Rights, Warrants, and ADRs

A company can issue equity in more shapes than common stock and preferred stock. Four more items belong to the equity family: rights, warrants, ADRs, and stock that carries selling restrictions. The exam asks a short question about each one. Learn who gets it, how long it lasts, and what it costs.

Rights: buying new shares before the public

A preemptive right lets an existing common shareholder keep the same percentage of the company when it issues new shares. Without that right, every new issue shrinks your slice of the company.

A company honors the right by running a rights offering. It gives each shareholder one right per share owned, at no cost. The rights buy new shares at a subscription price, which the company sets below the current market price.

Rights expire fast, typically within a few weeks. Unexercised rights then expire worthless.

Say you own 1,000 shares of a stock trading at $50. The company offers one new share for 10 rights plus $45. Your 1,000 rights buy 100 new shares at $45 each, a $5 discount on every share.

You have three choices with a right: exercise it, sell it, or let it expire. Rights trade in the secondary market, so letting them expire throws money away.

Warrants: the long-dated attachment

A warrant lets the holder buy the company's stock at a fixed exercise price for years. Some warrants run as long as 15 years.

The exercise price starts above the market price. A warrant issued while the stock trades at $20 might carry a $30 exercise price. The holder gains only if the stock climbs past $30 before the warrant expires.

Warrants usually arrive attached to another security. A company selling bonds or preferred stock attaches warrants as a sweetener, an extra that lets it sell the issue at a lower coupon. The warrant then detaches and trades on its own.

Exercising a warrant makes the company issue new shares, which dilutes existing shareholders. A warrant holder receives no dividend and no vote until they exercise and hold the stock.

How rights and warrants differ

• Who gets them: rights go to existing shareholders; warrants go to buyers of the security they are attached to.
• Price: a subscription price sits below the market price; an exercise price sits above it.
• Life: rights last weeks; warrants last years.
• Cost: shareholders receive rights free; warrants come with a purchase.

Both come from the corporation, both create new shares on exercise, and neither one pays a dividend or carries a vote. The exam swaps "below market" and "above market" often. A right is a discount today. A warrant is a bet on a higher price later.

ADRs: a foreign company through a US bank

An American Depositary Receipt (ADR) is a certificate issued by a US bank that represents shares of a foreign company. It trades on a US market, in US dollars, through a US broker.

That US bank is the depositary bank. It holds the foreign shares abroad and issues receipts against them. One ADR can represent one foreign share, several shares, or a fraction of a share. The ADR price follows the home-market price, adjusted for that ratio and converted into dollars.

Dividends reach you in dollars. The foreign company pays in its home currency, the depositary bank converts the money, and you receive dollars after the bank's fee. The foreign government often withholds tax before the dividend leaves the country.

Every ADR holder carries currency risk, the risk that an exchange rate move changes your return. If the home currency drops 10% against the dollar and the share price holds steady, your ADR loses about 10%.

ADR holders usually get limited voting rights or none at all. The depositary bank holds the real shares and votes them.

Control stock, restricted stock, and Rule 144

Two kinds of stock cannot go straight into the market. SEC Rule 144 sets the terms for selling both.

Restricted stock is unregistered stock bought in a private sale, such as a private placement. Control stock is stock held by an affiliate: an officer, a director, or an owner of more than 10% of the company. Control stock can be ordinary shares bought on the open market, because the holder makes it control stock.

Rule 144 attaches three conditions:

• Holding period: hold restricted stock 6 months when the company files reports with the SEC, 12 months when it does not. Control stock bought in the market carries no holding period.
• Volume limit: an affiliate may sell the greater of two caps. The first is 1% of the outstanding shares. The second is the average weekly trading volume of the previous four weeks. That cap covers any 90-day period.
• Form 144: file this notice with the SEC when a sale tops 5,000 shares or $50,000 in any 90 days. The filer must plan to sell within a reasonable time after filing.

The volume limit follows the affiliate, not the share. A non-affiliate who has held restricted stock past the holding period sells without a volume limit.

The exam offers "the lesser of" as a wrong answer here. The Rule 144 volume limit is the greater of the two numbers.

How this gets tested

Most items name one feature and ask you to pick the product:

• Free to shareholders, priced below market, gone in weeks: a right.
• Attached to a bond, priced above market, alive for years: a warrant.
• Foreign company, US exchange, dividend converted by a bank: an ADR.
• Officer selling shares, 1% or average weekly trading volume: Rule 144.

A sample of the logic: a company president wants to sell shares she bought last week on the open market. What limits her sale? The Rule 144 volume limit applies, because she is an affiliate and holds control stock. No holding period applies, because she bought the shares in the market instead of in a private sale.