In a down market, a public company may seek to take advantage of depressed stock prices by implementing a stock repurchase program or by deciding to “go private” through the purchase of all its stock. The following is a brief summary of federal securities laws applicable to such transactions as a prelude to further discussion with legal counsel.
Stock Repurchase Programs
When a public company’s stock is undervalued, stock repurchase programs may be used by the issuer to return value to shareholders, increase share price and earnings per share, and invest unused cash. A stock repurchase also indicates that the company believes that its own stock is a good investment, signifying its financial well-being.
Market Manipulation and Stock Repurchases under the Rule 10b-18 Safe Harbor
Stock repurchases by an issuer or by its affiliates are subject to rules prohibiting fraudulent practices and market manipulation through the creation of a false or misleading appearance of active trading of registered securities, or through the raising and lowering of the security’s price.
Rule 10b-18 provides an issuer with a safe harbor from liability for market manipulation, provided the issuer’s stock repurchase complies with each of the manner, timing, price, and volume restrictions set forth in the rule. An issuer whose stock repurchase is unable to meet all four of these restrictions will have those repurchases disqualified from the safe harbor for that day. The safe harbor is nonexclusive, meaning that an issuer may repurchase its common stock through other means, without manipulating the market (such as a privately negotiated purchase), and that a repurchase can be made outside of the safe harbor conditions without creating the presumption of a manipulative repurchase.
Conversely, Rule 10b-18’s safe harbor does not provide complete protection from liability if the issuer’s purchase is in violation of other federal securities laws (e.g., laws restricting purchases or sales while in possession of material, non-public information). As a result, issuers should structure their purchase plans to comply with the Rule 10b5-1 safe harbor, which provides that an individual or entity buying or selling securities while aware of material non-public information does not violate Rule 10b-5 if the purchase or sale is in conformity with a binding contract, instruction, or written plan that was put in place at a time when the person or entity was not aware of such information.
Purchasing Conditions under Rule 10b-18
- Manner. All bids or purchases on behalf of the issuer or an affiliated purchaser must be made from or through a single broker or dealer on a single day. Electronic communication networks (“ECNs”) or alternative trading systems (“ATSs”) are registered as broker-dealers. Issuers may effect repurchases directly through an ECN or ATS, but may not use both an ECN (or ATS) and a non-ECN (or non-ATS) broker-dealer to effect repurchases on a given day. If an issuer uses a non-ECN broker-dealer for all stock repurchases on a given day, however, that broker-dealer may access ECN liquidity on the issuer’s behalf for that day.
- Timing of Purchase. Issuers with an Average Daily Trading Volume (“ADTV”) of $1 million or more and a public float value1 of $150 million or more, may bid for or purchase their securities up until 10 minutes before the scheduled close of the primary trading session in any market in which the security trades. All other issuers are restricted from repurchasing stock during the 30 minutes before the close of the trading session. Trading may also be conducted after-hours until the last sales prices are reported in the consolidated system, subject to certain price thresholds.2 Additionally, an issuer’s bid or repurchase of its stock must not constitute the day’s opening transaction for the security.
- Price of Purchase. The purchase price may not exceed the highest independent bid or the last independent transaction price, whichever is higher, reported in the consolidated system.
- Volume of Purchase. An issuer’s daily repurchases are limited to 25 percent of the ADTV for that security. Block purchases are generally included in the calculation of the 25 percent limit and the ADTV. Rule 10b-18 provides, however, that issuers may repurchase one block each week, in lieu of purchasing under the 25 percent limit; provided that no other Rule 10b-18 purchases are made that day and that the block purchase is not used to calculate the four-week ADTV of the security.
The Merger Exclusion under Rule 10b-18
Rule 10b-18’s safe harbor excludes issuer repurchases after the public announcement of a merger, acquisition, or similar transaction involving a recapitalization of the issuer (“Corporate Transaction”), until the earlier of: (i) the completion of such Corporate Transaction; and (ii) the completion of a vote by target shareholders. The merger exclusion does not apply to: (i) Corporate Transactions in which there is no valuation period and the consideration consists solely of cash; (ii) ordinary purchases (namely those not made in connection with a Corporate Transaction) subject to Rule 10b-18 that do not exceed the lesser of 25 percent of the security’s four-week ADTV or the issuer’s average daily purchases for the three months preceding the announcement of the Corporate Transaction; and (iii) block purchases that do not exceed the average size and frequency of block purchases made during the preceding three months.
Stock repurchase programs should be authorized by board resolution setting forth the issuer board’s decision that a repurchase plan is the appropriate use of the issuer’s cash. Under most state corporation law, a stock repurchase is equivalent to a distribution and a company must, therefore, also meet the requirements for declaring a dividend under applicable state law. Moreover, stock repurchases are material transactions and, pursuant to NASDAQ and NYSE requirements, must be announced via press release prior to commencement. The press release should contain the terms of the repurchase program such as the commencement date, termination date, aggregate price, and total number of shares.
Both domestic and foreign private issuers must report all stocks repurchased, the average price paid per share, the number of shares purchased as part of a publicly announced plan, and the maximum number of shares that may be repurchased under future repurchase programs in their periodic reports, regardless of whether such repurchases were conducted pursuant to Rule 10b-18.
Accelerated Share Repurchase
An accelerated share repurchase (“ASR”) program is an increasingly popular alternative to traditional open market share repurchases. Rather than buy back shares of its stock from the market, a company purchases shares of its own stock from an investment bank at a pre-determined price on a specific date. The investment bank then borrows the shares and covers its short position through market purchases over a specified, extended period of time. ASR programs allow companies to obtain their securities immediately and to transfer the risk of fluctuating securities prices to the investment bank. Since the agreement between the company and the investment bank is a forward contract, however, neither the company nor the investment bank is eligible for Rule 10b-18’s safe harbor (which only protects traditional open-market stock repurchases). Companies should additionally consider counterparty credit risk when entering into ASR programs, especially since the company does not have the option to discontinue repurchasing its shares once an ASR program has been entered into.
There are a number of reasons why companies decide to “go private” when stock prices are depressed. Companies may wish to: (i) avoid the substantial costs of complying with SEC reporting obligations for public companies; (ii) demonstrate that its stocks are worth more than currently indicated by the market valuation; (iii) avoid disclosure of sensitive or competitive business information; or (iv) focus on long-term company objectives rather than the immediate management of market expectations. When a domestic or foreign private issuer engages in a specified transaction or series of transactions with the purpose or reasonable likelihood of causing it to become eligible to deregister, or to terminate or suspend a reporting obligation,3 the issuer is required to file a Schedule 13E-3 with the SEC in compliance with Rule 13e-3 of the Exchange Act. Such transactions are defined within Rule 13e-3 as: (i) stock repurchases by the issuer or its affiliate; (ii) tender offers; (iii) proxy solicitations or information statement distributions in connection with a merger or similar corporate transaction; (iv) sales of substantially all of the issuer’s assets to its affiliate; or (v) reverse stock splits.
In addition to the summary term sheet and background information on the transaction (e.g., the exact title and number of securities in question, the frequency and amount of dividends paid within the 9ast two years, and the identity and background of the filing person), Schedule 13E-3 requires disclosure of the following:
- Reason and nature. The material terms and the transaction’s purposes, reasons for the structure of the transaction, and why the transaction is being undertaken. Any consideration of alternative means for accomplishing the transaction’s purposes must also be disclosed.
- Fairness and consequences. The effects that the transaction will have on the issuer and security holders, whether the filing party believes the transaction is fair to the security holders, and the factors used to determine fairness. Any other reports, opinions, or projections related to the transaction should also be disclosed.
- Individual and company relationships to the transaction. Information regarding past contracts, transactions, negotiations, and agreements between the filing party and the company; people employed or compensated in connection with the transaction; the independence of the directors and special committee; and any solicitations or recommendations relating to the transaction made by the filing person to holders of the securities; is also required by Schedule 13E-3.
- Financial information. The amount and source of funds necessary to complete the transaction, along with any financial statements of the company. Additionally, the stock holdings of the filing party must also be disclosed.
- Other information. Any additional material information relevant to the security holder’s decision to sell or hold the securities should also be disclosed, such as the existence of any agreements or legal proceedings or any proposals regarding significant corporate transactions scheduled to occur after the company goes private.
Depressed stock prices in a down market provide many opportunities for companies seeking to make the most out of their undervalued stock. Stock repurchase plans and even “going private” demonstrate ways in which a company can use low stock prices to its advantage in furthering other important company objectives. Other tools in a company’s arsenal during a down market include issuer tender offers, reverse stock splits, deregistration, or restructuring. The suitability of any alternative depends upon the particular goals and attributes of the public company.