There are a number of legitimate reasons for an issuer of publicly traded equity securities to repurchase those securities. Issuers may, for example, believe that a stock repurchase program is preferable to paying dividends as a way to return investor capital; or issuers may desire to have additional shares available for employee stock ownership plans.
Alternatively, issuers may choose to reduce their outstanding capital stock after selling an operating division or subsidiary for cash. Investors may also benefit from issuer repurchases in the form of additional liquidity in the marketplace. Because issuer repurchases can affect the market price of its outstanding stock, however, an issuer may elect to repurchase its stock to artificially boost the stock price. Even where an issuer has a bona fide business purpose for repurchasing its stock, it may be subject to claims that it did so in a manipulative manner with the intention to boost the market price of the stock.
In 1982, the Securities and Exchange Commission (SEC) adopted Rule 10b-18 (the Rule) under the Securities and Exchange Act of 1934, as amended (Exchange Act), to provide issuers and their affiliates with a non-exclusive safe harbor from liability for alleged manipulation under the anti-fraud provisions of the Exchange Act. This safe harbor provides that an issuer that repurchases its common stock in the market in accordance with the Rule’s manner, timing, price and volume conditions will enjoy immunity from alleged manipulative conduct unless it violates other anti-fraud provisions. The Rule’s safe harbor conditions are structured in such a way as to minimize the market impact of the issuer repurchases and thereby ensure that changes in a security’s price are the result of independent market activity.
Although there is no presumption under the federal securities laws that an issuer’s repurchases of its common stock outside the Rule are manipulative under the anti-fraud provisions, issuers embarking on share repurchase programs have typically followed the conditions imposed under the Rule to minimize the risk of liability. Since the adoption of the Rule in 1982, there have been significant changes related to trading strategies and developments in the public securities markets. In recognition of those changes – including the development of automated trading systems and technology that have significantly increased the speed of trading – the SEC now proposes to amend the Rule to clarify and modernize the requirements of the safe harbor.
Specifically, the SEC is proposing the following amendments to the Rule:
- to modify the timing condition to preclude Rule 10b-18 purchases as the opening purchase in either the principal market for the security or the market in which the purchase is executed;
- to relax the price condition for certain repurchases effected on a volume-weighted average price (VWAP) basis;
- under certain circumstances, to limit the “disqualification condition,” which provides that the failure to meet any one of the four conditions disqualifies all of the issuer’s purchases for the day; and
- to modify the “merger exclusion” provision to extend the time in which the safe harbor is unavailable in connection with an acquisition by a special purpose acquisition company (SPAC).
The SEC notes that the principal market’s opening price for a security has become a widely followed benchmark for, and a significant indicator of, the direction of trading, demand and market value of that security; it therefore proposes to bar an issuer from executing a repurchase under the safe harbor as the opening purchase in both the principal market for the security and the market in which the purchase is executed. This change is consistent with the current limitations on purchases by the issuer at the end of the trading day.
The Rule currently limits an issuer to trading for or purchasing its security at a purchase price that is no higher than the highest independent bid or last independent transaction price quoted or reported in the consolidated trading system. The SEC proposes to exempt from this price limitation purchases by issuers executed on a VWAP basis, if certain criteria are satisfied. Those criteria include a requirement that the VWAP purchase must be for a security that qualifies as an “actively traded security” and must be entered into or matched before the regular trading session opens with an execution price that is based upon a full trading day’s volume. The proposed VWAP exception from the Rule’s price condition is therefore intended to provide issuers with greater flexibility in effecting transactions within the safe harbor.
The Rule provides a safe harbor for issuer purchases on a single day. The Rule’s manner, timing, price and volume conditions must all be met with respect to all purchases by or on behalf of the issuer, otherwise all such purchases on a given day are disqualified from the safe harbor. The SEC notes the increased speed of today’s trading markets, including the rapid changes in the current national best bid immediately prior to the execution of a safe harbor bid or purchase (“flickering quotes”), and the resulting difficulty in ensuring that every purchase of common stock during the day will meet the price condition. Recognizing that even an inadvertent violation of the current price condition of the rule triggers the daily disqualification provision, the SEC proposes to amend the Rule to limit the disqualification provision to only the non-compliant purchase. Thus, in instances in which the issuer’s repurchase order is entered in accord with the Rule but, immediately thereafter, the order is executed outside the price condition due to flickering quotes, only that non-qualifying trade would be disqualified from safe harbor treatment.
Currently, the Rule prohibits issuer repurchases from the time of public announcement of a merger or a similar transaction involving a recapitalization until the vote by the target shareholders to approve the transaction or the completion of the transaction, whichever is earlier. The SEC believes that SPAC acquisitions can present unique conflicts of interest because of the severe time pressure – typically 18 to 24 months – in which a SPAC must identify an appropriate target and complete the acquisition. Generally, if an acquisition target is identified, both the SPAC shareholders and target shareholders must vote to approve the proposed transaction, but the SPAC shareholder vote usually happens later in the process. In light of the special incentives and deferred compensation features of most SPACs, the SEC believes that management of a SPAC may attempt to rely on the Rule to repurchase a substantial percentage of the outstanding shares in the open market, thereby enhancing the probability that the acquisition will be approved. Accordingly, the SEC proposes to amend the Rule to increase the time during which the safe harbor is unavailable in connection with an acquisition by a SPAC until its shareholders have voted on the transaction.
The proposed amendments would, if adopted, update the safe harbor in light of market developments over the past 20 years. They would provide issuers (other than SPACs) greater flexibility to conduct their share repurchase programs within the Rule without sacrificing market integrity or investor protection. Additionally, the proposed amendments would provide clarity related to the scope of permitted market activity for issuers and the broker-dealers that assist them in executing their repurchase plans. In the absence of these modifications to the Rule, many issuers will be reluctant to execute share repurchase programs without being certain that their repurchases come within the current safe harbor. Although the Rule does not provide an exclusive safe harbor, disqualified repurchases that fall outside the Rule create substantial risks of liability for the issuer under the anti-manipulation provisions of the Exchange Act. The proposed modifications of the safe harbor should provide comfort to issuers that are contemplating share repurchase programs while providing increased liquidity to the marketplace.