A curious trend
Something strange has been happening in the U.S. stock market over the last year, and that something is exemplified by the case of Bit Brothers Limited, a Nasdaq issuer with the symbol “BETS”. It may surprise you to know BETS was the most actively-traded stock, by share volume, during the last six months of the year. With a trading price of around one cent per share, BETS’ volume ramped up especially in December – during the last week of the month, BETS averaged about two billion shares a day, or 19% of all listed stock volume. On December 27, 3.5 billion shares of BETS traded, amounting to 28% of total volume for that day.
According to public disclosures, BETS is a Chinese-based company incorporated in the Virgin Islands, which, for most of its existence, focused on selling tea and snack products to retail stores but recently announced its transition to bitcoin mining and “the formation of a blockchain ecosystem”.i Reflecting this new focus, its website leads with the motto: “Infinite Blockchain Make[s] Future Simpler”.ii BETS has disclosed that it moved its bitcoin mining business to North America following China’s ban on those operations in 2021. Its reported annual revenue for the year ended June 30, 2023 was about $2.9 million, with a recent market capitalization pegged at $2 million.iii
BETS is hardly alone as an example of a very low-priced security, or “penny stock”, with extraordinary trading volume. Another example is Esports Entertainment, a Malta-based company offering a “professional” video gaming platform, with the Nasdaq symbol GMBL (in keeping with a certain theme). GMBL, which traded for around 3 cents per share late in 2023, itself accounted for nearly 3% of all market volume for the first three weeks of December.
The two examples point to a broader trend. A recent market report by Jefferies looked at share volume in stocks with an average price of $5 or less (the price criterion used by SEC rules that require higher disclosure obligations for firms trading in penny stocks).iv Jefferies found that sub-$5 volume was fairly steady during most of the last two years, at about 20-25% of the total. But within this group, volume in stocks with an average price less than one dollar mushroomed to nearly 60% of sub-$5 volume by late 2023, an increase from 20% in the first quarter of 2021.v
The examples also are consistent with the observation that the sub-dollar stocks are heavily concentrated on Nasdaq. A recent Wall Street Journal article found that near the end of the year, there were 557 sub-dollar listed stocks, compared to fewer than a dozen in early 2021, and of these, the bulk (464) were Nasdaq-listed. As explained by the article, Nasdaq attracts most of the issuers with small market capitalization, and many of the current listings include issuers that went public during an IPO boom in 2020-21.vi This includes companies that resulted from a spike in the use of special purpose acquisition vehicles, or “SPACs”, many of which have since stumbled. Nasdaq requires listed companies to maintain a price above $1, but its rules build in delays that allow companies to avoid delisting for long time periods – more on that in a moment.
Why it matters
There are at least two implications from this emergent trend. The first has to do with how firms allocate their capital among different stocks. The largest exchanges offer rich incentives to firms that can achieve very high trading volumes on their markets, in the form of tiered rebate payments. The SEC recently proposed to restrict the use of rebate tier price schedules on the grounds that they are unfair and anti-competitive, by providing highly preferential pricing to a relative few trading firms. IEX, among others, supports SEC action to restrict tiered pricing.vii While the arguments in favor of restricting rebate tiers are fairly clear, the way that tiered pricing can drive trading in penny stocks is not well understood.
This is how these two things are connected. Exchanges typically set rebate tiers based on a percent of total consolidated volume (TCV), a measure based on total share volume on all markets. For example, assume that an exchange maintains a price tier that provides a rich payout to any firm that can trade on that exchange monthly volume equal to 1% of all TCV for all stocks reported for the same month. In general, to meet the test, all listed stocks are treated the same, so that every trade in a penny stock counts as much as a share in a stock like Apple, for example. Assume that Apple is trading around $190 per share (a price close to its current range). By actively trading a stock with a price of around 19 cents per share, a firm could generate 1000 times more trading volume with the same amount of capital than it could by trading Apple. With that much difference in leverage, the tiered pricing system can generate a strong incentive for a trading firm to favor trading in stocks that provide the “biggest bang for the buck”, in order to obtain better pricing for all of the firm’s other trading.viii
There is also a second-order effect. Inflated trading volume in penny stocks means that the absolute volume of trading needed to qualify for a TCV tier is higher, because the TCV denominator is higher – it becomes much harder to trade a number of shares equal to 1% of a larger pie. Overall, understanding the strange incentives that flow from the tier system tends to undermine the argument by defenders of the system that it serves to attract liquidity to issuers that most need it.
To put it another way, in a world where decisions are based on share count, rather than dollars invested, trading in low-priced shares can assume an outsized importance, which makes markets less efficient.
More fundamentally, while low price does not necessarily mean poor value, very low share price tends to be associated with higher risk and more speculation. It can be easier to manipulate stocks with very low prices simply because it requires less capital to move the per share price to a meaningful degree. Also, unscrupulous promoters can point to the existence of the exchange listing as a badge of legitimacy, while holding out the prospect of substantial gains if the price increases by only one or a few cents per share.
These concerns were validated by a detailed academic study in 2011 that focused on trading in Nasdaq stocks before and after Nasdaq first imposed a $1 minimum price test in 1991.ix The study found that a reduction in trade price below $1 was often associated with “catastrophic price drops relative to the market” in ways that can be “devastating to investors’ interests.”x The study concluded that “the $1 benchmark serves as an appropriate cutoff point in screening stocks listed on the exchange.”xi
What about listing standards
There is an obvious disconnect between Nasdaq’s $1 minimum price listing standard and the relative presence and influence of sub-dollar companies. The WSJ article points to two related reasons. First, the listing rules generally provide a cure period of 180 days to come into compliance, which can be extended for another 180 days unless the company fails to meet a different listing standard.xii
Second, a common way of regaining compliance is the reverse stock split. All other things being equal, a reduction in the number of outstanding shares will proportionately increase the price of each resulting share. A reverse split will also reduce trading volume, but of course it doesn’t change anything about a company’s business or prospects, or the value of any investor’s stake. In fact, because a reverse split is often read by the market as a negative signal, it can lead to a reduction in share price on an adjusted basis. Further, if the price again falls below $1 later on, at that point the company would generally be granted a new grace period.
Some companies use the reverse split strategy repeatedly, including GMBL, the video gaming company, which effected two splits last year, the most recent one in December at a ratio of 400:1.xiii Overall, the WSJ article reports that there were 255 reverse splits during the first 11 months of last year, up from 159 for all of 2022, in tandem with the rise in sub-dollar volume.
Balancing the interests
Issuers naturally have a strong incentive to avoid delisting at all costs, both to maintain liquidity for their shareholders and to be in a better position to obtain new capital. Countering those interests is the regulatory interest in enforcing listing standards and preserving overall market integrity. The extreme increase in sub-dollar issuers and trading volume seen recently raises reasonable questions about whether those competing interests have fallen out of balance on Nasdaq.
Circling back to Bit Brothers, where we started, you won’t be surprised to learn that facing delisting with its stock trading far below $1 over many months, on January 10 it completed a reverse split of 1000:1. Its stock closed at $4.16 on January 23, reflecting a drop in value following the split, but allowing the company to keep its listing in place for now. Whether that is viewed is a good thing or not likely depends on where you sit. From the company’s point of view, its ability to obtain more funding from investors is likely enhanced. And if it manages to obtain new funds, who knows, it might come closer to realizing its vision of a simpler future, based on infinite blockchain.
But you might not want to bet on that.
[iii] Bloomberg terminal, as of January 23, 2024.
[iv] See 17 C.F.R. § 240.3a51-1(d).
[v] Jefferies, U.S. Market Structure Update (January 8, 2024), at 8-9.
[vii] See Letter from John Ramsay, Chief Market Policy Officer, IEX, to Vanessa Countryman, Secretary, SEC, dated January 5, 2024, avail. at https://www.sec.gov/comments/s7-18-23/s71823-357479-882822.pdf.
[viii] Exchanges typically offer a different rebate structure that applies to stocks that are priced less than $1 per share. In contrast, rebate tier structures tied to TCV thresholds typically do not distinguish stocks trading for less than $1 per share from higher-priced stocks.
[ix] S. Ghon Rhee and Feng Wu, ”Anything Wrong with Breaking a Buck? An Empirical Evaluation of NASDAQ’s $1 Minimum Bid Price Maintenance Criterion,” Journal of Financial Markets (2012), at 258, avail. at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1940443.
[x] Id.at 280.
[xi] Id.at 258.