SEC proposes new rules on stock buybacks [updated]

[This post revises and updates my earlier post primarily to reflect the contents of the proposing release.]

At an open meeting last week, the SEC voted three to two to propose new rules regarding company stock repurchases. (At the same time, the SEC also voted unanimously to propose new rules regarding Rule 10b5-1 plans. See this PubCo post.) The amount that companies have spent on stock repurchases has generally increased substantially over the years—in 2020, companies spent almost $700 billion to repurchase their own shares, which, the SEC asserts, “has been accompanied by public interest in corporate payouts in the form of share repurchases.” These repurchases can impact the market, and, the SEC suggests, 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 the remarks of Corp Fin Director Renee Jones at the open meeting. The proposal would 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 SEC Chair Gary 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.” Dissenting Commissioners Hester Peirce and Elad 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, a time period that Roisman (perhaps taking a cue from Peirce) found to be of insufficient duration.

Happy holidays and happy new year!!

Background

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 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.”  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.

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.  However, according to the SEC, other studies have shown that repurchases can be used for earnings management (by decreasing the EPS denominator) to help executives meet or beat consensus forecasts. Some 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. It’s worth noting, however, that a 2020 staff study cited in the notes to the proposing release and highlighted by both dissenting commissioners found that, “based on a review of compensation disclosures in proxy statements for a sample of 50 firms that repurchased the most stock in 2018 and 2019, ‘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.’” 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.”  The proposing release also cites a number of commentators who raised concerns about ”the potential for share repurchases to be used by issuers as a mechanism to inflate the compensation of their executives in a manner that is not transparent to investors or the market,” as well as commenters who, in response to the 2016 Reg S-K Concept Release, expressed support for increasing the frequency of reporting share repurchases. The release also referenced remarks by former Commissioner Robert Jackson and others, who “have highlighted what they viewed to be the opportunistic and harmful use of issuer share repurchases by issuer insiders,” including by “extract[ing] value from the issuer instead of using the funds to invest in the issuer and its employees.”

To address these concerns and comments, the proposal seeks to “improve the quality, relevance, and timeliness of information related to issuer share repurchases” and to address the information asymmetries—especially in light of the quarterly timing of the current Item 703 disclosures—that “may exist between issuers and affiliated purchasers and investors with regard to information about the issuer and its future prospects.” These proposed disclosures may help investors understand a company’s motivations and the extent of its repurchase activity and potentially, gain “insight into any relationship between share repurchases and executive compensation and stock sales.”

The proposal

The proposal is focused on enhancing disclosure, requiring more detailed and more frequent and timely disclosure about stock buybacks. The proposal would require daily repurchase disclosure on a new Form SR, amend Reg S-K Item 703 to require additional detail regarding a company’s repurchase programs and require these disclosures to be tagged using Inline XBRL.

Proposed new Form SR. Proposed new Exchange Act Rule 13a-21 and Form SR would require a company, including a foreign private issuer, to report any purchase made by or on behalf of the issuer or any affiliated purchaser of shares (or other units) of any class of the company’s equity securities registered under Section 12—before the end of the first business day following the day on which the company executes a share repurchase.  The disclosure would also be required to be tagged using Inline XBRL. Any material errors or changes to information previously reported would need to be reported on an amended Form SR. Fortunately, as proposed, the Form SR would be furnished rather than filed, which means that the company would not be subject to liability for the Form SR under Section 18 and, because the information would not be incorporated by reference into filings under the Securities Act, would not be subject to liability under Section 11. In addition, as proposed, a late submission of Form SR would not affect Form S-3 eligibility.

The Form SR would require tabular disclosure of the following information, by date, for each class or series of securities:

(1) The class of securities purchased;

(2) The total number of shares (or, in each case, units) purchased, including all issuer repurchases, whether or not made pursuant to publicly announced plans or programs;

(3) The average price paid per share, excluding brokerage commissions and other costs of execution;

(4) The total number of shares purchased on the open market, excluding shares “purchased in tender offers, in satisfaction of the company’s obligations upon exercise of outstanding put options issued by the issuer, or other transactions”;

(5) The total number of shares purchased in reliance on the Rule 10b-18 safe harbor; and

(6) The total number of shares purchased pursuant to a plan intended to satisfy Rule 10b5-1.

The SEC believes that this “more detailed and timely disclosure” could be used by investors “to monitor and evaluate issuer share repurchases, and their effects on the market for the issuer’s securities.” For example, investors could have greater insight into the scale of the company’s activity in the market or how the company “structured its repurchase activity,” i.e., whether under a Rule 10b5-1 plan or Rule 10b-18.  The release also asserts that the more granular information provided on the new Form SR could enable investors “to better evaluate the market for the issuer’s securities and the actions of the issuer’s insiders. For example, when combined with existing executive compensation, Section 16… and financial statement disclosures, the proposed Form SR disclosures may improve the ability of investors to identify issuer repurchases potentially driven by managerial self-interest, such as seeking to increase the share price prior to an insider sale or to change the value of an option or other form of executive compensation.”

Proposed expanded disclosure in periodic reports. To “provide investors with more detailed and timely information they can use to evaluate issuer share repurchases,” the SEC is also proposing to amend Item 703 to expand the disclosure that appears in periodic reports. (Similar disclosures would be required for foreign private issuers in Form 20-F.) As proposed, Item 703 would require a company to disclose:

As proposed, this disclosure would be required to be tagged using Inline XBRL. In addition, the SEC is proposing to add a checkbox before the table of company repurchases currently required under Item 703 to indicate whether, within 10 business days before or after the company’s announcement of a share repurchase plan or program, any of the company’s Section 16 officers or directors purchased or sold shares of the same class of equity securities as the repurchase program.

The proposed disclosure about reliance on Rule 10b-18 or Rule 10b5-1, along with disclosures about policies, procedures and restrictions imposed on officers and directors during a repurchase plan, is intended to allow investors “to better understand how an issuer has structured its repurchase plan and whether it has taken steps to prevent officers and directors from potentially benefiting from issuer repurchases in a manner that is not available to regular investors.”  In addition, the release indicates that the requirement to add a discussion of the rationale or objective for the buyback is responsive to comments elicited by the 2016 Concept Release that suggested expanding the Item 703 disclosure to require that information. The SEC believes that, together with the Form SR data, these enhanced disclosures “would help investors to assess whether the issuer or its insiders are potentially engaged in self-interested or otherwise inefficient repurchases and thereby help mitigate some of the potential harms associated with issuer repurchases.” 

The proposed checkbox is designed to allow investors to see if officers or directors were trading near the time of a repurchase without having to actually review Section 16 filings. The SEC observes that, to comply with the proposed checkbox requirement, companies would need to rely on representations or Section 16 reporting by officers and directors and asks whether it should provide guidance about the company’s “scope of inquiry and explain what an issuer may rely on for purposes of complying with the checkbox requirement.”  Another question on which the SEC is seeking comment is whether some of the current requirements and proposed disclosures might overlap and, therefore, benefit from some streamlining or further alignment, for example, the proposed daily reporting of repurchases on Form SR and the continued quarterly reporting (by month) under Item 703 or the proposed enhanced Item 703 disclosure of policies and procedures relating to insider trades and the proposed Item 408 disclosure under the 10b5-1 proposal (see this PubCo post) that would require quarterly disclosure of the use of Rule 10b5-1 plans by the company, its officers and directors, as well annual disclosure of a company’s insider trading policies and procedures.

At the open meeting. Peirce began her statement on the first proposal at the open meeting, related to Rule 10b5-1, 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.” 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 neither did she “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,” citing the staff’s own 2020 study. “The staff’s overarching conclusion is also helpful context for today’s proposal,” she contended: “‘reasons for repurchases where the connection to efficient investment is less clear are unlikely to motivate the majority of repurchases since stock prices typically increase in response to repurchase announcements, suggesting that, at least on average, repurchases are viewed as having a positive effect on firm value.’”  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.” He also 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 2020 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.

In her statement, Commissioner Allison Herren 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 since 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.”

Commissioner Caroline 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.”