[co-author: Libby Brown¹]

On May 3, 2023, the Securities and Exchange Commission (the “SEC”) announced its adoption of amendments to the provisions of Item 703 of Regulation S-K (“Item 703”) related to the disclosure of an issuer’s repurchase of its shares (the “Amendments”).²

The SEC has long required disclosures regarding issuer share repurchases. In 2003, the SEC adopted Item 703 which requires issuers to disclose quarterly information regarding issuer buybacks on a monthly aggregated basis.³ These disclosures must be included in the issuer’s Form 10-Qs and Form 10-Ks in tabular form, and include the following information related to the buybacks (1) the total number of shares purchased, including a footnote disclosing the number of shares purchased other than through publicly announced plans or programs, along with the nature of such transaction, (2) the average price paid per share, (3) the number of shares purchased through publicly announced plans, and (4) the maximum amount (or dollar value) of shares the issuer is able to repurchase under their plans as of the end of the reporting period.

The Amendments will amend the current rules to require more detailed disclosure of share repurchase activity. First, the Amendments will require an issuer to disclose its buyback activity on a daily, rather than monthly, aggregate basis. These disclosures are to be filed with Form 10-Q or 10-K in tabular form, on the newly added Exhibit 26. In addition to the information already required under current law, described above, the issuer must also disclose (1) whether executive officers and directors engaged in any purchases or sales of the issuer’s securities in the four business days before or after the public announcement of any issuer repurchase plan, (2) the total number of shares purchased on the open market, (3) the total number of shares purchased that are intended to qualify for the Rule 10b-18 safe harbor, and (4) the total number of shares purchased under a plan intended to qualify for the Rule 10b5-1(c) affirmative defense.

Second, the Amendments require an issuer to disclose its reasons for the repurchases and the criteria used to determine the amount of shares to repurchase, as well as any policies or procedures related to the trading of the issuer’s stock by its officers and directors during the pendency of an issuer share repurchase plan or program.

Finally, the Amendments, pursuant to the adoption of new Item 408(d) of Regulation S-K (“Item 408(d)”), require an issuer to disclose on its Forms 10-Q and 10-K information related to the adoption and termination of any 10b5-1 plans of the issuer, including (1) whether the plan is intended to satisfy the Rule 10b5-1(c) affirmative defense, and (2) a description of the material terms (effective date, duration, aggregate securities to be sold) of the plan. In a departure from the Amendments as initially proposed, Item 408(d) will not require disclosure of information regarding the adoption or termination of trading plans that meet the criteria for a “non-Rule 10b5-1 trading arrangement” (as defined in Item 408(c) of Regulation S-K).

The Amendments follow a string of laws, regulations, and issued guidance regarding share repurchases. On August 16, 2022, the Inflation Reduction Act of 2022 (the “IRA”) was enacted,⁴ implementing a 1% excise tax on the fair market value of a public issuer’s aggregate share repurchases.⁵ Also, on December 14, 2022, the SEC adopted significant amendments to Rule 10b5-1 to strengthen the restrictions on insider trading plans, in efforts to curb perceived abusive practices occurring in connection with the adoption and operation of such plans.⁶

The Amendments are intended by the SEC to “increase the transparency and integrity” of share repurchases, which amounted to nearly $1.25 trillion in 2022.⁷ It is the SEC’s intent for investors to be able to better assess the efficiency, purpose, and impacts of an issuer’s buyback program through the more detailed information being disclosed. The detail of daily repurchase activity may reveal patterns or inferences, including whether the issuer’s repurchases may be motivated by factors other than long term value maximization (for example, hitting an earnings-per-share target) or whether the issuer’s use of cash aligns with investors’ goals.⁸

The SEC held multiple rounds of open periods for the public to submit comment letters to the Amendments when proposed, beginning on December 15, 2021. While some commenters questioned the SEC’s perception of abusive practices occurring in connection with share repurchases, the SEC responded that the potential for abuse and one-sided information may inhibit investors from wanting to trade, and thus the Amendments help to provide more comfort to investors in the face of the overall information asymmetries intrinsic in the trading of public securities.⁹

The Amendments are set to go into effect next month, on July 31, 2023. Any Form 10-Qs or 10-Ks covering a full fiscal quarter beginning on or after October 1, 2023 must include the new enhanced disclosures.

Board Diversity Initiatives Falter in the Courts but Investor Interest Is Likely to Remain Strong

Last year, Superior Courts in Los Angeles County invalidated two California statutes requiring specific diversity mandates for California public company boards (Senate Bill 826 “SB 826” and Assembly Bill 979 “AB 979”). The laws allocated a certain number of seats to female candidates and candidates from underrepresented communities. In two separate decisions, the trial courts held that the statutes violate the Equal Protection Clause of the California Constitution by requiring diversity-based “quotas.” While both cases are still on appeal, the Court of Appeals has left the trial courts’ orders in place, enjoining enforcement of either law.

AB 979 encountered another setback in federal court. On May 15, 2023, the United States District Court for the Eastern District of California held that AB 979 violated the Equal Protection Clause of the Fourteenth Amendment of the United States Constitution.¹⁰

Outside of California, a rule creating board diversity objectives for Nasdaq-listed companies faces similar constitutional challenges.¹¹

The Statutes

SB 826 mandates that public companies headquartered in California must include at least one individual on their board who self-identifies as female.¹²

AB 979 requires California public companies to have at least one board director from an “underrepresented community.”¹³ The statute defined “underrepresented communities” as “Black, African-American, Hispanic, Latino, Asian, Pacific Islander, Native American, Native Hawaiian, or Alaska Native” or “gay, lesbian, bisexual, or transgender.”

Both laws required a specified number of diverse directors, which varies depending on the size of the board. Companies that failed to satisfy the requirements of the statute could be fined as much as $300,000.

Our previous alerts discuss AB 979 and SB 826 in further detail.

The Nasdaq Rule

In 2021, the SEC approved a Nasdaq rule change designed to promote board diversity and to provide stakeholders with diversity-related information. This rule requires the boards of most companies listed on Nasdaq to have, or explain why they do not have, at least two diverse directors, including one female and one member of an “underrepresented minority” or who is LGBTQ+.¹⁴ “Underrepresented minority” is defined as “Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities.” More information about this Nasdaq rule can be found in our previous alert.

The Court Cases

The plaintiffs challenged the California statutes in the state court cases by arguing that California’s use of taxpayer funds to enforce diversity-based board quotas violated the Equal Protection Clause of the California Constitution. These suits, Crest v. Padilla (Padilla I) (attacking SB 826) and Crest v. Padilla (Padilla II) (attacking AB 979), are discussed in more detail in this alert.

Alliance for Fair Board Recruitment, the plaintiff in the federal case, challenged the validity of AB 979 under the United States Constitution. It argued that the law violated the Equal Protection Clause of the Fourteenth Amendment by requiring a minimum number of directors from a select racial and ethnic pool, which constituted a race-based “quota” and unlawfully created preferred classes based on diversity characteristics.

California countered that these racial classifications are permissible because the law aims to remedy past discrimination. California further asserted that the law did not create preferred classes as each candidate must go through an individualized consideration process and boards can expand to accommodate any number of directors who do not self-identify as diverse. The court, however, held that because the law requires “a certain fixed number of board positions to be reserved exclusively for certain minority groups,” which, in the court’s view, amounts to a racial quota, it is, therefore, facially unconstitutional.¹⁵

In August 2022, the Fifth Circuit heard oral arguments in the Alliance for Fair Board Recruitment’s challenge of the SEC’s approval of the Nasdaq board diversity rule. Plaintiffs alleged the Nasdaq rule violated the First and Fifth Amendments by encouraging discrimination against potential board members who do not identify as diverse. Plaintiffs’ arguments also included that the SEC lacked statutory authority to issue the order, which seeks to regulate demographics through the guise of “financial disclosures.”

The SEC and Nasdaq questioned whether constitutional scrutiny applies given that Nasdaq is a self-regulatory organization, not a state actor. The SEC contends that the rule withstands constitutional scrutiny because it does not require any particular board composition. Rather, a company that does not meet the specified diversity objectives need only provide investors an explanation of why it does not meet the stated objectives. The Fifth Circuit’s decision is pending.

Despite the recent court rulings, public and investor pressure to increase board diversity will likely remain for the foreseeable future. For example, Goldman Sachs stated it will only take a U.S. based company public if it has at least two diverse board members, including one woman.¹⁶ More impactfully, the “Big Three” institutional investors implemented proxy voting policies designed to foster increased board diversity. BlackRock believes boards should aspire to at least 30% diversity of membership, including at least two women directors and one director from an underrepresented community.¹⁷ State Street Global Advisors may vote against a nominating committee chair when a board does not meet State Street’s stated diversity objectives.¹⁸ And Vanguard will generally vote against a nominating committee if the board is making insufficient progress toward diversity Vanguard’s diversity objectives.¹⁹

Notes:

• ^[1] Snell & Wilmer 2023 summer associate Libby Brown provided material assistance in the production of this article. Libby Brown is not a licensed attorney.
• ^[2] U.S. Securities and Exchange Commission, SEC Adopts Amendments to Modernize Share Repurchase Disclosure, https://www.sec.gov/news/press-release/2023-85 (May 3, 2023).
• ^[3] U.S. Securities and Exchange Commission, Release No. 34-97424, Share Repurchase Disclosure Modernization (May 3, 2023).
• ^[4] Pub. L. 117-169, 136 Stat. 1818 (2022).
• ^[5] The SEC, in evaluating the Amendments, determined that the excise tax under the IRA was not likely to have significant impact on the Amendments.
• ^[6] U.S. Securities and Exchange Commission, Release No. 33-11138, Insider Trading Arrangements and Related Disclosures (December 14, 2022). [back]
• ^[7] Supra Note 1.
• ^[8] Supra Note 1 at 14-15.
• ^[9] Supra Note 1 at 24.
• ^[10] Alliance for Fair Board Recruitment v. Weber, No. 2:21-cv-01951-JAM-AC, 2023 WL 3481146 (E.D. Cal. May 15, 2023).
• ^[11] Alliance for Fair Board Recruitment v. SEC, No. 21-60626 (5th Cir. filed Aug. 10, 2021).
• ^[12] Cal. Corp. Code § 301.3.
• ^[13] Cal. Corp. Code § 301.4.
• ^[14] Nasdaq Rule 5605(f).
• ^[15] Alliance for Fair Board Recruitment v. Weber, No. 2:21-cv-01951-JAM-AC, 2023 WL 3481146 at *2 (E.D. Cal. May 15, 2023).
• ^[16] Goldman Sachs, Corporate Board Engagement, https://www.goldmansachs.com/our-commitments/diversity-and-inclusion/board-diversity/2022-update/index.html (last accessed June 14, 2023).
• ^[17] BlackRock, BlackRock Investment Stewardship 8-9 (Jan. 2023) https://www.blackrock.com/corporate/literature/fact-sheet/blk-responsible-investment-guidelines-us.pdf.
• ^[18] State Street Global Advisors, Proxy Voting and Engagement Guidelines 5 (Mar. 2023), https://www.ssga.com/library-content/pdfs/asr-library/proxy-voting-and-engagement-guidelines-us-canada.pdf.
• ^[19] Vanguard, Proxy voting policy for U.S. portfolio companies 7 (effective Feb. 1, 2023) https://corporate.vanguard.com/content/dam/corp/advocate/investment-stewardship/pdf/policies-and-reports/us_proxy_voting_2023.pdf.