May 13, 2024

Bring back the buyback rule?

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According to Bloomberg, there’s now a bipartisan push to re-propose the SEC’s stock buyback rule. As you may remember, the SEC’s Share Repurchase Disclosure Modernization rule, adopted in 2023, required quarterly reporting of detailed quantitative information on daily repurchase activity, filed as an exhibit to the issuer’s periodic reports. But, last year, the Chamber of Commerce petitioned the Fifth Circuit for review of the rule, and, in Chamber of Commerce of the USA v. SEC, the court granted the petition, holding that the “SEC acted arbitrarily and capriciously, in violation of the APA, when it failed to respond to petitioners’ comments and failed to conduct a proper cost-benefit analysis.” However, recognizing that there was “at least a serious possibility that the agency will be able to substantiate its decision given an opportunity to do so,” the court decided that, instead of vacating the rule, it would allow the SEC 30 days “to remedy the deficiencies in the rule,” and remanded the matter with directions to the SEC to correct the defects in the rule. But the SEC was unable to correct the defects on a timely basis, and the court vacated the rule. (See this PubCo post.) Now, Senators Marco Rubio and Tammy Baldwin have submitted a letter to the SEC urging the SEC “to promptly re-propose the rule.”

Under current rules adopted in 2003, a company is required to disclose in its periodic reports, under Reg S-K Item 703, information about share repurchases made by or on behalf of the company, or any affiliated purchaser, whether open market or private transactions. The current rules require companies to disclose, by month, the total number of shares repurchased during the period, the average price paid per share, the total number of shares purchased under a publicly announced repurchase plan or program and the maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs. The rules also require footnote disclosure of the principal terms of all publicly announced repurchase plans or programs, the number of shares purchased other than through a publicly announced plan or program, and the nature of the transaction.

However, the SEC believed that those rules provided investors with “insufficient insight into the efficiency, purposes, and impacts of an issuer’s share repurchases” to enable investors to “separate out and assess the different motivations and impacts of share repurchases” and to properly “value a company or identify when an issuer’s use of cash is well-managed, reducing investor confidence and market liquidity.” Accordingly, the SEC adopted new rules that would have required companies to file quarterly, in tabular format, exhibits to their Forms 10-Q and 10-K disclosing, for the period covered by the report (or the fourth quarter, for a Form 10-K), the total purchases made each day by or on behalf of the company or any “affiliated purchaser,” the average price paid per share, the maximum number (or approximate dollar value) of shares that may yet be purchased under a publicly announced plan, and other detailed quantitative information. In addition, the rules would have required companies to provide narrative disclosure regarding the objectives or rationales for each repurchase plan, the criteria used to determine the amount of repurchases, and any policies and procedures relating to purchases and sales of securities by officers and directors during a repurchase program, including any restriction on that type of transaction. (See this PubCo post.)

In its challenge to the rules, the Chamber successfully claimed that the SEC violated the APA by acting arbitrarily and capriciously “when it failed to (1) quantitatively analyze the economic implications of its proposed rule whenever feasible, (2) respond to petitioners’ comments about the agency’s economic implications analysis adequately, and (3) substantiate the proposed rule’s benefits adequately.” The court concluded that the “SEC—by continuing to insist that the rule’s economic effects are unquantifiable in spite of petitioners’ suggestions to the contrary—has failed to demonstrate that its conclusion that the proposed rule ‘promote[s] efficiency, competition, and capital formation’ is ‘the product of reasoned decision-making.’” Among other things, the court determined that the SEC failed to adequately substantiate the rule’s benefits and costs. While the rule’s benefits were more than “hypothetical,” they were not adequately substantiated under the APA’s arbitrary and capricious standard. What’s more, the Chamber claimed that the SEC never substantiated the underlying contention that improperly motivated buybacks were actually a problem. And the court agreed, concluding that the SEC must “show that opportunistic or improperly motivated buybacks are a genuine problem.” As noted above, the SEC did not timely correct the defects identified by the court, and the court vacated the rule. As a result, the buyback rules reverted to their status prior to the 2023 amendments. (For more on the court’s analysis, see this PubCo post.)

In their letter, the two Senators referred to their role as legislative sponsors of action by Congress directing the SEC staff “to study the recent growth of negative net equity issuances with respect to non-financial issuers, including the history and effects of those issuers repurchasing their own securities, and the effects of those repurchases on investment, corporate leverage, and economic growth.” As described by the Senators, the resulting report found that ”share repurchases have risen to eclipse total capital raised by public companies, and coincided with a period of relative decline in investment in tangible assets. This is an inversion of the conventional role that Congress and the public have long expected securities markets to perform.”

SideBar

A common rationale for conducting a stock buyback is that the shares are undervalued—thus signaling optimism about the company’s future. In addition, buybacks are often viewed as a useful way to provide shareholders with a cash distribution or to offset dilution. Some folks, however, perceive more manipulative motives. For example, the author of this study contended that, in some cases, the real motivation may be more opportunistic—managing EPS and increasing executive compensation, regardless of the operational success of the company, where EPS is a performance measure. (See this PubCo post.) And, back in 2019, almost 20 organizations, including the AFL-CIO and nonprofit consumer advocacy group Public Citizen, filed a rulemaking petition with SEC “to revise Rule 10b-18 to curb manipulative practices by firms and encourage corporations to fairly compensate American workers.” In essence, the petition sought to repeal the 10b-18 safe harbor to conduct stock buybacks and requested that the SEC “undertake a rulemaking to develop a more comprehensive framework for regulating stock repurchase programs that would deter manipulation and protect American workers.” The petition also pointed to the study by former SEC Commissioner Robert Jackson showing that executives often time the sale of their shares to benefit from the price increase created by stock repurchases and their announcement. The research revealed that, “[d]uring each of the eight days following an announcement, executives are twice as likely to sell shares as any other day and sell on average five times the volume of stock. As executives are not required to disclose their trading intentions to shareholders in advance of a repurchase program, shareholders are less able to scrutinize repurchase programs for conflicts of interest.” (See this PubCo post, this PubCo post and this PubCo post.)

Interestingly, the report to Congress sponsored by the two Senators concluded that

“[t]here are several possible reasons why firms conduct repurchases, only some of which are consistent with efficient investment. Three facts suggest that the theories inconsistent with firm value maximization cannot account for the majority of repurchase activity. First, repurchase announcements are accompanied by stock price increases. This announcement effect does not dissipate over time, as one would expect if repurchases were based on efforts to manipulate share prices. Second, most of the money spent on repurchases over the past two years was at companies that either do not link managerial compensation to EPS-based performance targets or whose boards considered the impact of repurchases when determining whether EPS-based performance targets were met or in setting the targets, suggesting that other rationales motivated the repurchases. Third, option-based managerial compensation cannot account for the increased substitution from dividends to repurchases, since option pay has declined over the past 20 years. Collectively, these findings potentially suggest that most repurchase activity does not represent an effort to artificially inflate stock prices or influence the value of option-based or EPS-linked compensation.”

Senators Rubio and Baldwin said that, as sponsors, they “were pleased to see the Commission exercising its authority in this area,” and that they expected “data provided by issuers from the required disclosures in the rule will provide additional insights to Congress about the appropriate role of buybacks in capital formation.” According to the two Senators, a “review of the comments submitted to the proposed rule reveals the various reasons that investors believe an issuer could be repurchasing its shares. Regardless of the reason—enhanced disclosure proposed by the final rule would have benefited all investors by improving price discovery. For this reason, we urge you to promptly re-propose the rule.”

So far, the SEC has not given any indication of its intentions on a re-proposal. The question remains as to whether the letter from these two Senators—in the absence of legislation—will pressure the SEC to revive the proposal.

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