At an open meeting yesterday, the SEC voted three to two to adopt a proposal intended to modernize and improve disclosure regarding company stock repurchases. Issuers have something to be relieved about and something to be mildly anxious about. The good news is what the SEC didn’t do: the new rule does away with the proposed Form SR for domestic companies and backs off the proposed requirement for almost real-time (daily) reporting of share repurchases. Instead, the final rule moves to quarterly reporting of detailed quantitative information on daily repurchase activity, filed as exhibits to issuers’ periodic reports. The more vexing aspect is that domestic issuers will be required to begin this reporting, along with the new narrative disclosure, starting with the first Form 10-Q or 10-K covering the first full fiscal quarter (i.e., for the 10-K, the 4th quarter) that begins on or after October 1, 2023. That means that companies will need to get on the stick to begin to develop processes and procedures for collection of that data. The amendments will also revise and expand the narrative requirements and add a new requirement for disclosure regarding a company’s adoption and termination of Rule 10b5-1 trading arrangements. In the press release, Chair Gary Gensler observed that “[i]n 2021, buybacks amounted to nearly $950 billion and reportedly reached more than $1.25 trillion in 2022….Today’s amendments will increase the transparency and integrity of this significant means by which issuers transact in their own securities. Through these disclosures, investors will be able to better assess issuer buyback programs. The disclosures will also help lessen some of the information asymmetries inherent between issuers and investors in buybacks. That’s good for investors, issuers, and the markets.” Commissioners Hester Peirce and Mark Uyeda dissented, with Peirce remarking that “better-than-it-might-have-been is not my standard for supporting a final rule.”
Under current rules adopted in 2003, a company is required to disclose in its periodic reports (including, for foreign private issuers, in Form 20-F) under Reg S-K Item 703, 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 adopting release observes that companies typically disclose repurchase plans or programs when they are authorized by the board, but “are not required to, and typically do not, disclose the specific dates on which they will execute trades pursuant to an announced repurchase plan or program.” As a result, investors usually don’t find out about a company’s actual trading activity until it files its periodic reports, leading to information asymmetries.
As discussed in the release, “share repurchases can have a positive or negative impact on the market for an issuer’s securities.” In some cases, “share repurchases may represent an efficient use of the issuer’s capital, such as when returning money to shareholders exceeds other possible internal investments of capital.” Some studies have found that issuers use repurchases to maximize shareholder value (e.g., to offset share dilution after new stock is issued), to facilitate stock-based employee comp programs, to signal that the company views its stock to be undervalued or simply because the board believes a repurchase to be a prudent use of cash. For some investors, they may offer potential tax advantages over dividends.
However, the SEC observed, some repurchases may not be efficient or may be motivated in part by factors other than long-term value maximization, such as “repurchases conducted to increase management compensation or to affect various accounting metrics, in either case when those actions do not increase the value of the firm.” Some studies have shown that repurchases can be used for earnings management (by decreasing the EPS denominator) to help executives meet or beat consensus forecasts. Studies have also found that announcements of repurchases and actual repurchase trades can help to increase share prices, which, some contend, could incentivize executives with share price- or EPS-tied comp to undertake buybacks to maximize their compensation. Other studies have found trading by insiders close in time to predictable price increases caused by repurchases or repurchase-plan announcements, such as in the period immediately following the issuer’s repurchase.
Some commenters questioned these assertions regarding the possible deliberate use of repurchases; however, the SEC continued to affirm its view that “personal benefit may be a factor in determining whether to undertake a share repurchase.” Even if opportunism does not drive the timing of most issuer share repurchases, the SEC contended, it is still “appropriate for investors to have more useful information about such repurchases.”
It’s worth noting, however, that a 2020 staff study cited in the notes to the release and highlighted by Commissioner Peirce in her statement, found that “a majority of the issuers included in the study 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”; approximately 18% of repurchasing issuers, however, “made compensatory awards based in part on EPS.” It is “difficult,” the staff study further observed, “to ascertain the motivations underlying insider sales,” concluding that “the data is consistent with firms using repurchases to maintain optimal levels of cash holdings and to minimize their cost of capital.”
Under current rules, investors are given “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.” These inadequacies make it difficult for investors to properly “value a company or identify when an issuer’s use of cash is well-managed, reducing investor confidence and market liquidity.” The SEC believes that “mandatory disclosures are necessary to overcome these informational asymmetries between issuers and their managers on the one hand and investors on the other.” The new quantitative data may “reveal patterns in which repurchases were undertaken at times or under conditions that were likely to affect imminent accounting metrics, or prior to the release of material nonpublic information by the issuer.” Similarly, the new qualitative disclosures “will provide investors with additional information about the structure of an issuer’s repurchase program and its share repurchases that will enable them to better understand how and why those repurchases are conducted. The qualitative disclosures, when combined with the daily repurchase activity disclosure, will allow investors to draw clearer and more informed conclusions about the purposes and effects of share repurchases.”
The final rules
As summarized in the fact sheet, the final rules will require companies to
- Disclose daily repurchase activity quarterly. The final rules require the same additional detail regarding the structure of a company’s repurchase program and its daily share repurchases as was proposed. The difference is in the timing and manner. Instead of daily filings on a new Form SR, domestic companies will be required to report on the daily activity quarterly. The tabular disclosure will include, for each day, the class of shares; the average price paid per share; the total number of shares purchased, including the total number of shares purchased as part of a publicly announced plan; the aggregate maximum number of shares (or approximate dollar value) that may yet be purchased under a publicly announced plan; the total number of shares purchased on the open market; and the total number of shares purchased that are intended to qualify for the safe harbor in Rule 10b-18 and separately the total number of shares purchased under a 10b5-1 plan. Domestic companies will file the repurchase data quarterly as exhibits to their Forms 10-Q and Form 10-K; foreign private issuers will be required to file, within 45 days after the end of an FPI’s fiscal quarter, a new Form F-SR. (See below for the criticism by Commissioner Mark Uyeda that the final rule essentially upended the historical treatment of FPIs.) The new rules also eliminate the requirement in current Reg S-K Item 703(a) for disclosure of monthly quantitative repurchase data in their periodic reports. In a change from the proposal, the daily quantitative repurchase data will be treated as filed, instead of furnished, with the result that the new repurchase disclosure will be subject to Section 18 liability and “the information will be deemed incorporated by reference into filings under the Securities Act, which will be subject to Securities Act Section 11 liability.”
- Check a box. Companies will be required to check a box, preceding the tabular disclosures, if any Section 16 directors or officers traded in the securities that are the subject of a share repurchase plan or program within four business days before or after the announcement of that plan or program, rather than the ten business days as originally proposed. (For FPIs, this requirement applies to any director and member of senior management who would be identified pursuant to Item 1 of Form 20-F.)
- Expanded narrative. Each company must provide expanded narrative disclosure about the company’s repurchase programs and practices in its periodic reports, including (1) the objectives or rationales for its share repurchases and the process or criteria used to determine the amount of repurchases and (2) any policies and procedures relating to purchases and sales of the company’s securities during a repurchase program by its officers and directors, including any restrictions on those transactions.
- 10b5-1. Each company must provide quarterly disclosure, under new Reg S-K Item 408(d), in periodic reports on Forms 10-K and 10-Q regarding the company’s adoption and termination of 10b5-1 trading arrangements.
- Structured data. The disclosure must be reported using inline XBRL.
As noted above, domestic issuers will be required to comply with the amendments on Forms 10-Q and 10-K (for their fourth fiscal quarter) beginning with the first report covering the first full fiscal quarter that begins on or after Sunday, October 1, 2023. For most calendar-year companies, that will mean the fourth quarter of 2023 to be included in the 2023 Form 10-K filed in 2024. FPIs that file on FPI forms will be required to comply with the amendments in new Form F-SR beginning with the Form F-SR that covers the first full fiscal quarter that begins on or after April 1, 2024. The Form 20-F narrative disclosure that relates to the Form F-SR filings will be required starting in the first Form 20-F filed after the FPI’s first Form F-SR has been filed. (Note that the rule also applies to listed closed-end funds, not discussed in this post.)
At the open meeting
In his statement, Gensler maintained that the new tabular and narrative disclosures will enhance the transparency and integrity of the buyback process and help investors “to better assess issuer buyback programs. The disclosures also will help lessen some of the information asymmetries inherent between issuers and investors in buybacks. Based on public comment, the final rule adjusts the proposed cadence of the daily-buyback disclosure to be provided periodically rather than one business day after execution.”
Peirce issued a dissenting statement. Although she was pleased that final rule “scrap[ped] the proposed requirement to disclose share repurchases within one business day,” she could not vote in favor of a rule “that mandates immaterial disclosures without sensible exemptions.” In her view, the “release fails to demonstrate a problem in need of a solution”: it only hinted at potential problems—buybacks “could be ‘conducted to increase management compensation or to affect various accounting metrics,’ rather than to increase firm value”—and suggested “that granular disclosure might unearth nefarious practices related to buybacks.” Although some might argue—and perhaps correctly—that companies should use excess cash for employee wage increases or R&D, “share repurchases are not inherently problematic. To the contrary, they enable companies to return excess cash to shareholders with greater tax-efficiency than dividends.” This “skepticism” about buybacks, she contended, is inconsistent with the 2020 staff study (referred to above) which found that “repurchases help issuers ‘maintain optimal levels of cash holdings and minimize their cost of capital’ and ‘on average’ have ‘a positive effect on firm value.’ The study also found that increasing or meeting executive compensation levels or meeting ‘earnings-per-share (EPS)-based performance targets’ is ‘unlikely’ to motivate ‘most repurchase activity.’”
In addition, she criticized the final rule for its excessive granularity. Citing TSC Industries, she argued that the “reasonable investor does not need to know about every repurchase by every public issuer. Disclosure of daily repurchase information will ‘bury [investors] in an avalanche of trivial information[,] a result that is hardly conducive to informed decision-making.’” Although investors may not be certain about the purpose of every repurchase, they’re likewise uncertain about the motives behind every capital investment or R&D project. “The antidote,” she said, “is not requiring companies to describe in painstaking detail every corporate action.” She also expressed concern about the possible costs of the rule, the potential for release of confidential information, the absence of reasonable accommodations for small companies, the failure to adhere to the historical treatment of FPIs and the “unnecessarily aggressive” compliance deadlines. Peirce concluded that, while the final rule was “not as bad as it could have been,… better-than-it-might-have-been is not my standard for supporting a final rule.”
Following delivery of her statement, Peirce raised several questions: Did the staff believe that the level of buybacks was suboptimal? Corp Fin Director Erik Gerding took no position. How would the staff judge the effectiveness of the rule retrospectively? What are the markers? Gerding responded that he would look to whether the shareholders received high-quality disclosure. What was the reason for the aggressive deadlines? Were companies given adequate time to adopt procedures for disaggregation of data? Gerding replied that he did not think they were aggressive, given that reporting would not begin before 2024 and that the required disclosure was similar to the current disclosure required under Item 703.
In her statement, Commissioner Caroline Crenshaw observed that the new rule “advances the goals of the foundational statutes of our agency; statutes that provide investors and the markets with a continuous disclosure regime that evolves according to, and modernizes with, investor and market needs.” In her view, the disclosures will “provide more comprehensive information for investors, allowing them to better understand how such programs are impacting the market, the corporation’s motivation and rationale to use funds to conduct buybacks rather than other projects, and executive transactions during buybacks announcements and activity—all ultimately shedding more light on corporate value.” In support, she cites an article by former Commissioner Robert Jackson, Jr., which stated, in connection with insider transactions executed close in time to buyback announcements, that “[e]xecutives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash it out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”
Commissioner Uyeda, who dissented, focused his statement on one key issue: while the rulemaking was about repurchase disclosure, “in the future,” in his view, “these amendments may be remembered as the beginning of the end for the Commission’s approach to foreign private issuers.” For 55 years, he observed, FPIs have been able to report under a separate regime designed to bend to their home country rules. However, the new repurchase disclosure rules “will require FPIs to make quarterly filings to report share repurchases regardless of their home country’s disclosure requirements. This change fundamentally upends the Commission’s long-standing and bipartisan approach of largely deferring to the disclosures made by FPIs pursuant to their home country reporting requirements. Given the significance of this shift in regulatory philosophy, the Commission should have undertaken a separate rulemaking on the issue, instead of including this change as part of a rulemaking focused on share repurchase disclosure.” This approach sends a message to our foreign partners that the SEC “will sacrifice principles of mutual recognition and international comity to impose its own views on the rest of the world. This approach may ultimately harm U.S. investors and companies,” through, among other things, ultimately higher prices and lower returns.
In addition, he contended that the final rules “fail to recognize important differences between FPIs and domestic companies.” The SEC justified the need for daily repurchase data as a way to enable investors to determine if repurchases were motivated by a desire to increase executive comp or achieve accounting targets. But FPIs “are neither subject to Section 16 of the Exchange Act nor extensive executive compensation disclosure. Thus, it will be nearly impossible for FPI investors to use the daily data to determine whether repurchases were motivated by executive compensation reasons.” In addition, FPIs are not required to report their financial results quarterly; as a result, quarterly disclosure of repurchase activity may not be “aligned with its disclosure of financial results, [and] investors will be hard pressed to use the repurchase data to assess whether the FPI was attempting to reach an accounting target.”
Commissioner Jaime Lizárraga used part of his statement to respond to the issue of FPIs raised by Uyeda. He contended that the 2020 Holding Foreign Companies Accountable Act (see this PubCo post) “reinforced the principle that absent compelling reasons, foreign issuers should not be treated differently than U.S. issuers; instead, there should be a level playing field for all companies that choose to raise capital in our markets. Stated another way, whether investing in a U.S. or a foreign issuer, investors should be equally protected. While our periodic reporting system for private foreign issuers differs from domestic issuers in several respects, wherever possible, it is in the interest of investor protection to strive for a level playing field.”
In addition, he argued that, given the 2022 annual record for repurchases by S&P 500 companies of $923 billion (as compared with global IPO offerings of less than $180 billion or even $626 billion in 2021), it just “stands to reason that information on repurchases is material to investors.” If repurchase activity is motivated by “opportunistic insider behavior,” it can negatively affect “the issuer and its shareholders—for example, by foregoing investments that could have resulted in better returns.” The final rules will allow investors to “distinguish between repurchases intended to increase shareholder value, and those that are motivated by other reasons, such as short-term attempts to boost share price.” In addition, the new requirement to disclose the rationale for repurchases and the “process or criteria used to determine the amount” should not elicit boilerplate disclosures; “[t]o the contrary, issuers are able to provide tailored disclosures of how a repurchase program compares to other investment opportunities that generate financial returns, such as capital expenditures or workforce investments, to improve their quality and help avoid boilerplate. The same applies to discussions of sources of funding that would make it more or less advantageous for an issuer from a tax, cost, or other perspective.”