Rules for a Stock Split
The U.S. Securities and Exchange Commission, SEC, administers the rules for stock splits. The SEC sanctions two types of stock split. The first -- forward stock splits -- is the more popular choice for most successful publicly traded corporations, as it makes their stock more affordable. The second -- reverse stock splits -- although less common, achieve a reduction of outstanding shares and a higher stock price when an organization wants to take some shares off the market.
Forward Stock Split Rules
Corporations choosing forward stock splits increase the number of outstanding shares in the market. A common stock split formula is issuing two shares for every one share outstanding. Another popular variation has the corporation issuing three shares for every two shares in the market. On paper, the value of the new stock generates no immediate profit for shareholders. For example, a stock currently selling for $100 per share, will have a price of $50 per share immediately after a two for one split.
Reverse Stock Splits
Instead of increasing outstanding shares, reverse stock splits reduce the number of shares in the market. For example, a common reverse stock split happens when a corporation issues one share for every two outstanding shares. The price of outstanding stock works in the reverse of a forward split. For example, a stock currently selling for $50 per share will have a price immediately after the reverse split of one share for every two shares of $100 per share.
Stock Exchange Rules
Public companies wanting to complete a stock split must also comply with the rules of the stock exchange on which they are listed. Regardless of the exchange, organizations must register their stock split intentions with their exchange. For instance, a stock listed on the New York Stock Exchange must be registered and split in accordance with the NYSE Listed Company Manual, section 703.02. Stocks listed on the NASDAQ stock exchange also must comply with their specific procedures, in Rule 5250(e)(6), when conducting a stock split.
While the IRS does not set specific rules for stock splits, it recognizes that stock splits, whether forward or reverse, are not taxable events. Since the taxable value of stock does not change after a split, IRS treats stock splits as non-taxable occurrences. With the stock price either decreasing or increasing in direct proportion to the volume of new stock issued or reduced, there is no profit or loss for shareholders at the time of the split.
The SEC regulates all procedural matters regarding stock splits. For example, they mandate registration of an organization's intention to make a stock split. Corporations must notify the SEC a minimum of 10 days before the stock split, listing the shareholders who are eligible to participate and the proposed date of the actual stock split. The SEC has set and enforced stock split rules since 1934, to prevent a repeat of the 1929 devastating stock crash.