Splits, tender offers and proxies

Cost basis moves with the share count. An investor who paid $6,000 for 100 shares had a basis of $60 a share; after a two-for-one split the same $6,000 is spread across 200 shares, so the per-share basis is $30. Total basis is untouched, no gain has been realized, and there is nothing to report. A split is not a taxable event, which is one of the most reliably tested facts in this area.

A reverse split runs the other way. In a one-for-five reverse split, five old shares become one new share worth five times as much, so 500 shares at $2 become 100 shares at $10. The value is again unchanged. Companies usually do this to lift a price that has fallen too low, sometimes to keep an exchange listing, so the reason behind it is often unhappy even though the arithmetic is neutral.

A split is also not a new issue, and that comparison is worth holding on to. Issuing new shares to raise money hands part of the company to somebody new, so an existing holder’s slice of the whole shrinks. A split hands nothing to anybody: every holder is multiplied by the same factor, so nobody’s proportion moves and there is no dilution. What does move alongside the price is the dividend: if the company pays one, the dividend per share falls in the same proportion, because the same total payment is now spread over more shares.

Not every payment a shareholder receives is a dividend, and the difference is a basis question rather than an income question. A distribution that qualifies as a return of capital is a return of part of what the investor put in, so it is not taxed when it arrives. It reduces the adjusted cost basis of the stock instead, and the lower basis makes the eventual gain on sale larger — the tax is deferred rather than avoided. Once basis has been reduced to zero there is nothing left to reduce, and any further nondividend distribution is a taxable capital gain in the year it is received. Non-traded real estate programs are where a candidate most often meets this, because a distribution paid out of offering proceeds or borrowings rather than out of earnings is exactly such a payment.

Two other corporate actions are taught with this topic and are frequently confused. A tender offer is an active, widespread solicitation by a bidder to buy a substantial percentage of a company’s securities, and it can be for equity or for debt. Where the company offers to buy its own securities it is an issuer tender offer; where an outsider offers for another company’s securities it is a third party tender offer. Three features drive the questions: the offer is open only for a limited period, its terms including the price are fixed, and it is made to each holder individually so that each one decides separately whether to tender. The price is usually a premium to the market, which is what persuades holders to part with the shares. An offer may also carry a minimum tender condition — if the bidder set five million shares as the minimum and only four million are tendered, the bidder is under no obligation to buy any of them.

A proxy is about the vote, not the shares. Where a company’s securities are registered under Section 12 of the Securities Exchange Act of 1934, the SEC requires that shareholders receive a proxy statement before a shareholder meeting, whether that meeting is the annual one or a special one, and the information in it must be filed with the SEC before any vote is solicited on the election of directors or on other corporate action. The duty to disclose all important facts about the issues being voted on falls on whoever is soliciting — management and dissident shareholders alike. Schedule 14A sets out what the statement must contain. So one of these two actions asks whether you will sell, and the other asks how you will vote.

Street name puts a firm between the issuer and the voter, and the rules are written to stop the firm becoming the voter. The firm or its nominee is the record holder, so the proxy material arrives at the firm; it must forward that material to the customers who are the beneficial owners no later than five business days after it receives it. Its own position is that no member may give a proxy to vote stock registered in its name unless it is the beneficial owner, or one of the narrow exceptions in the rule applies.

What a firm may do with shares it has heard nothing about is the point candidates get wrong. Under the exchange rule, if voting instructions have not been received by the tenth day preceding the meeting, the firm may vote on certain matters — but only where it has no knowledge of any contest over the action, the action is adequately disclosed to shareholders, and the matter does not include authorization for a merger, consolidation or any matter which may affect substantially the rights or privileges of the stock. Congress narrowed it further: Section 957 of the Dodd-Frank Act amended the Exchange Act to require exchange rules to prohibit an uninstructed member vote on the election of directors, on executive compensation, and on any other significant matter the Commission designates.

Read the two together and the shape is simple. Routine and uncontested, the shares may be voted uninstructed; anything that changes what the shareholder owns or who runs the company, the shares go unvoted unless the owner replies. A merger sits on the wrong side of that line however uncontroversial it looks, and no amount of waiting or good faith moves it across.

An issuer can also buy back its own shares. A repurchase reduces the number of shares outstanding. Earnings per share is total earnings divided by shares outstanding, so the same earnings spread over fewer shares produce a higher per-share figure even though the business has earned nothing more. The SEC has noted that issuers may repurchase partly to reach an accounting metric such as an earnings-per-share target, so a rise in earnings per share after a buyback is not, by itself, evidence that the business improved.

Three more corporate actions change what a shareholder holds. In a tender offer, a company or a third party asks holders to sell a substantial percentage of the company’s securities, for a limited time, usually at a fixed price above the market price; each holder decides whether to tender. An exchange offer is a tender offer in which the holder is offered other securities, such as new shares or bonds, in exchange for the ones tendered, and those new securities may be registered with the SEC. A merger combines two or more companies into a single entity. Shareholder approval is governed by state law and typically requires a majority of the target company’s outstanding shares, and a reporting company sends holders a proxy statement, an information statement or a joint proxy statement and prospectus describing the terms and what they will receive.