SEC proposes rules affecting share repurchases
The SEC has proposed new rules for issuer repurchases of equity securities. The proposed rules would have two functions: adding a requirement for more timely (ie, daily) disclosure of share repurchases, and expanding the existing disclosures that are currently included in Forms 10-Q and 10-K to include information on the repurchase plan’s structure and details regarding trading by insiders around the time of issuer stock repurchases.
In this alert, we summarize the proposed rules and note several issues relating to implementation.
In 2003, the SEC adopted rules to require disclosures on a quarterly basis (currently in Forms 10-Q and 10-K) of any share repurchases made by or on behalf of the issuer. The Commission notes that this disclosure was intended to inform investors whether, and to what extent, issuers had followed through on proposed plans for repurchases.
While noting several academic studies that have found issuers often use repurchases in a manner aligned with maximizing shareholder value, the proposed rules also note “concerns” expressed by some observers about the potential, more troublesome use of share repurchases, such as a form of earnings management or as a means to affect incentive compensation programs. The SEC release also notes potential concerns regarding the relationships between issuer share repurchases and purchase or sale transactions by insiders, such as announcements of repurchase programs that tend to increase trading prices shortly before insider resales.
The SEC states that its proposed rules are intended to improve the “quality, relevance and timeliness” of information related to issuer share repurchases by providing additional information that reduce “information asymmetries” between issuers and investors. The SEC indicated that the additional information could allow investors to better understand the extent of an issuer's share repurchases (including potential effects on the issuer share price); provide better understanding of the motivation for share repurchases and execution of purchase plans; and give potential insight into any relationship between share repurchases and both executive compensation and insider transactions.
Additional reporting obligations; New Form SR
Proposed Rule 13a-21 is intended to enhance transparency and enable more timely investor review by requiring disclosure, no later than the business day after execution of a share repurchase, of specific information regarding the previous day’s trades.
This information, which would be reported in a tabular format on a new Form SR, would include:
- the total number of shares purchased that day
- the average price paid per share
- the aggregate total number of shares purchased on the open market
- the aggregate total of shares purchased in reliance on the Rule 10b-18 safe harbor and
- the aggregate shares purchased under a 10b5-1 plan.
While daily information may sometimes benefit some shareholders (especially those who trade against the company), it could also harm the company and its long-term stockholders. Since companies generally announce the maximum amounts and terms of their repurchase programs, and thereafter must report the number and value of securities repurchased on a quarterly basis, daily reporting would only provide incremental information regarding execution of repurchase programs that in many situations would be unquestionably immaterial. However, the compliance costs would not be insignificant for a company to incorporate new filings into its disclosure controls and procedures, to ensure agreements with brokers position the company to satisfy reporting obligations, and to prepare and make ongoing filings. These burdens may discourage company repurchases and otherwise defer or eliminate the increases in stock price they tend to spur.
Additionally, requiring daily trading data and linkage to a 10b5-1 plan would allow hedge funds and others to reverse-engineer significant elements of applicable pricing grids or other formulas used to determine the amount and timing of repurchases. That knowledge would clearly benefit those who trade against the company to the detriment of the company and its remaining stockholders, especially when combined with the proposed revisions to the rules regarding 10b5-1 plans. Rather than reducing “information asymmetries,” the proposed rules would tilt the playing field against the company.
The SEC notes that it will need to balance the benefit of additional disclosure with the additional efforts required for more frequent disclosure, and it is possible that the reporting requirement may be extended to a weekly or longer period or exclude de minimis repurchases from reporting obligations. By changing the reporting periodicity to monthly (as opposed the proposed daily requirement), the SEC could reduce many of the adverse consequences and compliance costs, while still providing enhanced disclosure.
Additionally, we note that in some transactions, such as certain accelerated share repurchase (ASR) arrangements, the transaction information is not available to issuers on a daily basis, and the transactions do not completely settle within the next day. It is not clear under the proposed rules how an ASR would be reported and whether issuers would need to insist on daily information regarding transactions by the counterparty to the ASR arrangement. If the SEC determines additional reporting burdens are warranted, we hope the SEC will address these transactions in the final rulemaking or related guidance.
Enhancement of existing disclosures
The proposed rules would also expand the current disclosure requirements that are reported in sections of Forms 10-Q and 10-K by requiring the issuer to disclose:
- the objective or rationale for its share purchase
- the process or criteria used to determine the amount of repurchases
- any policies or procedures relating to trading of issuer securities by its officers and directors during a repurchase program (including any restrictions on such transactions) and
- whether the issuer made repurchases pursuant to (i) a 10b5-1 plan (and the date that the plan was adopted or terminated), and (ii) the Rule 10b-18 safe harbor.
The SEC is also proposing to require companies to disclose if any of their officers or directors purchased or sold shares within 10 business days before or after the announcement of an repurchase plan.
We expect that the rationale for share repurchase programs could easily become boilerplate. Nearly all companies are likely to list similar reasons for the repurchase: for instance, that it is a tax-efficient means of returning excess capital to stockholders or offsetting dilution from equity compensation plans, or that it is an appropriate investment when shares are viewed as undervalued.
We also note that the required disclosure of purchases by officers or directors within 10 business days before or after announcement of an issuer repurchase plan is information that is already available through Section 16 reports and required public disclosures of information regarding the share repurchase program. Additionally, the proposed disclosure requirements would appear to be triggered by insider transactions under previously established 10b5-1 plans that occur around the time of a share repurchase announcement. So, there will likely be many “false positive” disclosures of transactions where insiders did not use information about the issuer’s share repurchase program in connection with individual purchase or sale decisions.
Learn more about this development and its implications for your company by contacting either of the authors or your usual DLA Piper attorney.