At an open meeting yesterday, the SEC voted to propose new rules addressing trading in the market by insiders and companies. The commissioners voted—unanimously—to propose new rules regarding Rule 10b5-1 plans and voted three to two to propose new rules regarding issuer stock repurchases. The proposal to add new conditions to use of the Rule 10b5-1 affirmative defense and new disclosure requirements for 10b5-1 plans has long been anticipated. After all, these plans were one of the first rulemaking targets that SEC Chair Gary Gensler identified after he was sworn in as Chair: 10b5-1 plans, he said back in June, “have led to real cracks in our insider trading regime” and called for a proposal to “freshen up” these rules. (See this PubCo post.) Yesterday, Gensler again highlighted concerns about “gaps in Rule 10b5-1—gaps that today’s proposals would help fill.” What wasn’t anticipated was that the vote to issue the proposal would be unanimous! (Remember, though, even former SEC Chair Jay Clayton had discussed the need for “good corporate hygiene” in connection with Rule 10b5-1 plans. See this PubCo post.) But how likely is it that this newfound spirit of unanimity will carry forward to adoption? Time will tell. But do the statements on the proposal, discussed below, of Commissioners Hester Peirce and Elad Roisman already give us a preview of issues they might raise in possible future dissents on adoption of the rulemaking? The second proposal, stock buyback disclosure, is designed to enhance transparency around stock repurchases, including by requiring daily reports of stock repurchases on a new Form SR and expanding the disclosure required regarding repurchases in periodic reports, including a requirement for use of Inline XBRL. According to Gensler, “[s]hare buybacks have become a significant component of how public issuers return capital to shareholders….I think we can lessen the information asymmetries between issuers and investors through enhanced timeliness and granularity of disclosures that today’s proposal would provide.” Both Peirce and Roisman seemed to view the proposal as a rulemaking without much of a reason. There is a 45-day comment period after publication in the Federal Register for both of these proposals, a time period that Roisman (perhaps taking a cue from Peirce) found to be of insufficient duration.
Here are the rule proposals regarding 10b5-1 plans and stock repurchases. along with the press releases, here and here, and fact sheets, here and here. I plan to publish updates to this post with more detail about the proposed rules at a later time, so stay tuned.
Proposal Regarding Rule 10b5-1 Plans
Concerns have long been expressed that 10b5-1 plans provide a vehicle that allows insiders to opportunistically trade on the basis of material non-public information. Issues have also been raised about “spring-loaded” awards to executives, that is, awards made in coordination with the release of MNPI (see this PubCo post), as well as the timing of executive gifts of shares. The proposal is designed to address these concerns by adding conditions to Rule 10b5-1 that would fill “critical gaps in the SEC’s insider trading regime” and enhancing disclosure requirements “to help shareholders understand when and how insiders are trading in securities” when “they may at times have material nonpublic information.”
The proposal. The proposed amendments would add several new conditions to the availability of the Rule 10b5-1(c)(1) affirmative defense:
- Officers and directors must include a 120-day cooling-off period after adoption of the plan before any trading can commence, including adoption of a modified trading arrangement;
- Issuers must include a 30-day cooling-off period after adoption of the plan before any trading can commence, including adoption of a modified trading arrangement;
- Officers and directors must certify that they are adopting the plan in good faith and that they are not aware of MNPI about the company or the security when adopting a new or modified trading arrangement;
- Multiple overlapping Rule 10b5-1 trading arrangements for open market trades in the same class of securities are not permitted;
- Only one 10b5-1 trading arrangement to execute a single trade is permitted in any 12-month period; and
- Rule 10b5-1 trading arrangements must be entered into and operated in good faith.
The proposal would also require enhanced disclosure regarding Rule 10b5-1 plans, option grants and issuer insider trading policies and procedures:
- Disclosure by companies in their annual reports of whether or not (and if not, why not) they have adopted insider trading policies and procedures, including disclosure of those insider trading policies and procedures, if adopted;
- Disclosure by companies in their annual reports of their option grant policies and practices, including tabular disclosure of grants made within 14 days before or after the release of MNPI and the market price of the underlying securities on the trading day before and after the release of that information;
- Disclosure by companies in their quarterly reports of the adoption and termination of Rule 10b5‑1 trading arrangements and other trading arrangements by directors, officers and issuers, and the terms of these arrangements; and
- A requirement that Section 16 officers and directors disclose, by checking a box on Forms 4 and 5, whether a reported transaction was made pursuant to a 10b5-1(c) trading arrangement.
The proposed amendments would also require Section 16 insiders to disclose promptly on Form 4 bona fide gifts of securities.
At the open meeting. Peirce began her statement by saying that, given her many dissents and policy disagreements with the Chair, she felt much like the Grinch at Christmas. (Gensler responded that he did not think of her that way; he thought of her as a colleague and friend, to which she replied, “just wait.”) However, on this proposal, thanks to the great collaboration among commissioners and staffs, she was actually going to support the proposal. She believed that the proposed changes regarding insider cooling-off periods and overlapping plans were reasonable and that the limitation on single-trade plans was narrowly tailored. Not that she didn’t have some concerns—here providing us perhaps with a trailer of coming attractions. She viewed the certification requirement and the need to retain it for 10 years as burdensome. In addition, the release provides that the certification will not be considered an independent basis for liability, but why was that language not included in the text of the proposed rule? Might the proposed condition that the plan be “operated” in good faith lead directors and officers “to consider their Rule 10b5-1 plans in connection with corporate actions long after establishing their plans. The general idea behind a Rule 10b5-1 plan is for the director or officer to ‘set it and forget it’ to ensure that she is not trading on the basis of material nonpublic information. Are we inadvertently rendering the safe harbor a ‘sort-of safe harbor’ by making its availability contingent on ongoing good faith to be judged in hindsight?” She also questioned whether the disclosure requirements related to insider trading policies and procedures were necessary and whether the proposed disclosure requirements relating to spring-loaded options would discourage the use of equity-based compensation. (With regard to both proposals, she declared that she does not support “the indirect regulation of corporate activity through our disclosure rules.”)
Roisman also had “mixed feelings” about the proposal, approving of the cooling-off period for insiders (not companies) and gift reporting, but not much else. Really, is all the rest of this even necessary? In his view, the 120-day cooling-off period will “do almost all the work.” To say that he has “reservations about other aspects of the proposal is an understatement,” he said. Roisman expressed a fundamental concern about the rulemaking process for both proposals on the agenda: in his view, this proposal is premised on the justification that “10b5-1 plans and buybacks are being used hand-in-glove by executives to artificially inflate their companies’ share prices to benefit themselves and facilitate insider trading. Underpinning this justification are assumptions that existing rules may not adequately enable us to prosecute illegal insider trading and that 10b5-1 plans are facilitating this evasion. I have not seen evidence to support this conclusion or these underlying assumptions.” In addition, he thought that the overlap with the proposal regarding company stock buybacks “muddies the waters” about the impact of the two proposals and how they would operate together. This proposal involves real costs, but he could see few benefits. He noted that much of the comp provided to executives is in equity, and they need to be able to access their wealth. He favored the 120-day cooling-off period for insiders as a reasonable period in that MNPI would likely be stale in that time period. For companies, however, their knowledge of MNPI “should be easier to ascertain,” the cooling-off requirement would be too burdensome and would make consideration of timing, prices and amounts in repurchase programs more uncertain. In sum, it was not the rule he would have written. He also took up cudgel that Peirce previously raised about the unusual brevity of the 45-day comment period, especially in light of the timing over the holidays.
In her statement, Commissioner Lee expressed her concern that 10b5-1 plans can be used to enable rather than avoid insider trading. The SEC rule, she said, “should offer a safe harbor, not a pirates’ cove.” She contended that “prophylactic measures designed to prevent the misconduct (rather than punish it after the fact) are vital. Because if companies and corporate insiders profit by trading on information that is available only to them, they not only disadvantage other shareholders, but also erode investor confidence and thereby undermine the integrity of our markets. So today’s proposal seeks to ensure our rules are operating as intended to prevent, rather than shield, trading on inside information and bolster investor confidence in our markets.” After two decades of experience with Rule 10b5-1, she observed, these plans have proliferated and, notwithstanding the absence of disclosure requirements, many commentators have observed the “potential for abuse,” and academic studies “have produced compelling findings that suggest opportunistic use of 10b5-1 plans.” Accordingly, she was pleased with the proposal. In her view, the “proposal seeks to curb potential abuses of our rules and enhance transparency for investors, while not unduly restricting issuer and individual trading in a company’s securities for foreseeable, appropriate purposes.”
In her statement, Commissioner Caroline Crenshaw asserted that “[e]xperience and academic research [support] the need for changes.” For example, she noted that “recent academic work shows a concentration of loss avoiding trades by corporate executives made using single trade plans adopted within 60 days of an earnings announcement. Today’s proposal may reduce the prevalence of such trades by imposing important additional requirements and restrictions.” In addition, the proposed disclosure requirements would empower “corporate boards and shareholders, who have an incentive to scrutinize trades and plan cancellations that occur near in time to the release of news that moves the share price.” However, she questioned “whether some changes, particularly those impacting single trade plans, go far enough or will be as effective as other available alternatives.”
Gensler believed that the proposed amendments “would help close potential gaps in our insider trading regime.” The cooling-off periods would “more distinctly separate establishing a trading plan from the actual trades.” In addition, the prohibition of overlapping plans and limitation on single-trade plans would help eliminate the ability of insiders to “seek to pick amongst favorable plans as they please.” He also noted that “charitable gifts of securities are subject to insider trading laws,” and he was pleased about the “improved visibility that this proposal would provide into those gifts (via Form 4).” These issues, he said, “speak to the confidence that investors have in the markets. Anytime we can increase investor confidence in the markets, that’s a good thing. It helps investors deciding where to put their money. It lowers the cost of capital for businesses seeking to raise capital, grow, and innovate, and thus facilitates capital formation.”
Proposal Regarding Stock Repurchase Disclosure Rules
The amount that companies have spent on stock repurchases has generally increased substantially over the years—in 2020, some of the commissioners note, companies spent almost $700 billion to repurchase their own shares. These repurchases can impact the market, and questions have been raised as to the adequacy of buyback disclosure. The proposal is intended to modernize and improve that disclosure, taking into consideration the academic literature and the SEC’s own analysis, according to Corp Fin Director Renee Jones.
Under current rules adopted in 2003, a company is required to disclose in its periodic reports information about purchases made by or on behalf of the company, or any affiliated purchaser, of shares or other units of any class of the company’s equity securities registered under Section 12 of the Exchange Act, 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.
The proposal. The proposal is focused on disclosure, requiring more detailed and more frequent and timely disclosure about stock buybacks.
The proposed rules would create a new Form SR for next-day repurchase reporting. Under the proposal, a company (including a foreign private issuer and certain registered closed-end funds) would be required to report, on new Form SR, using Inline XBRL, any purchase made by or on behalf of the company (or any affiliated purchaser) of shares or other units of any class of the company’s equity securities registered under Section 12 of the Exchange Act, before the end of the first business day following the day of a repurchase. Form SR would require the following disclosure in tabular format:
“• Date of the repurchase;
• Identification of the class of securities purchased;
• The total number of shares (or units) purchased, including all issuer repurchases whether or not made pursuant to publicly announced plans or programs;
• The average price paid per share (or unit);
• The aggregate total number of shares (or units) purchased on the open market;
• The aggregate total number of shares (or units) purchased in reliance on the safe harbor in Exchange Act Rule 10b-18; and
• The aggregate total number of shares (or units) purchased pursuant to a plan intended to satisfy the affirmative defense conditions of Exchange Act Rule 10b5- 1(c).”
The proposal would also amend S-K Item 703 to require the company to disclose the following:
“• The objective or rationale for its share repurchases and process or criteria used to determine the amount of repurchases;
• Any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions;
• Whether repurchases were made pursuant to a plan that is intended to satisfy the affirmative defense conditions of Exchange Act Rule 10b5-1(c), and if so, the date that the plan was adopted or terminated; and
• Whether repurchases were made in reliance on the Exchange Act Rule 10b-18 nonexclusive safe harbor.”
The proposed rules would also require the company’s disclosure to be tagged using Inline XBRL. Under the proposal, the company would also need to check a box indicating whether any of the company’s Section 16 officers or directors purchased or sold shares (or other units) of the class of equity subject to the share repurchase plan or program within 10 business days before or after the announcement of the plan or program.
At the open meeting. As she opened her dissenting statement on the stock buybacks proposal, Peirce revealed just what she meant by her “just wait” response to Gensler, mischievously describing share buybacks as triggering events: “Both dividends and share repurchases are ways companies return cash to shareholders. Yet, say ‘dividend,’ and nobody gets angry, but say ‘share buyback,’ and the rage boils over. Today’s proposal channels some of that rage against repurchases in a way that only a regulator can—through painfully granular, unnecessarily frequent disclosure obligations.” Certainly she objected to the daily disclosure requirement and, as she stated with regard to the proposal on 10b5-1 plans, she didn’t “support the indirect regulation of corporate activity through disclosure requirements.” If there were information asymmetries between companies and investors, then “[w[hy not address such a concern through a more tailored requirement to disclose buyback announcements and terminations?” Instead, she argued, the proposal justified its “burdensome approach” by suggesting that companies seek to enhance executive comp and insider stock value through “opportunistic share repurchases.” But, she argued, studies “are decidedly mixed as to whether this is a real issue. Indeed, as noted in the release, last year the SEC staff reported the results of its study of the 50 firms that repurchased the most stock in 2018 and 2019 and concluded that ‘82% of the firms reviewed either did not have EPS-linked compensation targets or had EPS targets but their board considered the impact of repurchases when determining whether performance targets were met or in setting the targets.’” Why discount the staff’s own study, she asked? What’s more, she challenged the contention that, instead of conducting buybacks, companies should use surplus corporate cash for reinvestment in the company and its employees. Unsurprisingly, she argues, wouldn’t management—not regulators, politicians or academics—be in the best position to make that determination?
Roisman also dissented on this proposal. While he believed that there were regulatory enhancements that might be beneficial, he did not think that the proposal provided the right approach; rather, it “could likely result in companies reducing their use of buybacks, even when they believe that conducting a buyback would be in the best interest of the company and shareholders.” He regretted the absence from the proposal of a detailed discussion of the process companies employ to make buyback decisions, which could have helped to educate the SEC and the public about “the diligence and care companies take when they make these decisions” and “illuminate how companies and boards address the risk of buybacks being misused by insiders.” Again he observed that this proposal was “inextricably linked” with the proposal on 10b5-1 plans, which complicated the economic analysis. Buybacks can benefit our capital markets, he argued, allowing investors to redeploy capital elsewhere and communicating information about the company’s share value. They could even help to avoid dilution resulting from executive equity comp, better aligning executives’ incentives with shareholders’ interests. He agreed with Peirce that the justification for this rulemaking—that insiders use buybacks for manipulative purposes—is not well founded and that the release minimized reference to the staff’s own recent study that provided “substantial contrary evidence.” How did the staff suddenly shift gears on this point to reach a conclusion that the scale of manipulation actually “merit[ed] a dedicated rulemaking to address it”?
Roisman was more persuaded by a different justification for rulemaking—that companies may conduct buybacks when they believe their stock is undervalued but then fail to adequately and timely inform the market, enabling companies to exploit the information asymmetry to repurchase shares at reduced prices to the detriment of investors who sell into the buyback. To address this issue, companies should be required to notify the market of their intent to conduct buybacks and to provide the relevant buyback information. But this proposal did not achieve that goal. Instead, the burden of daily reporting could deter companies from conducting buybacks at all, and if they do go forward, the daily reports could provide roadmaps for traders to game the repurchases. And again, he was critical of the brief comment period.
In her statement, Lee contended that, although companies may conduct buybacks for a variety of reasons, “one of those reasons should not be for the opportunistic, short-term benefit of executives,” a practice she said (off script) that she saw in her prior experience in Enforcement. This proposal “does not prescribe how or why companies may elect to engage in share repurchases. Rather it requires disclosures intended to enhance the ability of investors to evaluate how, why, and to what effect companies are engaging in buybacks. In other words, to help put investors on more equal informational footing with companies and their officers and directors who make the decisions to engage in these transactions.” The requirements for disclosure of share repurchases were adopted in 2003, but there have been calls for the SEC to revisit its rules, including in response to the 2016 Reg S-K concept release, where “commenters favored enhanced share repurchase disclosure requirements by a margin of nearly two to one.” In addition, Lee observed that share repurchases have increased in recent decades by “orders of magnitude,” leading one commentator (Matt Levine, of course) to describe the public market in 2020 “as a ‘place where companies return money to shareholders’ rather than one where capital is raised. This phenomenon should be thoroughly and accurately disclosed and well understood by investors and markets. To the extent companies are making smart and thoughtful choices regarding buybacks, this increased transparency will serve them well. On the other hand, if anticipated disclosure operates to dampen enthusiasm for buybacks, that may well arise from flaws in the strategy behind the practice at certain companies.”
Crenshaw focused on the importance of the Inline XBRL requirement, which she believed “can meaningfully improve transparency. Data structuring can lower costs and increase the usefulness of our disclosures by enabling automatic processing and analysis, especially when it comes to granular data” of the type required by this proposal. Another aspect of the proposal that she highlighted was the proposed disclosure of policies and procedures relating to purchases and sales of company securities by officers and directors during a repurchase program. This provision was intended to address “possible opportunistic trading by insiders around the announcement of an issuer’s stock buyback program. Typically, a jump in the share price follows that announcement, creating a window for an advantageous trade. And evidence suggests that insiders can personally benefit from this window and sell shares in the days after an announcement.”
Gensler believed that “investors would benefit from the timeliness and granularity that today’s proposal would provide.” He observed that other countries, such as Australia and the UK, require next-day share buyback disclosures. He concluded with his belief that “freshening up our own share buyback disclosures would help the U.S. capital markets remain the most competitive in the world.”