In addition to the proposed rules regarding insider trading policies that we wrote about a few weeks ago, the Securities and Exchange Commission has also proposed amendments to its rules regarding disclosure about stock buybacks. The proposed rules would require an issuer to provide a new Form SR before the end of the first business day following the day the issuer executes a share repurchase. The new Form SR would require issuers to identify the class and total amount of securities purchased, the average price paid, and whether the amounts were repurchased in reliance on the safe harbor found in Exchange Act Rule 10b-18 or pursuant to a Rule 10b5-1 plan.
Further, the proposed rules would also enhance existing periodic disclosure requirements regarding repurchases of an issuer’s equity securities. Among other requirements, issuers would be required to disclose in their 10-Ks and 10-Qs (and in the case of foreign private issuers, their 20-Fs) (i) the objective or rationale for the share repurchases, (ii) the process or criteria used to determine the repurchase amounts, (iii) whether the amounts were repurchased in reliance on the safe harbor in Exchange Act Rule 10b-18 or pursuant to a Rule 10b5-1 plan, and (iv) any policies and procedures relating to purchases and sales of the issuer’s securities by its officers and directors during a repurchase program, including any restriction on such transactions. Companies would also have to disclose whether their Section 16 officers or directors purchased or sold shares or other units subject to the repurchase plan within 10 business days before or after the announcement of a repurchase plan or program covering the same class of securities.
In light of these proposed rules, you may want to take the following steps in advance of potential required disclosure:
1. Revisit with your treasury department the basis for repurchasing shares. Investors are generally fine with buybacks when they are used to maximize shareholder value – for instance, when they are used to offset share dilution from employee equity compensation programs, to help signal the issuer’s view that its stock is undervalued, or because the issuer’s board has otherwise determined that returning value to shareholders is a prudent use of the issuer’s excess cash. Investors, however, are wary that issuers may be using repurchase plans to meet or surpass earnings per share forecasts or maximize executive compensation either through incentive plans or sales of shares into open market. As the rationale for repurchases may soon have to be disclosed, it is increasingly important to make sure appropriate rationales can be articulated, and have been documented at the time decisions are made.
2. Consider developing policies regarding the timing of open market sales by executive officers and directors. Given that issuers will have to disclose such transactions, it may be a good idea to consider adding to your insider trading policies a prohibition on executive officers and directors selling or purchasing the issuer’s stock within 10 business days before or after the announcement of a repurchase plan or program, and/or creating an automatic blackout period during these dates. If there is a blackout period, you may also need to develop internal policies and mechanisms for notifying brokers as to an impending repurchase plan or program. It may be preferable to prohibit some transactions than to disclose them, given the SEC’s concerns driving the proposed disclosure requirement. As the SEC notes, “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.”
If you choose not to change your policies and procedures to limit such trades, given potential reputational issues, you may wish to encourage the use of Rule 10b5-1 plans for both the issuer and insiders and provide a memo in advance to the issuer’s executive officers and directors (and other affiliates) about the risks of buying or selling while the issuer is repurchasing shares.
Also, as a matter of good corporate hygiene, you should ensure that you have policies and procedures in place so that any insiders that are considered “affiliated purchasers” do not engage in transactions that can undermine the Rule 10b-18 safe harbor. For example, such policies could include provisions prohibiting insiders who could be deemed to be affiliated purchasers from purchasing securities in excess of the Rule 10b-18 volume limitations when taking into account issuer purchases, and also include safeguards against the price and timing limitations in Rule 10b-18.
3. Consider adopting option grant policies that take into account repurchases. A number of companies do not have option grant policies or do not specifically contemplate the impact of granting options and similar instruments in close proximity to the announcement of stock repurchases. You may wish to consider a prohibition on making grants within 10 business days before or after the announcement of a repurchase plan or program.
4. Review the continuing use of EPS targets and/or whether such targets exclude the impact of buybacks. A 2020 staff study cited in the notes to the proposed rules and highlighted by both dissenting commissioners emphasized the need to monitor the use of EPS targets and the impact of buybacks on such targets by noting 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.’”
5. Reevaluate process with broker. While traditionally the role of issuers in administering 10b-18 and 10b5-1 plans has been quite limited, some companies employ a near daily process of checking in with their broker. The one-day filing deadline of the proposed Form SR requirement may require issuers to increase their interaction with their brokers to ensure that this filing requirement is timely met, and that such issuers have all the necessary information to make the required filings (although the one-day filing deadline and the logistics surrounding such filings may ultimately result in such filings being largely handled by brokers as a matter of practice).
Issuers also typically delegate persons employed by the issuer to work with the broker to carry out buybacks. While a point person can be someone who is considered an “affiliated purchaser” under Rule 10b-18, you should consider developing policies or preclearance procedures to ensure that such point person will not sell at the same time that the issuer is buying back stock.