“Managing the New Buyback Disclosure Rules”
Wednesday, May 24, 2023
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Stock buybacks are more popular than ever among public companies, but with the SEC’s adoption of new disclosure rules intended to promote more transparency about corporate repurchases, the compliance issues associated with them are about to become a lot more complicated.
John Jenkins, Managing Editor, CCRcorp and TheCorporateCounsel.net: Welcome to today’s webcast, “Managing the New Buyback Disclosure Rules.” Stock buybacks are more popular than ever among public companies, but with the SEC’s adoption of new disclosure rules intended to promote more transparency about corporate repurchases, the compliance issues associated with them are about to become a lot more complicated.
Fortunately, we’ve brought together a terrific panel of experts to help shed some light on the new rules and offer practical guidance on what companies should be doing to prepare to comply with them. Joining me today is Era Anagnosti, a Partner at DLA Piper; Robert Evans, a Partner at Locke Lord; Allison Handy, a partner at Perkins Coie; and my colleague Dave Lynn, who is a partner at Morrison Foerster and Senior Editor at TheCorporateCounsel.net. I’m going to turn things over to Dave to kick off today’s program.
Overview of the New Rules
Dave Lynn, Partner, Morrison & Foerster LLP and Senior Editor, TheCorporateCounsel.net: Thanks, John. I’m going to start the discussion by spending a few minutes talking about the context in which these new share repurchase disclosure rules came about. It’s always helpful to understand these rules by trying to figure out why they exist in the first place.
Keep in mind that we’re not talking about an entirely new regime for share repurchase disclosure. Item 703 of Regulation S-K has been out there since it was adopted in 2003 and so we’ve had periodic disclosure of monthly share repurchase data. We’ve gotten used to the ins and outs of that. Now, we’re just adapting to a much more detailed approach. I would characterize the rules that we’re going to talk about as a data dump of information as compared to the more high-level information that we have provided in response to Item 703, because we’re moving from a world of monthly repurchase data to daily repurchase data that’s presented basically in an exhibit to the required filings or as part of the required filings.
I think it goes without saying, perhaps, that the agency approved this rulemaking against a backdrop of negative attention on share repurchases, even at a time when share repurchases are booming at public companies. In some ways, I compare this to the Rule 10b5-1 rulemaking that we just saw the SEC adopt at the end of last year. You have a ubiquitous practice related to transactions in securities that makes a lot of sense from a practical perspective, but a range of parties — politicians, institutional investors, the media, academics and governance professionals, and regulators like the SEC — seem to be ganging up in an effort to discredit the practice to some extent out of a concern that there are some perceived abuses. Some of those perceived abuses were articulated in this adopting release for the rule.
The persistent complaints about share repurchases are that you’re promoting the use of capital for short-term purposes instead of long-term purposes, and you’re jeopardizing growth by not investing in growth activities, but just returning capital to shareholders; that repurchases somehow provides a mechanism by which management can effectively manage their per-share earnings metrics to meet analyst estimates or to achieve objectives under compensation programs; that this type of activity benefits corporate insiders who are selling their share stock when share prices are appreciating after a share buyback has been announced or during the activity under that share buyback program; and that it’s somehow not an appropriate allocation of capital to pay employees higher wages or to not lay people off. There’s a populist element in the notion that companies just think the best use of their capital is to repurchase their own stock.
It’s not just this disclosure effort. We had the enactment of the Inflation Reduction Act of 2022, which included an excise tax of 1% on share repurchases. The president has talked about upping that to 4%, which doesn’t seem to put a dent at all in the activity that issuers undertake with respect to share repurchases. Just today in The Wall Street Journal, it talked about the fact that Russell 3000 companies have announced plans to buy back $600 billion in shares this year, which is on pace with where we were last year where the Russell 3000 companies completed over $1 trillion in buybacks, an all-time high.
While we’re moving toward this much more detailed disclosure framework, it’s probably not going to serve as a deterrent in any way to companies continuing to conduct share repurchases much the way they’ve done before. The possible downside of the “data dump” approach that the SEC has taken here is it will facilitate the ability of external parties to take this data and determine whether there are comparisons to be made between the share repurchase activity and the transactions of insiders, the release of material nonpublic information, the outcome of the company’s financial results and other potentially relevant variables. In a lot of ways, I feel like this is the best example yet of an SEC rule that’s conceived by economists, for economists, to give them some juicy data to analyze.
The last point I wanted to make before we get into the discussion of what the rules actually require is this could have been worse than the way it ultimately turned out. I suppose we should all be thankful, in that in the original proposal from back in December of 2021, the SEC had proposed adopting a new Form SR that would require issuers to report any repurchases before the end of the first business day following the day on which the share repurchase was executed. The best way to think about that proposal is that it was analogous to Section 16 reporting for insider transactions in securities where you have a real-time data feed of transactions. Obviously, in the final amendments, the Commission moved away from that real-time disclosure approach to a periodic approach with more detail, including the daily share repurchase activity. In that way, they heard the concerns of commenters which focused on the fact of how difficult it would be to report this information on such a rapid basis and the potential problems with having that data out there on a real-time basis as companies are trying to execute their share repurchase program. We ultimately did get the rule changess here, but the changes definitely were not as difficult to implement as they possibly could have been as originally proposed.
With that, it’s a good time to delve into what the rules actually require with Era.
Era Anagnosti, Partner, DLA Piper LLP: Thanks, Dave. This is almost a full-circle moment for me. I was on the Staff for over 10 years and when the SEC started to prepare the concept release, I was tasked with focusing on 703 disclosure. The time was always considered to be a little bit of a “sleepy side” of the disclosures. Coming here and talking about this is an interesting moment.
As Dave said, the rule ended up being a little bit better than feared, at least for domestic companies (probably not so much for foreign private issuers). I’ll go over the summary of the new rules and highlight some of the areas where the rules departed from the proposed release. I’m intentionally not going to address the listed close-end funds, since I believe most of our audience are corporate entities anyway.
The new rules adopted this quarterly disclosure regime for both domestic issuers and foreign private issuers of daily repurchase data. The issuer has to disclose this information for each day a share buyback occurs. Again, in a departure from the prior rule, there is no Form SR for domestic issuers. They’re required to file, on a quarterly basis, a new Exhibit 26 to their Form 10-Q and 10-K, and then the Form 10-K will include disclosure for an issuer’s fourth fiscal quarter. Foreign private issuers (“FPIs”) also are required to make this disclosure quarterly on a new Form F-SR, which will be due 45 days after the end of the fiscal quarter.
Somewhat surprising is that there is no exemption for any category of issuers such as emerging growth companies or SRCs. The Staff felt that just because we have a reduced disclosure requirement for some of the smaller issuers such as EGCs and SRCs, it didn’t think that information about their stock repurchases was less material or important to the investors. Also, in a departure from the proposed rules, the information in the exhibit will be actually considered filed, not furnished, which makes the disclosures subject to the liability provisions of the Exchange Act and the Securities Act to the extent that that information gets incorporated by reference in any registration statements. Also, the structure of 703 tabular disclosure was maintained.
Some of the categories of disclosure remain the same, and there are three new categories added to the tabular disclosure. Starting with what’s old, the companies are still required to disclose in that exhibit: the class of shares, the average price paid per share, total number of shares purchased, and the aggregate maximum number of shares they yet may be purchased under a publicly announced plan. What was new is that the registrant now has to disclose the total number of shares purchased in the open market, the aggregate total number of shares purchased in reliance on the 10b-18 safe harbor and then the aggregate number of shares purchased under a 10b5-1 plan.
The applicable exhibit or form where the issuers have to report this daily repurchase data now has to include a check box that indicates whether the officers and directors reporting pursuant to Section 16(a) of the Exchange Act, whether they traded in the relevant securities in the four business-day window before or after the announcement of a repurchase plan. Originally as proposed, there was a 10 business-day window for this requirement, but it was reduced to four business days in the final rule.
For domestic issuers, they can rely on Forms 3, 4 and 5 that are filed with the Commission by the Section 16 insiders in determining whether they need to check the box, provided that the reliance be reasonable, meaning if the company had reason to believe that the form was inappropriately filed or had some material errors in it, then reliance would not be reasonable. For FPIs, this check-the-box requirement would apply to the directors or the members of senior management who would be identified in Item 1 of Form 20-F, and the FPI would be permitted to rely on a written representation from these directors and senior management, provided that the reliance would be reasonable.
What we have also under these new rules would be expanded and enhanced disclosure under the current Item 703 of S-K and Item 16E(a) of Form 20-F. What the issuers now have an obligation to disclose is the objectives and the rationale for the share repurchases and the process or criteria used to determine the amount of repurchases. They have to disclose the number of shares purchased other than through a publicly announced plan or program and the nature of those transactions. They have to provide information about each plan announced, the date of announcement, the dollar or share amount, when it expires, if there were any plan expiring during the period of disclosure, plans that were terminated or plans that the issuer does no longer intend to make any further repurchases, as well as policies or procedures related to trading of issuer securities by its insiders, officers and directors during the pendency of a repurchase program.
A lot of commenters were against disclosure around objectives and criteria, because they felt that that would cause companies to rely on boilerplate disclosure. Heading it off, the Commission said that they expect the disclosure not to be boilerplate. Some of the factors that companies should take into consideration in discussing how they arrived at the determination to adopt a repurchase plan would be to discuss factors driving the repurchase, which would include whether the company considers the stock to be undervalued, whether there were other economically viable prospective internal growth opportunities, attractive valuation of potential targets, the sources of funding that the company is using for the repurchase to the extent material, such as the case where the source of funding results in a tax advantage that would probably not be available for a repurchase.
Another new rule as part of the new amendment was the addition of Item 408(d) of Reg S-K, which will now require disclosure of an issuer’s adoption and termination of a contract, instruction, or written plan to purchase or sell its own securities that is intended to satisfy the affirmative defense conditions of Rule 10b5-1. Also, in a departure from what was proposed, the new Item 408(d) will not require disclosure of a non-Rule 10b5-1 trading arrangement while the issuer will have to talk and disclose the material terms of the plan and arrangement. In response to comments, this new Item 408(d) will not require disclosure of the price at which the party that executed the trading arrangement is authorized to trade.
The Commission recognizes that some of the disclosures under 703 and new Item 408(d) may be duplicative and provided that, to the extent the disclosure under 703 is also responsive and satisfies the disclosure requirement of 408(d)(1), the disclosure can be cross-referenced under that section. The issuers are also required to tag information disclosed pursuant to the new exhibit under Item 601 of S-K, Item 703, Item 16E of Form 20-F and new Form FSR in Inline XBRL, in accordance with rule 405 or Reg S-K as well as the EDGAR Filer Manual.
Lastly, the prior monthly disclosure requirements under 703 as well as Item 16E of Form 20-F were eliminated in light of the new daily disclosure requirements that will still be done on a quarterly basis.
Lynn: One thing I was going to just note is the interesting policy call that the Commission made with respect to foreign private issuers — and I’d definitely be interested in Rob’s perspective on this, as well — in that Commissioner Uyeda, in his statement about the rule, basically said these amendments may be remembered as the beginning of the end of the Commission’s approach to foreign private issuers because for many years, FPIs just filed Form 20-Fs on an annual basis and then Form 6-Ks to report disclosures made under home country requirements. Now we have this new form in which quarterly reporting will be required specifically for foreign private issuers around share repurchases. It’s interesting that in light of where the Commission’s been going around foreign private issuers for several years now, it seems like a significant shift in approach.
Robert Evans, Partner, Locke Lord LLP: I agree with that. It offends me a little, because I think for non-U.S. companies that have a deep and liquid trading market in their home country, but have a secondary listing in the U.S., their buybacks are done under home country rules, and their buybacks are done outside the U.S. While it does have an impact here and it is disclosure that the SEC is making U.S. companies give, it’s not directly implicating the U.S. and it feels like the kind of thing that historically would’ve been left off the list for foreign private issuers, in the same way that Section 16 reporting doesn’t apply to foreign private issuers.
Lynn: Let’s turn it over to Allison for always our favorite topic, the interpretive questions that inevitably arise when these types of rules come down the pike.
Compliance Challenges for Public Companies
Allison Handy, Partner, Perkins Coie LLP: With the way that this rule ended up, there may be fewer interpretive questions, or they may be a little less new or nuanced.
You can see that even in the adopting release. A lot of people in comments had asked things like, what about reporting accelerated share repurchases or what about equity compensation? The SEC, in the adopting release, said, “Given that you don’t have to do reports every day, those questions just don’t matter anymore,” which maybe is right, maybe is not. At least in terms of thinking about reporting on accelerated share purchases and equity compensation issues, in large part, it’s just going to be consistent with the prior 703 disclosure.
Just some background for those who haven’t been using them, in case they become more popular. With accelerated share repurchases, it’s basically a company entering a forward contract with a broker. On Day 1, you enter the program and at that time, the company buys about 80% of the shares that they anticipate buying under the program from the broker. The broker goes out into the market and borrows shares to deliver that 80% to the company. Over the life of the program, which is often three to six months, the broker is out in the market buying shares in order to return the borrowed shares that they delivered to the company upfront.
The way that companies have typically disclosed this under 703 is to report, in the month in which the agreement is entered into, the number of shares delivered on the day of execution of the contract with a footnote saying that it’s an accelerated share repurchase. At the end of the program, it gets settled. If the price goes up significantly, the company might need to return some shares or pay cash in lieu of those shares. If the price stays in the same general area or goes down, the broker might be delivering shares at the end of that program. The way that companies have reported this under 703 is to report that settlement at the end of the program. I think that that’s going to look fairly similar to existing disclosures.
Equity compensation is one of the few areas where there’s some CDIs for S-K 703 from the SEC about option net exercises. Also, if you go to the JCEB notes from 2004 on TheCorporateCounsel.net, there’s helpful guidance on thinking about different types of equity and compensation, and which things need to be reported as repurchases. A lot of companies have been living under that framework for many years and with the SEC not providing any more guidance in the adopting release, we can anticipate that things will be the same as to how it was treated before.
Another interpretive question is what to do if you have not made any repurchases. For domestic issuers, Reg S-K Item 601(b)(26), the new exhibit requirement, says “every issuer with a class of equity securities registered pursuant to Section 12 that files reports must file this exhibit.” There’s no instruction or anything that says, “If you made repurchases, you must file.” It just says, “Everyone must file it.” That’s one area where we might be hoping to get further guidance from the SEC, that if you don’t have any repurchases in a particular quarter, you don’t have to file the exhibit. Absent guidance, I think there’ll be companies that will get comfortable with a disclosure in the appropriate part of the 10-Q or 10-K saying, “There were no repurchases,” and then not filing it, but it’s not clear from the rules that you can do that.
For foreign private issuers, there’s even more ambiguity. New rule 13a-21 provides that every foreign private issuer must file Form FSR within 45 days after the end of the quarter, but then if you actually look at Instruction 1 to Form FSR, it says the form must be filed if purchases are made. Again, it’s not totally clear. We may see some guidance from the SEC on that, maybe not, or they might just say, “You’re all grown-ups, make a decision with what makes sense.”
Lynn: It’s a great point that until we hear otherwise, we can continue to apply the guidance from Item 703 situations to the extent relevant, and that seemed to be what the Commission was intimating in the adopting release when it brushed off all those interpretive questions and requests for more clarity in the rules. I’m sure we’ll get more questions coming up as we move into the compliance period and people try to capture this information. We’ll keep addressing those as they come along on TheCorporateCounsel.net.
Speaking of compliance dates, I’ll turn it over to Rob to talk about when we have to start doing all this stuff.
Evans: Sometimes, understanding the transition rules and the effective dates of SEC pronouncements can be tricky. In this one, in trying to come up with the right way to talk about it, it helps to focus on, “When are you doing a buyback?” It’s not so much when the rule becomes effective, but which buybacks that a company is going to be doing starting now, will have to be subject to these rules.
For example, for calendar-year companies, for U.S. companies reporting on 10-K and 10-Q, buybacks starting in the fourth quarter of this year, the company will need to comply with the new rules in reporting 703 information and the other narrative disclosures that are required by the new rules. That means, if you’re doing buybacks before the fourth quarter, those are under the old rules. Once you get to the fourth quarter, any buyback in that quarter will be the first time when you would apply those rules. If you don’t do a buyback in the fourth quarter, you’d still need to file that exhibit with your 10-K. The 2023 10-K filed in early 2024 would include that exhibit, but presumably it would be blank.
For non-U.S. companies filing Form 20-F, again focusing on when the buybacks become subject to the new rule, it is buybacks beginning within the second quarter of next year. If the company does the buyback all the time — as a number of companies do — starting with that second quarter, that buyback would be subject to the new daily trading data disclosure requirement and that would be done on Form FSR and it would be filed within 45 days after the end of that quarter. The narrative disclosures that go along with that would be in the company’s first 20-F following their first Form F-SR.
As mentioned before, we’ll skip over the closed-end funds because that’s not the focus of our audience.
As you can imagine with respect to companies that are not on a calendar year, the calculation is a little bit different, but it mostly comes out in the same spot because again, we’re focusing on when the buybacks start. If you’re not a calendar year-end company, you start with the first full fiscal quarter after October 1st of this year. For example, if you were a company with a January 30 year-end, if you had a buyback in the last quarter of this year, it would be subject to the new rules. That’s how you apply the compliance states to the buyback information. I’ll turn it over to Allison.
Handy: Great. I’m going to talk a little bit about the litigation challenging the rules. The U.S. Chamber of Commerce and a few other interested parties have filed suit in the Fifth Circuit Court of Appeals to prevent implementation of the rules. There’s not much to their actual filing at this point. I think we’ll see their arguments a little bit later, but you can look at comment letters that they submitted over the life of this rule proposal to see the basis for their challenges.
It’s really two things. They’re arguing that the adoption of the rule did not comply with the Administrative Procedure Act, and then they’re also making a First Amendment argument.
On the Administrative Procedure Act, they have a few different things that it seems they’re arguing over. When the initial rule was proposed, the comment period was 45 days. Often, the SEC gives 60 days. They didn’t like that. It was reopened for two weeks in the fall of 2022 because there had been some technical problems with the SEC’s website. The Chamber also wrote a letter to argue that that two-week period wasn’t sufficient notice. Also in their letters, the Chamber also argued that the adoption of the Inflation Reduction Act created another pushback against stock repurchases, and that the SEC ought to put out a new economic analysis of their rule because there were now multiple different things pushing back against issuers doing stock repurchases. The Staff actually did that, and the SEC did put out an additional memorandum and a new comment period for comments on that, but overall, the Chamber of Commerce doesn’t believe, especially with that additional economic analysis, that there was sufficient time for people to comment on that or that it was done effectively.
On the First Amendment argument, this is one where — similar to the argument that ultimately won the day, in part, on the conflict minerals rule — there’s an argument that this is compelled commercial speech and that the government does not have a substantial interest and has not shown that the disclosure is purely factual, uncontroversial and not unduly burdensome. They have argued that in particular, the disclosure requirement that the companies talk about the rationale or objective of their buyback program is not purely factual uncontroversial information. That again echoes what Dave said at the outset that stock buybacks are a bit of a political issue right now. Therefore, the argument is that companies should not be compelled to talk about the rationale or objective of their corporate decisions that might be considered controversial. We’re at the very beginning of that litigation.
In terms of what might happen if they were to succeed on either one of these arguments, if a plaintiff wins on an Administrative Procedure Act claim, the rule gets set aside and the SEC would have to start from scratch. There are some nuances there, but that’s the big picture. If they were to win on the First Amendment argument, we would perhaps see something narrower, like what happened with the conflict minerals situation where there’s just a particular piece. If they actually won on that one, maybe that disclosure regarding the rationale or objective of repurchases would be eliminated. It’s still very early. I don’t know that this is going to have any effect, but we’ll see.
Lynn: That was a great summary of the litigation. I would ask people not to get their hopes up on litigation like this in terms of avoiding having to comply with the rules and that compliance schedule that Rob articulated, simply because it is hard to get the implementation of a rule stayed. That’s a whole other issue as to whether you can meet the burden there to actually stay the effectiveness of the rule before the court actually considers the arguments challenging the rule on the merits.
Then, a potential outcome is that just as parts of the rule are struck down. It was a good analogy to the conflict minerals rule situation — we still have to deal with and comply with that rule, but it’s basically gutted as to the whole point of the rule. The litigation is always something people see out there and hope that it could be promising — and there very well may be a lot of merit to the points that have been raised by the litigants here — but it’s a long path and it’s not necessary path we would avoid having to start filing this stuff for the fourth quarter of this year. Now, I’ll turn it over to Rob.
Impact on Insider Trading Policies
Evans: I’ll give some background on how companies currently do stock repurchases. The background section in the SEC’s adopting release for the final rules, which starts on page 12, is a good summary of why companies do buybacks and how they typically execute them. The Staff mentions a number of different ways that a company can execute a buyback. They could do a tender offer, a negotiated repurchase or an accelerated share repurchase, but the vast majority of buyback programs are done as what is called an “open market buyback program.” An open market buyback program means that the company buys shares in the trading market. There are a couple of different ways that a company can do that.
The typical way that we usually see it done is that when the company announces its quarterly earnings, it also announces that its board of directors has determined that the company will begin a buyback program. Typically, that disclosure will say that they can execute that buyback program through open market buybacks, negotiated purchases and 10b5-1 plans. Again, because a company’s buyback program can get shut down by the company having material nonpublic information, a company that really wants to accomplish that buyback program and to get those shares in is going to instruct a broker to conduct the buyback program pursuant to a set of instructions that will comply with 10b5-1.
In that context, the broker will execute the open market purchases and they will do so in accordance with the 10b-18 limits, because that’s the safe harbor from being viewed as the company manipulating its own stock price. They often will not have a live trader implementing these trades but will use an algorithmic trading program to buy in the shares. In that 10b5-1 plan that would be written down between the company and the broker, there would be instructions of the limits of what price the company wants to pay, how many shares it wants to buy or how aggressive it wants to be in acquiring shares. That will be part of the arrangement so that the broker can then go and do the transactions in the market without input from the company, because the company doesn’t give input. Those trades can be done even if the company subsequently obtains material nonpublic information that would block it from being able to trade.
On the officers and director side of things, in that usual approach of announcing your buyback at the same time you announce your earnings, the officers and directors would’ve been blocked from selling shares into the market during the blackout period that ends when the earnings are released. They would’ve been blocked from selling shares prior to the announcement of the stock buyback program. Once the earnings are released, those officers and directors would end up in an open window for stock sales so they could be able to sell through the broker under a 10b5-1 plan if buying in the market. There is some concern that’s been expressed by academics that somehow officers and directors of the company are benefiting from the fact that the company is in the market buying shares, and that there might be something wrong with an officer or director selling at that time. Therefore, there’s a requirement to check the box if officers or directors sell during the first four business days following announcement of the buyback program. It also covers the four days before it.
As we said, if you’re typically announcing it this way, the officers and directors won’t have been selling because they would’ve been in their own blackout period. Then the question becomes, should the company change its behavior as a result of this new check-the-box requirement? I suspect that companies may well do so. There’s no identifiable benefit to blocking officers and directors from selling in that first four days after the announcement of the buyback program, but I think companies will be shy about having to check the box. We may see people changing their open windows to cause officers and directors not to sell during their first four business days so that they don’t have to check the box. This is a little bit like naming and shaming. Why would you draw more attention to your buyback program by announcing that there were officers and directors selling during that time period? That may be one adjustment that we see in behavior.
Other than that, I don’t think there are likely to be many changes in behavior. I think that the level of detail that will be made available to the public will be much greater than it was than it is currently in the 703 disclosure. That type of information, the broker-dealer executing a repurchase program like this, provides all that information to the company anyway. Preparing the new exhibit that has to be filed should be relatively straightforward, and that information will be provided by the investment bank in the ordinary course. The company is buying back its own share, so it needs to know what price it bought them back and when that trade happens so it can keep the broker honest in terms of the implementation of the repurchase program.
In terms of market reaction to officers and directors being allowed to sell during a time period when there’s a buyback going on, I suspect that the reality is that, particularly for companies that are frequently in the market conducting buybacks, if they were to go further and say officers and directors may not sell while the company is in the market buying back and make that disclosure in there, they would be effectively blocking their officers and directors from being able to get any liquidity in their company stock and being able to sell any of the company shares for much longer periods during the year. They’re already constrained by anytime the company has MNPI and during the windows before the end of the quarter until the earnings are announced. That would tend to have an adverse effect on the officers and directors being able to get liquidity.
Another thing is that, particularly now with the extension of the waiting period on 10b5-1 plans, officers and directors may have entered their sale plans long before the company announces a buyback program. In some ways, there will be a disconnect between the sales by the officer, director, and the purchases in the market by the company, and therefore serve another reason why not to change behavior.
The only other change in behavior that I would expect is that the adopting release and the proposing release do go into some detail on the ways that academics and regulators have worried about things that a company could do — for example, announcing a buyback program in order to boost the stock to hit a compensation target for officers and directors, or other ways that the company might have measurements of success based upon its stock price or based upon its earnings per share. I think as a board member of a company, before approving a buyback program, it might be worth asking the questions that could cause the company to look bad in hindsight once the buyback is disclosed and the reason and the timing of the buyback is disclosed, and to make sure that the company management is not choosing to do the buyback for reasons that feel like they’re not related to the benefit for the company and the shareholders, but are more targeted on making sure that the company hits its earnings or that the company or that the officers and directors receive their bonuses for the year.
Let me turn this over to the next section and talk about controls.
Implications for ICFR and Disclosure Controls & Procedures
Anagnosti: Controls has been an interesting area where we see the SEC use it as a basis for bringing a number of enforcement actions, including a case in the stock buyback area a couple of years ago regarding inadequate controls around authorizing a stock buyback plan. Even though the company had a policy, the SEC felt that the company had failed to take reasonable steps to ensure that the people that were evaluating whether the company was in possession of MNPI should have been aware also about other significant corporate developments happening.
In light of these new disclosure requirements, as these precedents highlight, it is not sufficient just to have a policy, but it’s imperative that companies have a process to ensure that the policy is followed. Again, I want to emphasize that one size doesn’t necessarily fit all. Decisions around what control should be implemented or revised are based on the facts of circumstances analysis and also the company’s historical approach to stock repurchases.
There is this new disclosure requirement under the rules that the companies now have to disclose the objectives or the rationale and the process and criteria for determining the amount of repurchases. It’s important to set up a clear control framework to develop the proper rationale that would withstand investor and regulatory scrutiny.
Once the board approves their repurchase program, it’s usually up to management to develop the process or matrix, if you will, for determining how those are going to be taking place in the market. It’s important to develop a thoughtful narrative around the process and how the program will be implemented. While on a quarterly basis there may not be much variance on the rationale of the process to the extent that such criteria changes over time, companies should think about establishing disclosure controls to ensure that the disclosures are reviewed or adjusted as appropriate with respect to each quarterly disclosure. Companies should be careful about public statements made by executives on earnings calls or in press releases that relate to stock repurchases to make sure they are consistent with what the company is now disclosing on a quarterly basis through these exhibits and the enhanced narrative disclosures.
I also would focus on ensuring proper documentation for substantiating the objectives and the process used to determine the amount of repurchases. The board approves these repurchases, so it’s critical that in carrying out their fiduciary duties, the board’s process for determining these criteria and establishing the repurchase program to sound from a risk and liability perspective, considering the new disclosure requirements put a spotlight in this process.
We had several clients raise questions around, “What about existing repurchase programs that may still be effective by the time the rules go live?” Go back to look at what the board articulated as an objective criterion at the time that may not necessarily be up to par with a new disclosure requirement. It’s important for the board to reassess the objective and criteria of previously approved plans. In connection with the disclosure of daily repurchase data, I don’t think it is going to require a major lift for domestic companies, because companies were already receiving that information from the brokers. It was being aggregated monthly as opposed to daily. It’s still worth re-evaluating the existing controls to ensure the collection of the daily data does not require any updating in order to make sure that the companies are compliant with the new disclosure requirements.
As mentioned earlier in the program, the harder adjustment will be for foreign private issuers. Again, as mentioned by Dave, Allison and Rob already, I think that this is probably the first requirement for an FPI to file something on a quarterly basis. A lot of FPIs file earnings reports, but they’re not on a prescribed timeline. With the adoption of this new Form F-SR, FPIs need to think about putting in place the necessary controls to enable the timely gathering of the relevant information to ensure accurate and timely disclosures. Also, FPIs often are listed on another exchange and they’re subject to their home country rules. Starting the work out now to map out the disclosure requirement of these new rules and how they fit within the home country or foreign exchange regimes will hopefully eliminate a lot of the friction by the time that the FPIs will have to come to comply with these new disclosure obligations.
One of the other critical areas will be the consideration of establishing policies or procedures related to purchases or sales of shares by officers and directors during the pendency of a repurchase program. As already mentioned, the companies are what’s called “always in the market” repurchasing their shares, and precluding sales by executives while companies are repurchasing their shares seems unnecessarily restrictive since the potential for abuse in this situation is viewed as largely theoretical. Again, compliance with the 10b-18 safe harbor designed to insulate an issuer for press manipulation liability should also provide additional comfort that same-day insider sales and company resources are not designed to benefit insiders, especially if both transactions are executed under 10b5-1 plans.
However, I do want to make the point that the SEC or the plaintiffs’ bar will have the benefit of hindsight with all the information about daily trading the companies now are required to make. Companies should expect greater scrutiny. It would be advisable to ensure that companies have some controls in place and, if not, design and implement them to help monitor and keep track of the insider’s open market transactions so they can evaluate the risks of corporate action or significant announcements that might be viewed as questionable in hindsight. Companies may also want to consider developing policies that address specific scenarios like an accelerated share repurchase program, which typically is based on how they implemented it now and explained they have a greater impact on the share price on the same day as significant sales by insiders are taking place, especially if they’re affected by either the CEO or the other executives that may be expected to be involved in managing the repurchase program.
Those are some of the ideas for the companies to start thinking around controls for purposes of the rule compliance. I’ll hand it off to Dave.
Practical Consequences of Heightened Buyback Disclosures
Lynn: I think the control issues then lead us to, are there policies that we have to put in place, are there policies that we have to revisit as a result of these rules and other things that have happened recently? In my mind, there’s probably one paramount consideration. When you look at the Rule 10b5-1 and insider trading disclosure release at the end of last year that was implemented earlier this year, and then you look at this share of purchase requirement, it raises the question of, do I need to put in place a policy, specifically around the issuers’ transactions in company securities?
In my experience — and this varies quite a bit, so you can only just talk anecdotally here — a lot of issuers have a process around share repurchases, but they don’t necessarily have a policy around share repurchases or other transactions in company securities. Consistent with the description that Rob gave of how the purchases are undertaken, often there are decisions made by management (the CFO, treasurer, etc.), as to when to engage in share repurchase activity or when to initiate a share repurchase plan or change the amount that the company contemplates buying under a plan. Then, the board is involved and considers management’s presentation and resolutions to approve either the implementation of a plan or the changes to a plan. It’s then left to the management folks involved to enter into 10b-18 arrangements that Rob talked about or enter into 10b5-1 plans if they’re planning on purchasing at a time when the company has the material nonpublic information. Individuals will go through a process to make sure the company is not in possession of material nonpublic information at the time that they’re engaging in share repurchases and open market transactions, or at the time when they’re entering the 10b5-1 plans.
That is a process that works well for issuers that are active in share repurchases or even issuers that only do it incidentally. The company’s actual repurchase of the shares is a different situation from insider transactions in company’s securities, for which we have a full-blown insider trading policy applicable to those individuals that is designed to protect people from themselves and to protect the company from control person liability. Up until now, I don’t think people thought of having a policy of that sort in place and articulated for the issuer’s own transactions in its securities. It seems from some of these disclosure requirements that the SEC has a concept that they think that companies do have these policies in place, or they would expect companies to have these policies in place, so that’s why they’re asking for companies to have disclosure about such policies.
The first shot across the bow on this was with the 10b5-1 rules when Item 408(b) was adopted under Reg S-K — that talked about policies and procedures governing the purchase sale or other dispositions of securities by, among other parties, the issuer itself. In these new rules, we have more specific disclosure around policies and procedures relating to purchases and sales by the issuer of securities, including by officers and directors during the repurchase program.
There’s more talk about policies than perhaps people have thought to implement prior to this time. Given these disclosure developments, it puts the onus on us as advisors and people working in companies to figure out, is there some need for a new or revised policies in order to have the controls that we need for this purpose and also to satisfy these disclosure obligations in a way that indicates the company is on top of this? For example, to put in place something more formal in terms of policies around the issuers’ transactions in its own securities? To revisit existing policies like the insider trading policy? To address the point that Rob was talking about in terms of the four-day window before and after announcement of share repurchases, whether that’s something that people would want to bake into a restricted period within their insider trading policies for insiders?
Then, to the point that both Rob and Era talked about, which is this notion of employees or insiders engaging in transactions of company securities at the same time that the company is engaging in repurchases of its own securities. That is the much harder question for which there’s no good answer other than it would be difficult to prohibit those insiders from engaging in those transactions at the time the company is engaging in its own transactions in the company securities, simply because it would, for many companies that are so active with share repurchases, substantially limit the availability of market transactions for those executives. That would make things very difficult.
The risk, as we’ve alluded to a few times on the webcast, is that now people will have this data and they can much more easily juxtapose transactions in companies’ securities by insiders at the same time the company’s engaging in those transactions and try to draw negative inferences from that information. Companies will need to be sensitive about that. I think it will just continue to be an evolving area as people are now focused on this topic.
With that, I’ll just go around the panel and see if anybody has any closing thoughts or words of wisdom.
Anagnosti: Thankfully, these are not completely brand-new rules. There is work to be done, but it’s not the company’s first rodeo with stock repurchases. The bigger questions are going to be around these tricky policy issues around insider transactions and company purchases.
Evans: The big news on this is how much better the rules are in the final adoption compared to the proposal. This feels like it will be straightforward for companies to implement, but they do need to pay attention and perhaps tweak their blackout periods for officers and directors to avoid having to check the box in a quarter where they announce a buyback program. It will be quite an adjustment for foreign private issuers having a new reporting regime that they’ve never been subject to before but for U.S. domestic companies, this should be straightforward, and we won’t know the impact until academics and plaintiffs’ lawyers get access to the daily detail and start trying to identify things that the company did wrong. At that point, we’ll just have to see how those things turn out.
Jenkins: Great. Thank you to our panelists for a great program, and I want to thank all of you for joining us today. This concludes today’s webcast.
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