Key Takeaways

• A federal appeals court reviewed enhanced share repurchase disclosure requirements adopted by the SEC in May 2023 and determined that they were “arbitrary and capricious,” in violation of the Administrative Procedure Act. The court has given the SEC 30 days to address deficiencies in the amendments implementing the disclosure requirements, after which time the amendments will either survive or be invalidated.
• The court’s ultimate decision with respect to the amendments will affect the disclosures required in issuers’ Forms 10-K and 10-Q covering the first fiscal period beginning after Oct. 1, 2023. For a calendar year issuer, this means its Form 10-K for the period ended Dec. 31, 2023.
• Although the amendments may potentially be invalidated, issuers, for now, should operate under the assumption that the amendments will survive and should continue to collect the information they may need to satisfy the enhanced disclosure requirements regarding share repurchases.

Introduction

A federal appeals court has directed the Securities and Exchange Commission (SEC) to rework certain regulatory amendments, adopted in May 2023, requiring public companies to provide enhanced disclosures on repurchases of their shares. The amendments, which are otherwise scheduled to become effective for calendar year issuers with respect to their filings on Form 10-K for the period ended Dec. 31, 2023, now hang in the balance, pending the court’s further review, and are potentially subject to invalidation.

Background

The amendments represent an attempt by the SEC to address an information imbalance between issuers and investors that may affect investors’ investment decisions. The imbalance arises because there are different reasons for why an issuer may initiate a share repurchase. An issuer may repurchase its stock because it believes the stock is undervalued, in which case the buyback would signal that the shares are an attractive investment; however, stock buybacks may also be motivated by purposes unrelated to the stock’s value, including an issuer’s desire to achieve certain accounting metrics or to trigger additional executive compensation, where receipt of such compensation is contingent on the issuer’s share price or earnings per share. Without knowing the actual reason for an issuer’s stock buyback, investors are left to make inferences from a buyback about an issuer’s beliefs about its stock value, which inferences may or may not turn into faulty premises for their investment decisions relating to the stock.

To remedy this information imbalance, the SEC promulgated amendments requiring issuers to do the following, among other things:

• Disclose daily quantitative repurchase data on a quarterly basis in their Forms 10-Q and 10-K (for an issuer’s fourth fiscal quarter).
• In the same filings, disclose the objectives or rationales for their share repurchases.

(See our prior client alert, linked here, for a full discussion of the rules.)

Determination that Amendments Are “Arbitrary and Capricious,” Subject to Invalidation

The amendments were challenged swiftly after their adoption in a lawsuit filed by the U.S. Chamber of Commerce and two other petitioners, and, on Oct. 31, 2023, the U.S. Court of Appeals for the Fifth Circuit agreed with certain arguments by petitioners that the amendments were “arbitrary and capricious” and therefore in violation of the Administrative Procedure Act and subject to invalidation.

In reaching its conclusion, the court laid out a fairly incisive critique of the reasoning the SEC employed in its adoption of the amendments. First, the court found that the SEC had failed to adequately substantiate the amendments’ costs and benefits. It said that the SEC had not established its threshold proposition that opportunistic or improperly motivated stock buybacks are “genuine problems” for investors; therefore, the primary benefit of the amendments was not proven and none of the costs justified. To this point, the court elaborated, “Almost every part of the SEC’s justification and explanation of the rule reflects the agency’s concern about opportunistic or improperly motivated buybacks. That error permeates—and therefore infects—the entire rule.”

Second, the court determined that the SEC made a critical error in not considering significant comments submitted by petitioners during the amendments’ comment period. For context, the SEC’s position when it submitted the proposed amendments for public comment was that the economic effects of the amendments were largely unquantifiable. The SEC asked the public to provide data that would assist in the conduct of a quantitative analysis, and, in response, petitioners pointed to several data sources, including on key topics like the prevalence of opportunistic buybacks and the potential effect of enhanced regulation on issuers’ behavior. Yet, when it adopted the amendments, the SEC maintained that a quantitative analysis of the impact of the amendments was not possible. The court determined that this position was not supportable in light of petitioners’ comments. Further, it found that, in failing to consider such comments, the SEC “failed to demonstrate that its conclusion that the proposed rule ‘promote[s] efficiency, competition, and capital formation’ is the ‘product of reasoned decision-making.’”

On the basis of the foregoing, the court determined that the amendments were arbitrary and capricious and, therefore, in violation of the Administrative Procedure Act. However, rather than invalidating the amendments immediately, the court remanded them for 30 days, giving the SEC a limited opportunity, until Nov. 30, 2023, to correct the noted deficiencies. Indeed, the court noted that there is “at least a serious possibility” that the SEC will be able to do so, in which case the amendments would survive and become effective as originally intended.

Conclusion

Issuers will want to keep track of the outcome of the court’s decision in this case, as it will have implications for their disclosure obligations in their upcoming securities filings. For most issuers, the enhanced disclosure requirements become effective beginning with the first filing that covers the first full fiscal quarter that begins on or after Oct. 1, 2023. For calendar year issuers, this means that the requirements will be effective for the purposes of their Forms 10-K for the year ending Dec. 31, 2023. In the meantime, issuers should, as a precaution, operate under the assumption that the amendments will survive and should continue to collect the information they may need to satisfy the enhanced share repurchase disclosure requirements.

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