SEC Commissioner calls for updates to stock buyback rules07.09.18
Securities and Exchange Commission Commissioner Robert Jackson has recently shared some noteworthy thoughts on the growing practice of corporate stock buybacks.
In calling for the SEC to update its rules to limit executives from using stock buybacks to cash out from their respective companies, Jackson stated 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.”
Rule 10b-18 and Stock Repurchase Programs
Companies frequently rely upon Rule 10b-18 to conduct their stock repurchase programs because the rule provides a non-exclusive “safe harbor” from securities fraud liability if certain conditions are satisfied. Notably, Rule 10b-18 does not provide an absolute safe harbor because a company may still be liable under Rule 10b-5 if the company engages in repurchases while in possession of material non-public information or in connection with a plan or scheme designed to evade federal securities laws.
Recent Proliferation of Executives’ Participation in Buybacks
Commissioner Jackson noted that the SEC still has not promulgated certain rules designed to provide investors with more information about executive compensation (i.e., rules requiring that companies disclose the link between the granting of equity-based compensation and pay-for-performance and that companies implement policies related to the clawback of erroneously awarded compensation and insider hedging of stocks).
He further expressed concern that the combination of the SEC’s failure to implement the foregoing rules, the lack of stringency in the SEC’s existing rules regarding cash-outs and the recently passed Tax Cuts and Jobs Act of 2017 has created an environment that is ripe for executives to cash out at the expense of investors. Accordingly, Commissioner Jackson’s staff studied 385 buybacks that occurred during the last 15 months and found the following expected and unexpected results:
- A buyback announcement leads to an increase in stock price;
- Executives overwhelmingly decided to sell following a buyback announcement; and
- In the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day, representing a five times increase over the average amounts in the days prior to the announcement.
To Commissioner Jackson, the research showed that “executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement” which permits executives to take cash off the table and break the pay for performance link. Commissioner Jackson acknowledges that “this trading is not necessarily illegal. But it is troubling because it is yet another piece of evidence that executives are spending more time on short-term stock trading than long-term value creation.”
It's important to note the flip side, however, which is that executives are often locked up with few opportunities to actually convert their equity to cash. Buybacks, like registrations, are rare opportunites to do that when all material info is made public.
A Call for Action
Noting that the SEC has not revised its buyback rules since 2003, Commissioner Jackson proposed a two-step plan to address the executive buyback issue.
- Federal securities laws should not subsidize this behavior; rather, they should encourage executives to keep skin in the game for the long term. Accordingly, at a minimum, Rule 10b-18 should be revised to deny the safe harbor if companies permit their executives to cash out during the buyback; and
- In the context of a proposed buyback, compensation committees should be required to review whether executives will use the buyback as an opportunity to cash out and if so, approve that decision and disclose to investors the reasons why such a course of action is in the best long-term interests of the company. When reviewing and making such decisions, compensation committees were specifically encouraged to consider the impact that a buyback and potential executive involvement would have on the link between the granting of equity-based compensation and pay-for-performance.
“At the SEC, it’s time for our rules to require corporate managers who say they want to manage for the long term to put their money where their mouth is,” Jackson said in a recent speech. “At the very least, [SEC] rules should stop giving executives incentives to use buybacks to cash out.”