Almost 20 organizations, including the AFL-CIO and nonprofit consumer advocacy group Public Citizen, have 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 seeks to repeal Rule 10b-18 and requests 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.” In light of the almost—dare I say it—“bipartisan” interest in reviewing the practice of stock buybacks, will the SEC decide that it’s worth taking a look?
As you know, Rule 10b-18 provides a “safe harbor” from liability for “manipulation” under the Exchange Act where a company conducts a stock repurchase program in conformity with the Rule’s volume, manner, price and timing conditions. As described in the petition, the SEC intended the Rule to be “a scheme of regulation that limits the ability of an issuer *** to control the price of the issuer’s securities.” The petition characterizes the impact of adoption of the Rule in 1982 as giving rise to “a sea change in corporate finance, after which stock repurchases became more common. Prior to its adoption, repurchase programs were relatively rare due to the threat of a manipulation charge; after the Rule took effect, the aggregate value of stock repurchases rose significantly.”
And, after the enactment of the recent Tax Cuts and Jobs Act, the use of buybacks “skyrocketed”: according to the petition, in 2018, “the first full year after the tax cut, repurchases surged 64 percent over the previous year and topped $1 trillion overall. Yet real wages for typical workers remained flat.” Although the tax bill “provided significant tax benefits to large corporations, such as a lower corporate tax rate and an incentive to repatriate offshore cash,” instead of raising wages, as was widely touted by those promoting the bill, companies “raced to repurchase their own stock[, leading] to a 64 percent increase in stock repurchases while real wages for workers remained flat. Indeed, analysts estimate that in 2018 corporations used nearly 60 percent of their corporate tax cut to repurchase stock. In other words, at a time when wages for average workers have failed to keep up with inflation, corporations have used the corporate tax break to collectively pay $1 trillion to executives, boards of directors, and large share sellers. Instead firms could dedicate this capital to worker wages, training, hiring, and other investments necessary for innovation and growth.”
What’s more, the petition argues, the conditions of the Rule have failed to achieve their essential purpose of limiting the ability of a company to manipulate its stock price and volume: the Rule has “failed to prevent executives from using repurchases to boost a company’s stock price or meet other performance goals at the expense of investing in its workers. And the inadequate disclosure requirement in Rule 10b-18 frustrates oversight by investors and the Commission.” Because stock repurchase programs tend to pump up stock prices, the petition contends, executives have a “strong financial incentive …to use these effects of repurchases to increase their own compensation.” The impact is compounded by the recent trend to award executive compensation that is “performance-based, tied to stock price or earnings per share…. Repurchase programs offer a direct lever to achieve those [performance] goals. Indeed, empirical analysis of firm behavior has revealed that the likelihood of repurchases is higher at firms that would have just missed analyst earnings expectations without the effect of the repurchase. This strongly suggests that firm executives rely on repurchases to meet earnings targets and thus increase their own performance-based compensation.” But nowhere does Rule 10b-18 address this issue, the petition claims.
In addition, the petition contends, the lack of effective disclosures obscures whether repurchase programs conform with the conditions of the Rule 10b-18 safe harbor. Firms disclose quarterly information about repurchase programs, but only after the fact and tabulated by month.
The petition also points to the study by 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.”
The petition follows calls by a number of politicians for legislation revisiting the buyback rules. At the beginning of February, in an NYT Op-Ed, Senators Chuck Schumer and Bernie Sanders wrote that the “pervasive corporate ethos” of shareholder preeminence—again, the idea that the duty of management and the board should be to maximize shareholder value (see this PubCo post)—has obsessed corporate boardrooms “to the detriment of workers and the long-term strength of their companies, helping to create the worst level of income inequality in decades. One way in which this pervasive corporate ethos manifests itself is the explosion of stock buybacks. So focused on shareholder value, companies, rather than investing in ways to make their businesses more resilient or their workers more productive, have been dedicating ever larger shares of their profits to dividends and corporate share repurchases.”
The problem, as they describe it, is both that buybacks benefit only a small percentage of the population and that, “when corporations direct resources to buy back shares on this scale, they restrain their capacity to reinvest profits more meaningfully in the company in terms of R&D, equipment, higher wages, paid medical leave, retirement benefits and worker retraining. It’s no coincidence that at the same time that corporate stock buybacks and dividends have reached record highs, the median wages of average workers have remained relatively stagnant.” Americans, they suggest,” should be outraged….”
Central to the Schumer-Sanders Op-Ed was the undertaking “to introduce bold legislation to address this crisis. Our bill will prohibit a corporation from buying back its own stock unless it invests in workers and communities first, including things like paying all workers at least $15 an hour, providing seven days of paid sick leave, and offering decent pensions and more reliable health benefits. In other words, our legislation would set minimum requirements for corporate investment in workers and the long-term strength of the company as a precondition for a corporation entering into a share buyback plan. The goal is to curtail the over-reliance on buybacks while also incentivizing the productive investment of corporate capital.”
Shortly thereafter, Republican Senator Marco Rubio released a proposal to “curb incentives for companies to use excess capital to buy back shares,” which would have taxed buybacks like dividends and allowed companies to immediately write off capex and R&D expenses.
Similarly, in this 2018 letter to SEC Chair Jay Clayton, 21 senators requested, in light of the accelerating pace of stock buybacks, that he look into how companies and executives are using the buyback process and solicit public comment regarding the buyback rules. The letter indicates that both Commissioner Peirce and the Chair himself had previously indicated support for a review of Rule 10b-18. During her confirmation process, Peirce indicated that, in her view, “a review of Rule 10b-18 would be ‘timely’ given the increase in buyback activity, adding ‘I look forward to working with my fellow Commissioners and the SEC staff to look at the evidence about how and why buybacks are occurring and assess whether, in light of this evidence, changes to the regulatory framework are needed.’ Similarly, at a Senate Banking Committee hearing last year [Clayton] noted, ‘one thing that does trouble me is if these stock buybacks are motivated not by the long-term interest of the company but some short-term interest.’”
To make that case (and just in time for the upcoming Corp Fin roundtable on short-termism—see this Pubco post), the petition presents the buyback issue as squarely within the ambit of short-termism: large repurchase programs further the trend of favoring short-term returns over strategic re-investment for the long term, “as firms suppress wages even for educated and experienced workers to shift capital to short-term shareholders. Long-term shareholders, alternatively, may lose out as firms fail to make strategic long-term re-investments to improve their market position in the future.”
More specifically, the petition requests:
- Repeal of 10b-18 with the aim of “keeping firms subject to the deterrent effect of market manipulation charges for abusing repurchase programs.”
- Development of “a more comprehensive framework for regulating stock repurchase programs that would deter manipulation and protect American workers.” Here the petition looks to SEC proposals from the 1970s that “would have placed conditions ‘designed to ensure that an issuer neither leads nor dominates the trading market in its securities’ on repurchase programs,” including:
- “Limiting repurchases to 15 percent of the average daily trading volume for that security.“Creating a narrower safe harbor and allowing repurchases that fall outside this safe harbor to be reviewed and approved on an individualized, case-by-case basis.
- “Providing that repurchases inconsistent with the safe harbor are expressly ‘unlawful as fraudulent, deceptive, or manipulative.’
- “Requiring various disclosures, including whether any officer or director is purchasing or disposing of the issuer’s securities, the source of funds to be used to effect the repurchases, the impact of the repurchases on the value of the remaining outstanding securities,and specific disclosures for large repurchases.”
In addition, the petition recommends that the SEC look to the rules of other countries that “require immediate disclosure, have bright-line trading limits, require shareholder rather than board approval, and prohibit executive trading during repurchase program periods.”