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Trading a Stock in Bankruptcy: 5 Facts

Editor's Note: This story was published in Sept. 2010. Since then, Blockbuster's pink sheets have been temporarily suspended by the SEC.

NEW YORK ( TheStreet) -- The Chapter 11 bankruptcy announced by Blockbuster (BLOKA) on Thursday didn't slow down trading in shares of the video rental company. In fact, trading in its shares was more furious than ever.

An investor might rightly wonder why anyone would trade shares of a company that has declared itself bankrupt. An investor might also wonder how a company can even continue to trade shares after declaring bankruptcy.

Companies in Chapter 11 can and do trade shares, and those shares can re-emerge with the company after the bankruptcy process is complete. That is, if the company re-emerges from bankruptcy as a viable public company. In any event, trading in shares of companies going through the bankruptcy process is a high risk strategy.

Here are 5 key questions and answers about trading in shares of a company that has declared Chapter 11 bankruptcy, courtesy of the Securities and Exchange Commission (important caveat: these rules do not apply to Chapter 7 bankruptcy).

QUESTION 1: How can shares of a company that is in Chapter 11 bankruptcy proceedings continue to trade?

ANSWER: A company's securities may continue to trade even after the company has filed for bankruptcy under Chapter 11. In most instances, companies that file under Chapter 11 of the Bankruptcy Code are generally unable to meet the listing standards to continue to trade on Nasdaq or the New York Stock Exchange.

However, even when a company is delisted from one of these major stock exchanges, their shares may continue to trade on either the OTCBB or the Pink Sheets. There is no federal law that prohibits trading of securities of companies in bankruptcy.

QUESTION 2: What is the risk level of trading in shares of a Chapter 11 company?

ANSWER: Buying common stock of companies in Chapter 11 bankruptcy is extremely risky and "is likely to lead to financial loss" according to the SEC. Although a company may emerge from bankruptcy as a viable entity, generally, the creditors and the bondholders become the new owners of the shares.

In most instances, the company's plan of reorganization will cancel the existing equity shares. This happens in bankruptcy cases because secured and unsecured creditors are paid from the company's assets before common stockholders. And in situations where shareholders do participate in the plan, their shares are usually subject to substantial dilution.

QUESTION 3: How do shares traded during bankruptcy proceedings re-emerge after bankruptcy?

ANSWER: If the company does come out of bankruptcy, there may be two different types of common stock, with different ticker symbols, trading for the same company.

One is the old common stock (the stock that was on the market when the company went into bankruptcy), and the second is the new common stock that the company issued as part of its reorganization plan.

If the old common stock is traded on the OTCBB or on the Pink Sheets, it will have a five-letter ticker symbol that ends in "Q," indicating that the stock was involved with bankruptcy proceedings. The ticker symbol for the new common stock will not end in "Q."

Sometimes the new stock may not have been issued by the company, although it has been authorized. In that situation, the stock is said to be trading "when issued," which is shorthand for "when, as, and if issued." The ticker symbol of stock that is trading "when issued" will end with a "V". Once the company actually issues the newly authorized stock, the "V" will no longer appear at the end of the ticker symbol.

The SEC cautions investors to be sure to know which shares they are purchasing, because the old shares that were issued before the company filed for bankruptcy may be worthless if the company has emerged from bankruptcy and has issued new common stock.

QUESTION 4: What happens to the old shares of the company and any dividends due after re-emergence from bankruptcy?

ANSWER: During bankruptcy, bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends.

Bondholders may receive new stock in exchange for bonds, new bonds, or a combination of stock and bonds.

Stockholders may be asked by the bankruptcy appointed trustee to send back old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than old shares.

The reorganization plan will spell out rights as an investor, and what a shareholder can expect to receive, if anything, from the company.

QUESTION 5: Are there case in which the bankruptcy court decides that shareholders should get nothing?

ANSWER: Yes. The bankruptcy court may determine that stockholders don't get anything because the debtor is insolvent.

A debtor's solvency is determined by the difference between the value of its assets and its liabilities.

If the company's liabilities are greater than its assets, any stock may be worthless.

For tax purposes, holders of worthless stock should contact an Internal Revenue Service (IRS) office or call 1-800-829-1040 for information about how to report worthless securities as a loss on an income tax return.

For more in-depth information on trading companies whose shares are in bankruptcy, consult this SEC web page:

--Written by Eric Rosenbaum in New York.

>To contact the writer of this article, click here: NAME.


Copyright 2009 Inc. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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