Today, the SEC announced that it had issued an order postponing the effective date of the Share Repurchase Disclosure Modernization rule. As a result, the Rule is stayed pending further SEC action. Why? You might recall that, on Halloween, the Fifth Circuit issued an opinion in Chamber of Commerce of the USA v. SEC, granting the Chamber’s petition for review of the final share repurchase rule and remanding to the SEC “to correct the defects” that the Court had identified. The deadline was set at November 30, 2023. Under the Administrative Procedure Act, the SEC observed, an agency may “postpone the effective date of action taken by it” pending judicial review when it finds that “justice so requires.” According to the SEC, in light of the Fifth Circuit’s decision, the SEC found that it was “consistent with what justice requires to stay the effectiveness of the Repurchase Rule pending further Commission action.” Will the SEC ultimately repair the defects to the satisfaction of the Court? Will the Court ultimately vacate the rule? That all remains to be seen.
In May this year, the SEC adopted final rules intended to modernize and improve disclosure regarding company stock repurchases. The rule requires quarterly reporting of detailed quantitative information on daily repurchase activity and revises and expands the narrative requirements, including disclosure regarding the rationale for the buyback. (See this PubCo post.) Just over a week following adoption, the U.S. Chamber of Commerce, along with two Texas co-plaintiffs, submitted a petition to the Fifth Circuit for review of the final rule. Petitioners made various arguments, but the one that persuaded the Court was that “the SEC acted arbitrarily and capriciously in adopting the final rule by not considering their comments or conducting a proper cost benefit analysis” in violation of the APA.
In particular, the Court was persuaded by Petitioners contentions that the SEC violated the APA by acting arbitrarily and capriciously when it failed to “respond to petitioners’ comments about the agency’s economic implications analysis adequately,” and failed to “substantiate the proposed rule’s benefits adequately.”
First, petitioners claimed that the SEC failed to respond to their comments about the economic implications of the rule, and that the SEC is required “to consider all relevant factors raised by the public comments and provide a response to significant points within.” In its buyback releases, the SEC “claimed that it provided quantified economic effects ‘wherever possible,’” but petitioners contended that that was not the case—and the Court agreed. In their comments, petitioners submitted three suggestions for quantifying the effect of the rule. For example, petitioners’ first suggestion was that the SEC quantify “the percentage of issuers’ annual and long-term incentive plans that is tied to [earnings per share] and how it correlates with buybacks” based on readily available “academic databases” that “provide detailed data on executive compensation.” According to the Court, the SEC admitted that “it never considered any of petitioners’ suggestions,” and sought to justify its omission by claiming that petitioners did not identify specific data for the SEC or raise any points that would require a change in the rule. But the Court found no merit in those contentions, pointing out that petitioners identified relevant academic databases, existing SEC disclosures and existing academic studies. Nor did the Court agree that petitioners’ comments were only “recommendation[s] to conduct new studies that [they] contend might produce useful data.” Rather, “[a]ll three suggestions address costs and benefits the SEC identified in the proposed rule,” and “[a]ll three suggestions provide quantification of the rule’s expected costs and benefits—the very same costs and benefits the SEC asserts ‘cannot be quantified.’” The Court concluded that the “SEC—by continuing to insist that the rule’s economic effects are unquantifiable in spite of petitioners’ suggestions to the contrary—has failed to demonstrate that its conclusion that the proposed rule ‘promote[s] efficiency, competition, and capital formation’ is ‘the product of reasoned decisionmaking.’”
Second, the Court determined that the SEC failed to adequately substantiate the rule’s benefits and costs. While the rule’s benefits were more than “hypothetical,” they were not adequately substantiated under the APA’s arbitrary-and-capricious standard. The SEC, the Court said, identified two primary benefits: first, “to help investors ‘better evaluate whether a share repurchase was intended to increase the value of the firm’ or for an improper purpose such as ‘providing additional compensation to management’”; second, the SEC asserted that the rule “promotes price discovery.”
Petitioners claimed that the SEC never substantiated the underlying contention that improperly motivated buybacks were actually a problem. The SEC responded that the rule was not premised on the idea that “‘improperly motivated buybacks regularly occur’ in ‘significant numbers,’” but that it addressed the issue of investor uncertainty about the motivations behind a buyback, substantiating the first benefit. But the Court agreed with petitioners that “[i]f opportunistic or improperly motivated buybacks are not genuine problems, then there is no rational basis for investors to experience any of the uncertainty the SEC now claims warrants the rule.” According to the Court, the “SEC must therefore show that opportunistic or improperly motivated buybacks are a genuine problem even under its theory of investor uncertainty. Because the agency has not done so, the first benefit is inadequately substantiated.”
As to the second cited benefit of price discovery, the SEC argued that more granular information about repurchases and prices would allow investors to infer management’s beliefs about company value. The Court found that the SEC failed to demonstrate that it considered relevant factors in concluding that the costs of the more granular disclosure would be modest. According to the Court: “Looking at the rule’s disclosure requirements explains why that is the case. Plainly put: The rule’s requirements are clear as mud.” As illustrations, the Court asserted that the rules offered little guidance and omitted a safe harbor. What’s more, “when pressed at oral argument, counsel for the SEC offered little in the way of clarifying what disclosures the rule actually mandated. The price-discovery benefit is not the product of reasoned decision-making.”
The Court concluded that the primary benefit of easing investor uncertainty about motivations for buybacks was inadequately substantiated. In essence, the SEC had failed to show “that opportunistic or improperly motivated buybacks are a genuine problem.“ But, the Court said, the SEC’s concerns about opportunistic or improperly motivated buybacks permeated the SEC’s justification and explanation of the rule and infected the rule itself.
The Court granted the petition for review, holding that the “SEC acted arbitrarily and capriciously, in violation of the APA, when it failed to respond to petitioners’ comments and failed to conduct a proper cost-benefit analysis.” However, recognizing that “there is at least a serious possibility that the agency will be able to substantiate its decision given an opportunity to do so,” the Court decided that, instead of vacating the rule, it would allow the SEC 30 days “to remedy the deficiencies in the rule,” and remanded the matter with directions to the SEC to correct the defects in the rule. The three-judge panel, however, “retain[ed] jurisdiction to consider the decision that is made on remand.”
Had the SEC not stayed the effective date of the Rule, reporting would have been required beginning with the first Form 10-Q or 10-K covering the first full fiscal quarter (i.e., for the 10-K, the 4th quarter) that began on or after October 1, 2023. (See this PubCo post.) Stay tuned.