When Companies "Go Dark", Investors Can Lose

Sarbanes-Oxley is raising the cost of being public

At 37 minutes past 6 p.m. on Apr. 27, Niagara Corp. filed its quarterly profit report. The steelmaker, which took in revenues of $295 million in 2003, is little-known yet in some ways extraordinary. For one, Niagara enjoys solid standing with Detroit, which uses its specialty bars for such critical systems as steering racks.

For another, its headquarters can be found within one of Manhattan's most elegant towers, 667 Madison Ave. And, after years of tough industry conditions, the financial news from Niagara's home office that day was most special: First-quarter sales had risen 24%, while earnings per share doubled. CEO Michael Scharf pronounced the results "excellent."

INVESTORS, WHO HAVE TRADED Niagara shares since Scharf took it public in 1993, had to be delighted. They also had no time to celebrate. Nine minutes later, Niagara filed notice that it would deregister its stock with the Securities & Exchange Commission, stop filing public reports and proxy statements, and delist from NASDAQ. Trading over the counter, the stock plunged and lately rests about 30% lower, near $3.64 (chart).

This nightmare is growing. Two University of Alberta economists, Nadia Massoud and Andras Marosi, combed SEC filings and counted 135 deregistrations unrelated to mergers last year, up from 46 in 2001 and 75 in 2002. In a 36-stock sample, they also found that stocks lost an average of more than 12% within two trading days of deregistration news. "It's a mystery to me why the SEC is not focusing on this," said Nelson Obus, president of Wynnefield Capital, which owns 6% of Niagara. "It's a cancer in the confidence that has to exist between management and investors."

Companies may deregister, or "go dark," if they have fewer than 300 shareholders of record (500 if assets fall below $10 million). With $186 million in assets, Niagara had 124 shareholders of record, but it likely has more actual holders because many accounts are in brokers' names. This criterion for deregistration is being challenged by a group of investors who last July petitioned the SEC to count ultimate shareholders, not just registered ones, in permitting companies to go dark. SEC staffers still are studying the issue.

Why would Niagara deregister? Scharf's critics see him as an excellent operating executive with a stellar record of delivering big gains to investors in earlier metals companies. But some speculate that Scharf aims to depress its value, buy a majority, and perhaps take over the company for a song. He owns 37% of the stock, and a brother, Gilbert, owns another 7%. Others worry that Scharf, who in 2003 received a salary and bonus of $880,000, up from $680,000 in 2002 and $480,000 in 2001, will enrich himself now that Niagara need not disclose executive pay.

Scharf told me none of these worries is valid. "I create shareholder value -- that's what I try to do," he said. Instead, driving Niagara's decision were the rising costs of staying public under the Sarbanes-Oxley Act and other new rules. Scharf was vague, however, about his estimate of the cost of staying public, putting it at "hundreds of thousands of dollars on an annual basis." This seems small next to the $10 million in market value Niagara lost the week it quit NASDAQ. Scharf also said he did not know how many investors own the stock, even though public companies use such a count in mailing proxies. Finally, he would not elaborate on how much weight Niagara's board gave a NASDAQ rule that this year would have forced it to have a majority of independent directors. It has six directors, with just three independent. One, Andrew Heyer, did not return my calls, and Scharf declined to help me reach the other two. "I am the spokesman," he said.

What should you make of all this? First, small-cap stocks have had a great run, but the risk of sudden deregistration is growing. Second, with vast disclosures and SEC scrutiny, it's no snap for a company to issue stock and take the public's money. But once public, it shouldn't be a snap to go dark.

By Robert Barker

    Before it's here, it's on the Bloomberg Terminal.