In late January, the Securities and Exchange Commission proposed amendments to Rule 10b-18 under the Securities Exchange Act of 1934, which provides issuers with a safe harbor from liability for manipulation in connection with certain repurchases of their common stock. The proposed amendments, which are intended to accommodate current market practices, would:
- Permit certain repurchases made using a volume-weighted average price (“VWAP”);
- Disallow purchases that constitute the opening purchase in the principal market for the relevant security or the market where the purchase is effected (in addition to the current prohibition on making the opening purchase reported in the consolidated system); and
- Extend the time during which the Rule 10b-18 safe harbor would be unavailable in connection with acquisitions by a special purpose acquisition company (a “SPAC”) until the shareholders of the SPAC have voted on the transaction.
A copy of the release, which also solicits comment on a number of other potential changes to the Rule, is available at http://www.sec.gov/rules/proposed/2010/34-61414.pdf. Comments are due by March 1, 2010.
Currently, Rule 10b-18 provides a safe harbor for issuer repurchases of common stock on a given day, so long as the following conditions are met on that day:
- Manner of Purchase – The issuer utilizes only one broker or dealer on that day to bid for, or purchase, its common stock.
- Timing – The issuer does not make the opening purchase reported in the consolidated system and does not effect any purchase of its shares during the final 30 minutes (10 minutes for actively-traded shares) before the scheduled close of the primary trading session in the principal market for the issuer’s common stock and in the market where the purchase is effected.
- Price – The issuer does not bid for or purchase its shares at a price that is higher than the highest independent bid or last independent transaction price, whichever is higher, quoted on the consolidated system.1
- Volume – The issuer’s purchases on that day do not exceed 25 percent of the average daily trading volume (“ADTV”) of its shares, except for a purchase of a “block” of shares (even if the number of shares purchased exceeds 25 percent of the ADTV for the shares) on one day per week on which no other Rule 10b-18 repurchases are made by the issuer.
Under the current Rule, failure to satisfy any one of these conditions will disqualify all of a day’s repurchases from the protection of the safe harbor. The Rule does not insulate issuers from potential liability where they engage in repurchases while in possession of favorable, material nonpublic information.
Proposed Changes to Price Condition
The SEC proposes to amend Rule 10b-18 to extend the safe harbor to repurchases utilizing VWAP pricing so long as specified criteria are satisfied. Specifically,
- the common stock must qualify as an “actively-traded security” (as defined in Rule 101(c)(1) of Regulation M);
- the VWAP purchase must be entered into or matched before the regular trading session opens;
- the execution price of the VWAP purchase must be determined based on all regular way trades effected in accordance with the Rule’s timing and price conditions that are reported in the consolidated system during the primary trading session for the security; the number of shares repurchased using VWAP pricing on any given day may not exceed 10 percent of the ADTV in the security;
- the repurchase must not be effected for the purpose of creating actual, or apparent, active trading in or otherwise affecting the price of any security; and
- the purchase must be reported using a special VWAP trade modifier.
To fall within the Rule 10b-18 safe harbor, VWAP purchases must also comply with the manner of purchase, timing and volume conditions of Rule 10b-18. These proposed changes would eliminate the risk that VWAP transactions would be disqualified from the safe harbor where a VWAP purchase effected at the end of the day exceeds the highest independent bid or last independent transaction price quoted or reported in the consolidated system for the security.
Other Alternative Passive Pricing Systems
The SEC is also considering, and has requested comment on, whether to allow repurchases made using other passive pricing mechanisms such as the mid-point of the national best bid and offer to be effected within the Rule 10b-18 safe harbor.
The SEC also proposes amending Rule 10b-18 to address the fast pace at which today’s markets operate – specifically, the impact of “flickering quotes” on the availability of the safe harbor. Flickering quotes occur when there are rapid and repeated changes in the current national best bid during the period between identification of the current national best bid and the execution or display of the Rule 10b-18 bid or purchase. Flickering quotes occur frequently with active NMS stocks, where the quotations can change multiple times in a single second.
Under the proposed amendment, transactions entered into in compliance with the manner of purchase, timing and volume requirements of Rule 10b-18, but are executed outside of the price condition due to flickering quotes, will not lead to the disqualification of all the issuer’s repurchase transactions for that day. Only the individual non-compliant transactions would be disqualified from the safe harbor, instead of the entire day’s transactions as currently provided under the Rule.
Proposed Changes to Timing Condition
Additional Limitations on Opening Purchases
If a trade is reported in the consolidated system before the first trade occurs on the security’s principal market, an issuer repurchase in the principal market can technically comply with current Rule 10b-18 even if it is the first trade of the day in that market. Because the opening trade in the principal market can be a significant indicator of the direction of trading, the strength of demand and the current market value of a security, the SEC proposes to expand the timing requirements of Rule 10b-18 to preclude an issuer from effecting the opening purchase in its common stock in both the principal market for the security and the market where the purchase is effected. In addition, the SEC believes that this amendment will address certain market confusion as to what constitutes the opening transaction for purposes of Rule 10b-18, especially when there is a delay in the opening of the principal market.
Expanded “Merger Exclusion” Provision For SPACs
Under the current rule, the Rule 10b-18 safe harbor is unavailable (or of limited availability) for share purchases by parties to certain merger and acquisition transactions during the period from the time of public announcement of the transaction until the earlier of the completion of such transaction or the completion of the vote by the target shareholders. The SEC proposes to extend this period for merger and acquisitions transactions involving SPAC issuers until the earlier of completion of the transaction and the completion of the votes by both the target and SPAC shareholders.
In the view of the SEC, the safe harbor should be available during “normal” market conditions, but not when an issuer “is under pressure to complete a merger or similar corporate action and may be inclined to utilize issuer repurchases in order to bring about a successful conclusion to the corporate action.” Because of the unique conflicts of interests and significant financial incentives for SPAC management, including the need for a SPAC to obtain its own shareholder approval for an acquisition, the SEC believes it is not appropriate to provide a safe harbor for purchases made by a SPAC until after that vote has occurred.
Other Areas of Proposed Changes
The SEC has solicited comments on a number of other significant issues relating to the scope of Rule 10b-18’s safe harbor, including:
- Whether the safe harbor should be extended to repurchases of securities other than common equity, such as preferred stock, warrants, rights, convertible debt securities or other products and, if so, what price, volume and time of purchase conditions should apply. In addition, the SEC has solicited comment as to whether the safe harbor should apply to repurchases effected outside of the United States or through the use of futures or options contracts.
- Whether the safe harbor should only be available to issuers who maintain current financial disclosure (either through mandated public filings or voluntary public disclosures), who disclose repurchases on a daily or real-time basis, and/or who are in full compliance with United States disclosure requirements regarding issuer stock repurchases.
- What other manipulative concerns arise, if any, by alternative or novel methods of repurchasing securities, such as the use of derivatives or share accumulation programs. Specifically, whether limitations should apply for issuers who engage in accelerated share repurchase plans or use forward contracts to repurchase their stock.
In general, the SEC’s proposed amendments to Rule 10b-18 are intended to modernize the safe harbor and adapt its provisions to address current market conditions. If adopted, the amendments will provide more certainty as to when and how issuers may take advantage of the benefits of the safe harbor. In addition, the SEC’s extensive request for comments suggests that more sweeping changes to Rule 10b-18, including a potential expansion of the safe harbor to securities other than common stock, may be forthcoming.