As the coronavirus (COVID-19) pandemic continues to rapidly unfold and create volatility in the market, companies are considering whether to opportunistically buy back their stock pursuant to existing or newly established share repurchase programs. When considering share repurchase programs, companies should consider sharp criticism of stock repurchase programs, which has become more heightened in light of the adverse economic impacts of COVID-19 and the federal government’s response to the crisis.

On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (the ‘‘CARES Act’’), which provides the Treasury Secretary with discretion to make loans, loan guarantees, and other investments to eligible U.S. businesses under certain circumstances. Pursuant to Section 4003 of the CARES Act, the agreements governing loans, loan guarantees and other investments to eligible businesses must include a prohibition, during the term of the loan, loan guarantee, or investment and for twelve months after the loan or loan guarantee is no longer outstanding, on the company’s and any affiliate of the company’s ability to repurchase shares of its or any parent company’s equity securities that are listed on a national securities exchange, unless a contractual obligation to repurchase shares was in effect on the date of enactment of the CARES Act. In light of these restrictions, companies receiving loans, loan guarantees, or investments from the U.S. Treasury generally will not be permitted to repurchase their listed securities. As a result, companies with existing stock repurchase programs or who are considering new programs will need to consider, among the other factors discussed in this client alert, whether the need for stimulus relief outweighs the possible benefits associated with stock repurchases, particularly given the length of the prohibition.

For companies that do not receive loans, loan guarantees, or other investments pursuant to the CARES Act, this client alert presents a brief discussion regarding share repurchases, including legal and other factors that should be considered when deciding whether to buy back stock, particularly in light of the continued volatility resulting from the COVID-19 pandemic.

Stock Repurchases Generally

We use the term “stock repurchases” to refer to a public company buying back company shares that were previously sold to the public. There are a variety of reasons why a company may want to repurchase its own shares in the market, including, among others: (i) to send a signal to the market that the company believes its stock is undervalued and is a good investment; (ii) to reduce its cost of capital; (iii) to move excess cash to a better investment when more favorable alternatives are unavailable; (iv) to improve financial metrics that are denominated by the number of shares outstanding (such as earnings per share); or (iv) to meet the needs of employee benefit plans and stock option plans.

Implementing a Stock Repurchase Program

Any stock repurchase program should be authorized and approved by the company’s board of directors. As part of this authorization, the board should document the purpose of the share repurchase, which must be a lawful purpose under applicable state law. It is important that the board concludes that the repurchase program is desirable and in the company’s and its stockholders’ best interests. When approving a repurchase program, it is advisable that the board establishes a record of discharging its fiduciary or statutory duties. The record should include a current review, in consultation with management, of the company’s capital position and a thorough discussion of the purpose of the program. The board should consider all of the circumstances when evaluating a stock repurchase program, including the legal, financial, regulatory, and public perception considerations discussed in this alert.

Among the factors that should be considered when determining whether to engage in stock buybacks include:

• the impact on the company’s cash position and capital needs for its continuing operations, particularly during periods of dislocation in the capital and credit markets when cash preservation may be paramount;
• alternative uses for the cash needed to repurchase the stock, including repayment of outstanding indebtedness and funding potential acquisitions or other investments; and
• the possible effect on per share financial metrics such as earnings per share.

Additionally, prior to implementing a stock repurchase program, the company should conduct a review of its charter, bylaws, and the agreements to which it is a party or by which it is bound, to determine whether there are any restrictions on or impediments to the company’s use of funds to acquire its own securities. Specifically, the company’s loan agreements and security documents should be reviewed for any such restrictions or limitations, because these types of agreements and documents often include consent or notice requirements or other direct limitations on repurchases and/or or indirect limitations in the form of financial ratios and restricted payment covenants. Companies should also ensure that the terms of any senior securities, such as preferred stock, do not prohibit or restrict the company’s ability to repurchase shares of junior securities, such as common stock. Any change in control or anti-dilution provisions also should be reviewed to ensure that the consequences of the company’s repurchase activity are well understood in advance of adopting the program. Further, the company should review its recent public disclosures regarding uses of cash to ensure that a stock repurchase is not contrary to such disclosures, confirm that there are no notice or other requirements or limitations under applicable stock exchange rules, and review its insider trading and other internal policies to confirm any proposed stock repurchase program is in compliance with such policies.

Before adopting a stock repurchase program and during the period in which buybacks will be executed, the company must assess whether it may engage in stock buybacks under applicable state law. For instance, companies incorporated in Delaware are subject to certain provisions of the Delaware General Corporation Law (“DGCL”) that contain restrictions regarding legally available funds that may be used to effect to repurchases of shares of the company’s capital stock. Under DGCL Section 160, a Delaware corporation cannot purchase shares of its capital stock when the purchase “would cause any impairment of the capital of the corporation.” Additionally, the California Corporations Code (§§ 500 et seq.) provides that a California corporation must follow certain requirements prior to engaging in a distribution, which includes company stock repurchases. Accordingly, a California corporation may only repurchase its own stock if either: (i) the amount of the retained earnings immediately prior to the distribution equals or exceeds the sum of (a) the amount of the proposed distribution, and (b) the amount, if any, of cumulative dividends in arrears on all shares having a preference with respect to payment of dividends over the class or series to which the applicable distribution is being made, or (ii) immediately after giving effect to the distribution, the value of the corporation’s assets would equal or exceed the sum of (a) its total liabilities, and (b) the amount, if any, that would be needed if the corporation were to be dissolved at the time of the distribution to satisfy the preferential rights, including accrued but unpaid dividends, of other shareholders upon dissolution that are superior to the rights of the shareholders receiving the distribution.

Many states’ corporate law statutes, including the DGCL, provide that directors may be jointly and severally liable to the company or its creditors for any “willful or negligent” violation of the provisions relating to stock repurchases. Furthermore, although state corporate law statutes permit companies to indemnify their directors from breaches of the duty of care, corporate law statutes in many states, including Delaware, expressly prohibit exculpation of liability for breaches of duties in connection with stock repurchases.

Accordingly, the company should consult with its outside counsel regarding any applicable state law restrictions prior to implementing a stock repurchase program.

Rule 10b-18 Generally

As noted above, there are a variety of reasons a company may determine to engage in stock repurchases, including to signal that the stock price is undervalued, to try to halt precipitous declines in the stock price and to improve per share financial metrics that are based on the number of outstanding shares. Given the potential impact of stock repurchases on a company’s stock price, a company’s stock repurchases could expose the company to a claim that it is manipulating the market in its own securities in violation of the antimanipulation provisions of the U.S. federal securities laws. The U.S. Securities and Exchange Commission (SEC) adopted Rule 10b-18 to provide a non-exclusive safe harbor for a company’s repurchases of its own common stock. Although most companies take steps to ensure compliance with the Rule 10b-18 safe harbor, Rule 10b-18 expressly provides that there is no presumption of manipulation simply because the company’s purchases do not satisfy the rule’s conditions.

Rule 10b-18 provides a company and its “affiliated purchasers” (as discussed below) with a non‑exclusive safe harbor from liability under certain antimanipulation provisions of the federal securities laws (i.e., Sections 9(a)(2) and 10(b) of the Securities Exchange Act of 1934, as amended (the ”Exchange Act”), and Rule 10b-5 under the Exchange Act, each to a limited extent) when the company repurchases its own common stock in the market in accordance with the rule’s manner, timing, price, and volume conditions. Rule 10b‑18’s safe harbor is available for purchases of the company’s common stock on any given day. To fall within the safe harbor, the company’s repurchases must satisfy, on a daily basis, each of the rule’s four conditions. Failure to meet any one of the four conditions will disqualify all of the company’s repurchases from the safe harbor for that day.

Companies should note that the Rule 10b-18 safe harbor only applies to purchases by a company of its common stock (or an equivalent interest, such as a unit of beneficial interest in a trust or limited partnership or a depository share). Rule 10b-18 does not apply to any other type of security, including purchases of preferred stock, warrants, convertible debt securities, options, or security future products. However, many companies analogize to the conditions of Rule 10b-18 in connection with repurchases of other equity-linked securities.

Conditions for the Rule 10b-18 Safe Harbor

Rule 10b-18’s non-exclusive safe harbor is available only when the repurchases of the company’s common stock in the market are made in accordance with the conditions of Rule 10b-18. Failure to meet any one of the rule’s conditions will disqualify all of the company’s purchases made on that day from the safe harbor. Accordingly, Rule 10b-18 requires satisfaction of all of the following conditions:

• Manner of purchase condition: The purpose of the manner of purchase condition is to avoid creating the false appearance of widespread purchasing interest and trading activity in the company’s common stock through the use of many brokers or dealers on any given trading day. Accordingly, on a single day, the purchases and any bids of the company, or its affiliated purchasers, must be made through one broker or dealer. However, this restriction does not bar the company or its affiliated purchasers from making purchases if they are deemed not solicited by or on behalf of the company, such as purchases not solicited from additional brokers or dealers or when a shareholder approaches the company to buy shares. A company must evaluate whether a transaction is “solicited” based on the facts and circumstances of each case. Additionally, from one day to the next, the company may use a different broker or dealer to execute its purchases. Furthermore, a company may use a different broker or dealer during an after‑hours trading session from the one used during regular hours.
• Timing condition: The purpose of the timing condition is to prevent the company from establishing either the opening or closing price of the stock, both of which are considered to be the guide in the direction of trading. A purchase by the company may not be the opening transaction reported in the consolidated system where the purchase is effected A consolidated system is a consolidated transaction or quotation reporting system that collects and publicly disseminates, on a current and continuous basis, transaction or quotation information in common equity securities pursuant to an effective transaction reporting plan or an effective national market system plan.

Additionally, for a security that has an average daily trading volume (“ADTV”) of $1 million or more and a public float value of $150 million or more, the purchase may not be effected during the ten minutes before the scheduled close of the primary trading session in the principal market for the security and the ten minutes before the scheduled close of the primary trading session in the market where the purchase is effected. For this purpose, ADTV is the volume reported for the security during the four calendar weeks preceding the week in which the Rule 10b-18 purchase is to be effected, calculated using any reasonable and verifiable method, and public float value is the aggregate market value of common equity securities held by non-affiliates of the company. For all other securities, purchases may not be effected during the thirty minutes before the scheduled close of the primary trading session in the principal market for the security and the thirty minutes before the scheduled close of the primary trading session in the market where the purchase is effected.

A company’s stock repurchase may be effected following the close of the primary trading session in the principal market until the termination of the period in which the last sale prices are reported in the consolidated system if: (i) the purchase is effected at a price that does not exceed the lower of the closing price of the primary trading session in the principal market for the security, and any lower bids or sale prices subsequently reported in the consolidated system; (ii) all of the other Rule 10b-18 requirements are met; and (iii) the company’s purchase is not the opening transaction of the session following the close of the primary trading session.

During a market-wide trading suspension, the volume condition under Rule 10b-18 does not apply either (i) from the reopening of trading until the scheduled close of trading on the day that the market-wide trading suspension is imposed, or (ii) at the opening of trading on the next trading day until the scheduled close of trading on that day, if a market-wide trading suspension was in effect at the close of trading on the preceding day.

• Price condition: The purpose of the price condition is to prevent a company from propping up its stock price through its repurchases, or from supporting the price at a level that would not otherwise be maintained by independent market forces. During trading hours, if the security is reported in the consolidated system, displayed, and disseminated on any national securities exchange, or quoted on any inter-dealer quotation system that displays at least two price quotations for the security, company purchases must be made at a price not exceeding the highest independent bid or the last independent transaction price, whichever is higher. For all other securities, company purchases must be made at a price not exceeding the highest independent bid obtained from three independent dealers.

For after-hours trading, stock repurchase prices must not exceed the lower of the closing price of the primary trading session in the principal market for the security and any lower bids or sale prices subsequently reported in the consolidated system. The company is permitted to repurchase until the termination of the period in which last sale prices are reported in the consolidated system.

• Volume condition: The purpose of the volume condition is to prevent the company from dominating the market by purchasing a large amount of its common stock, relative to purchases in the independent market. A company’s and its affiliated purchasers’ purchases on any single day, including “block” transactions, may not exceed 25% of the ADTV in the preceding four weeks. “Block” transactions consist of trades (i) with a purchase price of $200,000 or more, (ii) with a volume of not less than 5,000 shares and a purchase price of not less than $50,000, or (iii) of at least 20 round lots of the security and totaling 150% or more of the trading volume for the security, but exclude any securities the company knows or has reason to know were accumulated by a broker-dealer, acting as a principal, for the purpose of resale to the company, or were sold short to the company or an affiliated purchaser. In the alternative, the company may make one “block” purchase per calendar week and not be subject to the 25% ADTV limit, provided the “block” purchase (a) is the only Rule 10b-18 purchase made on that same day, and (b) is not included when calculating a security’s four-week ADTV under Rule 10b-18.

Rule 10b-18’s volume calculation carries over from the regular trading session and continues to apply to after‑hours trading sessions on the same day.

Affiliated Purchasers

Under Rule 10b-18, an affiliated purchaser is: (i) a person acting, directly or indirectly, in concert with the company for the purpose of acquiring the company’s securities; or (ii) an “affiliate” who controls the company’s purchases or whose purchases are controlled by or under common control with the company. An “affiliate” is any person who controls, is controlled by, or is under common control with the company. However, the definition of affiliated purchaser does not include a broker or dealer (solely by reason of that broker effecting purchases on behalf of the company), or any officer or director of the company (solely by reason of that officer’s or director’s participation in the decision to authorize Rule 10b-18 purchases on behalf of the company). A financial institution with an affiliated broker-dealer may want to take special care in conducting this analysis.

All Rule 10b-18 purchases by an affiliated purchaser will be attributable to the company. As a result, if Rule 10b-18 purchases are effected by the company and one or more of its affiliated purchasers, or, by or on behalf of more than one affiliated purchasers, on a single day, then all such purchases must collectively comply with all of Rule 10b-18’s four conditions, including the requirement that all such parties use the same broker or dealer.

Interplay with Other Provisions of the Federal Securities Laws

Although Rule 10b-18 provides protection from certain market manipulation liability for stock purchases that comply with the rule, Rule 10b-18 does not provide a safe harbor from other types of liability, including anti-fraud liability under Section 10(b) of the Exchange Act or Rule 10b-5 thereunder. For example, Rule 10b-18 confers no immunity from possible liability under Rule 10b-5 if the company engages in repurchases while in possession of material non-public information (“MNPI”). Moreover, the safe harbor does not provide protection for purchases that, although made in technical compliance with the rule, are part of a plan or scheme to evade the federal securities laws.

Note that a company may exceed the limitations or otherwise not comply with the specific requirements of Rule 10b-18 and still not incur liability under the anti-manipulation provisions of Section 9(a)(2) or Rule 10b-5. However, there is greater uncertainty associated with purchase activities outside the “safe harbor” provided by Rule 10b-18 because of the lack of specific guidelines for such activities.

Rule 10b5-1 Plans and Stock Repurchases

A Rule 10b5-1 plan is a written plan for trading securities that is designed in accordance with Rule 10b5‑1(c) under the Exchange Act. While Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit the purchase or sale of a security on the basis of MNPI, any person or entity executing pre-planned transactions pursuant to a valid Rule 10b5-1 plan has an affirmative defense against accusations of insider trading. This is so even if actual trades made under the Rule 10b5-1 plan are executed at a time when the person or entity may be aware of MNPI. In the context of share buybacks, the affirmative defense of a Rule 10b5-1 plan is available if the company can demonstrate that the plan meets all the required elements, including:

• The plan was entered into in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5‐1;
• The plan was adopted at a time when the company was not aware of any MNPI;
• The terms of the plan specified the amount, pricing (such as trigger price if applicable), and date of the transaction(s) (or included a written formula, algorithm, or computer program for determining the amount, pricing, and date);
• The company trading under the plan did not exercise any subsequent influence over how, when, or whether to make purchases; and
• The purchase or sale was made pursuant to the plan.

If a company complies with the conditions of Rule 10b5-1(c), it can establish an affirmative defense against Rule 10b-5 liability in connection with its stock repurchase program. For a Rule 10b-18 stock repurchase program to meet the requirements of Rule 10b5-1(c), the program must contain one of the following elements: (a) it must specify the amount, price, and date of the transactions(s); (b) it must include a written formula, algorithm, or computer program for determining amounts, prices, and dates for the transaction(s); or (c) it must not permit the company to exercise any subsequent influence over how, when, or whether to make purchases (and any other person exercising such influence under the stock repurchase program must not be aware of MNPI when doing so). Furthermore, the repurchase program must be entered into in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5-1. The company should also implement reasonable policies and procedures to ensure that individuals making investment decisions on its behalf would not violate the laws prohibiting trading on the basis of MNPI.

Disclosure of Stock Repurchase Programs

While Rule 10b-18 does not specifically require a company to publicly disclose a stock repurchase program, the disclosure provisions of other federal securities laws, including Rule 10b-5, still apply. It is generally advisable, at a minimum, for a company to announce the existence of a significant stock repurchase program. However, an announcement should not be made unless the company actually intends to repurchase shares, because any termination of the repurchase program without purchases could be deemed manipulative in the absence of a sound business reason.

The specifics of the public announcement depend on the circumstances, but the company should generally include the following information in any public disclosures:

• The reason for the repurchase program;
• The approximate number or aggregate dollar amount of shares to be repurchased;
• The method of purchase to be used;
• Any significant corporate developments that have not been previously disclosed, including the adverse effects of COVID-19 on the company’s business;
• The impact of the repurchase program on the remaining outstanding shares;
• Any arrangement, contractual, or otherwise, with any person for the purchase of the shares;
• Whether the purchases are to be made subject to restrictions relating to volume, price, and timing in an effort to minimize the impact of the purchases on the market for the shares; and
• The duration of the program.

The company should also consider filing a Form 8-K with any press release as an exhibit for purposes of ensuring compliance with Regulation FD.

Public companies are also subject to public reporting obligations relating to stock repurchases in their periodic reports. In particular, Regulation S-K and Forms 10-Q, 10-K, and 20-F (applicable to foreign private issuers) require quarterly periodic disclosure for all repurchases of the company’s own equity securities. This disclosure is required regardless of whether the repurchase is effected under the safe harbor of Rule 10b-18.

In the event of any stock repurchase, a company must disclose in tabular form (i) the total number of shares, by month, repurchased by or on behalf of the company or any affiliated purchaser during the past fiscal quarter; (ii) the weighted average price paid per share; (iii) the number of shares that were purchased as part of a publicly announced repurchase plan or program; and (iv) the maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs. For publicly announced repurchase plans or programs, the company is also required to disclose (by footnotes to the table) (a) the announcement date of the plan or program; (b) the share or dollar amount approved; (c) the expiration date (if any) of the plans or programs; (d) each plan or program that has expired during the period covered by the table; and (e) each plan or program that the company has determined to terminate prior to expiration or under which the company does not intend to make further purchases.

Additionally, the company should consider discussing any repurchase program under the “Liquidity and Capital Resources” discussion of its “Management’s Discussion and Analysis of Financial Condition and Results of Operations” disclosures, as any stock repurchase program could be considered a “known trend” or “commitment” that is reasonably likely to result in a material change to the company’s liquidity. The company should also consider and discuss with its accountants whether disclosure of significant repurchases is required in its financial statements or notes to its financial statements.

Enhanced Criticism of Stock Repurchase Programs

In recent years, politicians, institutional investors, the media, academics, and governance experts have voiced sharp criticism of stock repurchase programs for a variety of reasons, and the criticism has become more heightened in light of the adverse economic impacts of COVID-19 and the federal government’s response to the crisis. Many critics of stock repurchase programs believe that that these programs (i) promote the use of capital for short-term purposes (i.e., near-term appreciation in a company’s stock price) to the detriment of long-term initiatives like research and development, capital expenditures, and other growth prospects, (ii) may benefit corporate insiders who sell their stock when share prices have appreciated after the announcement and implementation of a stock repurchase program, and (iii) allocate capital that could be used to benefit employees in the form of higher wages or enhanced benefits.

Largely in response to the significant criticism of stock repurchase programs from the Administration and lawmakers, the recently enacted CARES Act specifically addresses stock repurchase programs. The CARES Act provides the Treasury Secretary with discretion to make loans, loan guarantees, and other investments to eligible U.S. businesses under certain circumstances. Pursuant to Section 4003 of the CARES Act, the agreements governing loans, loan guarantees, and other investments to eligible businesses must include a prohibition, during the term of the loan, loan guarantee, or investment, and for twelve months after the loan or loan guarantee is no longer outstanding, on the company’s and any affiliate of the company’s ability to repurchase shares of its or any parent company’s equity securities that are listed on a national securities exchange, unless a contractual obligation to repurchase shares was in effect on the date of enactment of the CARES Act.

Parting Thoughts

The current COVID-19 pandemic has undoubtedly created opportunities for companies to repurchase stock at prices that were seemingly unimaginable prior to the outbreak. In periods when interest rates are low and a company has available cash, a company’s decision to engage in a stock repurchase program may be the most efficient allocation of capital in the absence of superior investment alternatives. Notwithstanding the potential benefits of stock repurchase programs, companies must continue to be mindful of the legal, regulatory, public perception, and other considerations discussed elsewhere in this client alert. The following are some best practices when considering whether, and how, to implement a stock repurchase program:

• Monitor Trading by Insiders: The company should consider monitoring purchases by executive officers, directors, and other insiders, to ensure compliance with the requirements of Rule 10b‑18 and the prohibitions on insider trading. The company should encourage its insiders not to go into the market to purchase or sell, on their own behalf, the company’s common stock during the course of any repurchase program, unless, before any such purchase or sale, they advise a designated officer and secure confirmation that such action will not violate any applicable securities or other laws or fiduciary obligations to the company or its stockholders.
• Be Thoughtful about Future Capital Requirements: In the current environment in which “cash is king,” the company must consider whether the allocation of capital to stock repurchases is in the best interests of the company and its stockholders under all of the circumstances. Boards of directors must ensure that they have sufficient information, including liquidity forecasts, which will allow them to make capital allocation decisions, especially in light of the potential for decreased access to the capital markets and a lack of availability of additional credit. This is particularly important for companies with debt maturities in the next 12 months, given the uncertainty of the availability of refinancing alternatives.
• Ensure the Accuracy and Sufficiency of Disclosures: Once a company implements a stock repurchase program, the company should be particularly mindful of making prompt and complete disclosure of all material information to the public that, if known, might reasonably be expected to influence the market price of the company’s stock. If a proposed repurchase happens to coincide with the announcement of material news about the company, the stock purchase program should be suspended until the information is adequately disseminated to the market. If a company has released earnings guidance, the company should also consider whether it is necessary or appropriate to address the impact of COVID-19 on previously issued guidance. A company should apply the same approach to disclosure decisions in connection with share repurchases as it would if it were selling securities in a registered offering.
• Be Mindful of Optics: In light of heightened scrutiny of stock repurchase programs, particularly during the COVID-19 pandemic, companies should consider how the announcement of a share repurchase program will be received by various constituencies, including employees, stockholders, creditors, the media, and government officials.
• Seek Guidance from Counsel: Given the requirements of federal and state law, limitations imposed under existing agreements to which the company is bound, and limitations included in many companies’ governing documents, a company seeking to establish or continue a stock repurchase program under the current market conditions should consider engaging outside counsel to assist in assessing the risks involved and determining the best path forward.

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