On November 14, 2023, the Securities and Exchange Commission announced a settled enforcement action against Charter Communications, Inc. (“Company”) imposing a $25 million civil penalty over allegations that the Company had used stock buyback plans that did not comport with Rule 10b5-1 of the Securities Exchange Act of 1934. The SEC claimed that the Company’s stock buyback plans did not comport with Rule 10b5-1 because the plans contained provisions that allowed the Company to change the total dollar amounts available to buy back stock and the timing of buybacks after the plans took effect; and while Rule 10b5-1 is a safe harbor rather than a standard that must be met, the SEC alleged that the use of buyback plans that did not meet the Rule 10b5-1 standard evidenced insufficient accounting controls in violation of Section 13(b)(2)(B) of the Exchange Act. While the SEC has been focused on Rule 10b5-1 for a number of years, bringing such an enforcement action over non-conforming 10b5-1 plans—particularly where the reason for non-conformance is nuanced—is an aggressive new approach that should cause companies to consider double-checking their own 10b5-1 plans against the current Rule.
Rule 10b5-1 provides an affirmative defense to claims of insider trading if certain conditions are met; accordingly, companies routinely enter into Rule 10b5-1 plans to allow their insiders to execute trades under defined parameters. Among other things, in order to comply with Rule 10b5-1, a stock buyback plan cannot allow a company to change the planned purchases or sales after adopting the buyback plan. This is the provision that the SEC claimed the Company’s plans violated, but for a nuanced reason.
The SEC alleged that the Company adopted nine stock buyback plans from 2017 to 2021 that were not in compliance with Rule 10b5-1. Specifically, the SEC claimed that the Company’s buyback plans included “accordion” provisions that were designed to align the amount of share repurchases with the cash the Company raised in debt offerings to fund the repurchases; the SEC claimed that these “accordion” provisions impermissibly allowed the Company to change the total dollar amounts available for buybacks, and the timing of the buybacks, because even though the Company was not able to directly change the number or timing of available buybacks, the Company retained discretion over whether and when to complete debt offerings that would automatically trigger these “accordion” provisions.
Even though the SEC did not claim that the allegedly non-conforming 10b5-1 plans were used to effect trading on the basis of material non-public information, the SEC claimed that their mere entry was evidence of a separate violation of the securities laws. Specifically, the SEC alleged that the entry into these non-conforming plans was evidence that the Company had not complied with its own Board of Director authorizations to enter into buyback plans that conformed with Rule 10b5-1, which in turn evidenced the Company’s failure to devise and maintain a system of internal accounting controls in violation of Section 13(b)(2)(B) of the Exchange Act. As the SEC put it, they claimed that the Company failed to implement “controls that reasonably assured that the company used trading plans in accordance with [the Board] authorizations.”
Again, while compliance with Rule 10b5-1 aims to protect against insider trading charges, failure to meet all of the Rule’s requirements is not a per se violation of the securities laws. Failure to comply with Rule 10b5-1 only deprives the trader of the protection of the Rule and trades may thus constitute illegal insider trading. However, the SEC did not allege that the Company was insider trading, but instead combined the Company’s Board’s repurchase authorization with a statutory provision regarding internal accounting controls. The SEC argued that the Company’s Board’s approval of the stock buyback plans was predicated on the plans’ compliance with Rule 10b5-1, and because the plans were not in compliance, the repurchases were not properly authorized and the Company had no internal controls to ensure the plans did comply with the Rule. The improper authorization then violated Section 13(b)(2)(B), which requires public companies to maintain internal accounting controls sufficient to ensure that transactions are executed in accordance with company management’s general or specific authorization.
The SEC’s “internal accounting controls” legal theory appears to be a potentially meaningful expansion of its enforcement approach. And two of the SEC’s Commissioners dissented from the Order, stating that the SEC’s internal accounting controls theory is “unsupportable and ill-considered” because it failed to distinguish between true “internal accounting controls” and controls designed to answer a legal question—“compliance with the regulatory conditions necessary to qualify for an affirmative defense.” But there is no reason to believe the SEC will not expand it further—indeed, it is a good reminder that the SEC can take an extremely broad view of its internal control provisions and seek to impose penalties on companies in a broad range of circumstances where companies permit conduct disfavored by the SEC.