreign issuers who trade ADRs (dollar-denominated shares of foreign-based companies). And then there are the emerging growth companies. Coulson thinks Pink Sheets meets the needs of the first three groups, but that it doesn’t do enough for the latter. “We’re creating a platform and template for disclosure,” he says. “We’re trying to do some things which will make OTCQX a place where companies are proud of the company they keep.”
C.P.O.
