On January 26, 2010, the Securities and Exchange Commission proposed amendments to Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the Exchange Act). The text of the proposed amendments can be found at http://www.sec.gov/rules/ proposed/2010/34-61414.pdf. Rule 10b-18 provides an issuer with a non-exclusive safe harbor from liability under the anti-manipulation provisions of the Exchange Act for open-market repurchases of its common stock. The rule was designed to balance legitimate business interests issuers may have in repurchasing their own securities with the market’s ability to independently establish the price of these securities. In proposing the new amendments, the SEC stated that it seeks to clarify and modernize the provisions of Rule 10b-18 in light of market developments since the rule’s adoption in 1982 and subsequent amendments in 2003. In particular, the proposed amendments to Rule 10b-18 would:
- modify the timing condition of the rule to preclude an issuer from making the opening purchase in the principal market for its common stock and in the market where the purchase is effected;
- relax the price condition of the rule for certain volume-weighted average price (VWAP) transactions;
- limit the disqualification provision of the rule to apply only to certain repurchases made in fast-moving markets under certain circumstances; and
- modify the merger exclusion provision of the rule to extend the time during which the safe harbor is unavailable in connection with acquisitions by a special purpose acquisition company (SPAC).
The proposed amendments would also make non-substantive changes to certain definitions.
Rule 10b-18 provides a safe harbor from the anti-manipulation provisions of the Exchange Act. To comply with the safe harbor, an issuer repurchasing its common stock must satisfy the rule’s manner, timing, price and volume conditions. The rule, as currently in effect, provides the following:
- Manner: An issuer is required to use a single broker or dealer per day to bid for or repurchase its common stock.
- Timing: An issuer is precluded from being the opening regular-way purchase reported in the consolidated system and is precluded from purchasing its common stock during the last half hour, or during the last 10 minutes for actively traded securities, before the scheduled close of the market.
- Price: An issuer is precluded from repurchasing its common stock at a price higher than the highest independent bid or the last independent transaction price, whichever is higher, quoted or reported in the consolidated system.
- Volume: An issuer may only repurchase in one day an amount up to 25 percent of the average daily trading volume in its common stock. Alternatively, an issuer may repurchase one block of its common stock once each week.
Proposed Amendments to the Timing Condition
Rule 10b-18 currently permits an issuer to be the opening purchase in the principal market for its common stock and the opening purchase in the market where the purchase is effected, provided there is already an opening purchase reported in the consolidated system that day (i.e., in another market). The proposed amendments would prohibit an issuer from making the opening purchase in both the principal market for the security and in the market where the purchase is effected, regardless of whether there have already been reported transactions in another market. The SEC reasons that the change is necessary because the opening purchase in both the principal trading market and in the market where the purchase is effected can be a significant indicator of the direction of trading, the strength of demand and the current market value of a security. Additionally, the amendments would also provide guidance to an issuer in complying with the rule, particularly in situations where the principal market has a delayed opening and another exchange’s smaller opening transaction is reported in the consolidated system first. Under the proposed amendments, the issuer would be required to wait until both opening transactions were reported in the consolidated system, rather than just the first transaction.
Proposed Amendments to the Price Condition
In some instances, an issuer may wish to repurchase its common stock on a VWAP basis. Because VWAP transactions are priced on the basis of individual trades throughout the day, however, the VWAP may exceed the highest independent bid or the last independent transaction price in violation of the rule’s price condition. To provide flexibility to issuers, the proposed amendments would allow issuers to conduct repurchase programs using VWAP under the following circumstances:
- the security being repurchased must be actively traded as defined under Rule 101(c)(1) of Regulation M;
- VWAP repurchases must be entered into or matched before the regular trading session opens, and the execution price of the VWAP-matched trade must be determined based on a full trading day’s volume; and
- VWAP repurchases must not exceed 10 percent of the average daily trading volume in the security.
In addition, VWAP must be calculated in the manner set forth in the proposed amendments and must be based on trades effected in accordance with the rule’s timing and price conditions. VWAP transactions must not be effected for the purpose of manipulating the price of the security. If the proposed amendments are adopted, all VWAP repurchases will be reported using a special VWAP trade modifier.
The SEC is also considering whether to except certain other pricing mechanisms from Rule 10b-18. Under certain circumstances, issuers may wish to effect repurchases through electronic trading systems that use passive or independent-derived pricing mechanisms, such as mid-point of the national best bid and offer (mid-peg orders). Often, this type of pricing will be above the highest independent bid or the last independent transaction price and, therefore, would violate the pricing condition of the rule.
Amendments Concerning the Scope of the Safe Harbor
Under the current version of Rule 10b-18, any failure to meet one of the rule’s conditions on a given day disqualifies all repurchases from the safe harbor for that day. In its proposed amendments, the SEC notes that due to the increased speed with which trade and pricing information is reported in today’s market, such as flickering quotes or quotes that may change multiple times in one second, it is increasingly difficult to ensure that every repurchase meets the rule’s price condition. Accordingly, the proposed amendments would limit disqualification of repurchases in instances where an issuer’s repurchase order is entered into in accordance with the rule, but immediately thereafter executed outside of the price condition solely due to flickering quotes. In this instance, only the non-complaint repurchases would be disqualified from the safe harbor, rather than all repurchases by the issuer for that day.
Merger Exclusion Provision
Rule 10b-18 contemplates normal market conditions and does not provide a safe harbor for issuer bids and repurchases made during the pendency of certain corporate events, such as a merger, acquisition or recapitalization. Currently, the rule excludes from the safe harbor repurchases effected from the time of the public announcement of such a transaction until the earlier of the completion of the transaction or completion of the vote approving the transaction, if applicable, by the target shareholders. In its proposed amendments, the SEC notes that SPAC acquisitions are unique in that they present significant financial incentives for management and must generally be completed within 18 to 24 months. Additionally, approval by the SPAC shareholders typically occurs much later than the vote by the target shareholders. This, the SEC reasons, allows SPAC management a longer period of time to engage in open market repurchases in order to secure votes in favor of the proposed merger. In light of these concerns, the SEC proposes to modify the merger exclusion provision for SPACs to exclude from the safe harbor repurchases from the time of the public announcement of the transaction until the earlier of the completion of the transaction or the vote by both the target shareholders and SPAC shareholders.
The SEC solicited comments on a broad range of questions concerning the scope of the safe harbor. Comments on the proposed amendments were due on March 1, 2010.