Adjustment of Orders for Stock Splits and Dividends

The adjustment of orders rule protects a resting order from a mechanical price drop the customer did not choose. It has one duty, five adjustment branches, two special cases, and a short list of orders it does not reach at all.

What Is an Open Order Under This Rule?

The term "open order" means an order to buy or an open stop order to sell. It includes, but is not limited to, "good 'til cancelled" (GTC), "limit" or "stop limit" orders which remain in effect for a definite or indefinite period until executed, cancelled or expired.

Those two branches are the whole definition. The order-type examples inside it are open, but a resting order that is neither an order to buy nor an open stop order to sell is not an open order here.

Exam Tip: Gotchas

• The definition is two branches wide, not four. An order to buy of any kind, and an open stop order to sell. The exclusions later in the rule then remove open stop orders to buy and open sell orders, which is the same line drawn from the other side.
• A good 'til cancelled order is an example, not the definition. The rule reaches an order that remains in effect for a definite or an indefinite period, so a dated limit order to buy still qualifies.

When Must a Member Adjust an Open Order?

A member holding an open order from a customer or another broker-dealer shall, prior to executing or permitting the order to be executed, reduce, increase, or adjust the price and/or number of shares of the order.

The adjustment is by an amount equal to the dividend, payment, or distribution, made on the day the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest.

One exception sits in that sentence: the duty does not apply where a cash dividend or distribution is less than one cent ($0.01).

Exam Tip: Gotchas

• The trigger is the ex day, not the record date or the payable date. The adjustment is made on the day the security is quoted ex-dividend, ex-rights, ex-distribution or ex-interest.
• The sub-penny exception is written for cash only. It reaches a cash dividend or distribution of less than one cent, so a small stock distribution does not fall through it.
• The order can be adjusted in either direction. The rule says reduce, increase, or adjust, and it reaches the price, the number of shares, or both.

How Is Each Corporate Action Calculated?

Five branches. Four carry their own arithmetic; the fifth, an indeterminate value, stops any adjustment or execution until the member reconfirms the order with the customer.

Two branches carry a marking: unless the order is marked "Do Not Reduce," open order prices are first reduced by the dollar amount of a cash dividend, and unless it is marked "Do Not Increase," the size of the order is increased on a stock dividend or split.

Exam Tip: Gotchas

• The two roundings run in opposite directions. A cash dividend rounds the resulting price down to the next lower minimum quotation variation. A stock dividend or split rounds the distribution's value up to the next higher variation before subtracting it.
• "Do Not Reduce" and "Do Not Increase" do different jobs. The first blocks the price reduction on a cash dividend. The second blocks the size increase on a stock dividend or split. Neither blocks the other.
• The stock-split price adjustment has no marking that stops it. Only the size increase carries the "Do Not Increase" condition, so the price is still adjusted whatever the order is marked.
• The either-or dividend takes the greater value. The comparison is between the cash and the securities, and the size increase happens only where the stockholder opts for securities.
• An indeterminate value stops three things. The member may not adjust, may not execute, and may not permit execution, until it reconfirms the order with the customer.

Which Orders Fall Outside the Adjustment Duty?

The adjustment duty does not apply to four categories:

• Orders governed by the rules of a registered national securities exchange.
• Open stop orders to buy.
• Open sell orders.
• Orders for the purchase or sale of securities where the issuer has not reported a dividend, payment, or distribution under the untimely dividend announcement rule.

Read those against the definition of an open order. The definition reaches an order to buy and an open stop order to sell; the exclusions then remove open stop orders to buy and open sell orders. Read literally, "open sell orders" overlaps the open stop order to sell the definition includes, so treat that exclusion as reaching sell orders other than stop orders, the reading the course uses.

Exam Tip: Gotchas

• An unreported distribution is an exclusion, not a defense. The duty falls away because the issuer never gave the notice the untimely dividend announcement rule requires, and that failure is the issuer's problem rather than the member's.
• Exchange-governed orders sit outside the adjustment duty. The exclusion is written for orders governed by the rules of a registered national securities exchange, so this arithmetic is not the one that applies to them.

What Happens on a Reverse Split or an Unadjusted Split?

Two pending-order provisions sit outside paragraph (a).

• Reverse split. When a pending order involves a security that is the subject of a reverse split, the order, buy or sell, shall be cancelled.
• Stock split with no adjustment required. When a pending order involves a security that is the subject of a stock split but is not otherwise required to be adjusted under the rule, the member shall promptly notify the customer of the stock split.

Exam Tip: Gotchas

• A reverse split cancels both sides. The rule names the buy and the sell order together, so there is no surviving order to reprice.
• The notification duty covers the gap. Where a split reaches an order the adjustment duty does not, the customer still hears about it, promptly.

When Does the Issuer's Own Notice Duty Matter?

The untimely dividend announcement rule binds the issuer, not the member, and it is the reason the fourth exclusion above exists. It makes it a manipulative or deceptive device or contrivance for an issuer of a class of publicly traded securities to fail to give notice of three actions:

• A dividend or other distribution in cash or in kind, except an ordinary interest payment on a debt security, but including a dividend or distribution of any security of the same or another issuer.
• A stock split or reverse split.
• A rights or other subscription offering.

The ex-dividend, ex-rights and ex-warrants dates themselves, and who designates them, are covered in the unit on clearance and settlement.

Exam Tip: Gotchas

• An ordinary interest payment on a debt security is carved out. A distribution of a security of the same or another issuer is carved in, which is the opposite direction.

What Should You Check on Exam Day?

• Confirm the order is an order to buy or an open stop order to sell. Open stop orders to buy and open sell orders are excluded.
• Ask whether the distribution is cash under one cent. That is the only size exception, and it is cash only.
• Match the marking to the branch: "Do Not Reduce" blocks a cash-dividend price cut, "Do Not Increase" blocks a stock-dividend size increase.
• Round the right way. Cash dividends round the resulting price down; stock dividends and splits round the value up before subtracting.
• On a reverse split, cancel the order rather than adjusting it, whichever side it is on.