The Securities and Exchange Commission (the “SEC”) recently proposed amendments to clarify and modernize Rule 10b-18 (the “Rule”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Rule, adopted in 1982, seeks to provide issuers a safe harbor from anti-manipulation liability under the Exchange Act for repurchase transactions that comply with the Rule’s manner, timing, price and volume conditions. The proposed amendments recognize that intervening developments in the securities trading markets have compromised the effectiveness of the safe harbor.
The SEC is soliciting comments on the proposed amendments through March 1, 2010.
Background of Rule 10b-18
Rule 10b-18 sought to provide an issuer  a means to repurchase its own common stock  for legitimate business purposes, while minimizing the impact of such repurchases on the market’s independent establishment of the price of the stock. The Rule did so by establishing a non-exclusive safe harbor based on the manner, timing, price and volume of an issuer’s repurchases of its common stock in the market. Compliance with those conditions protected an issuer from liability for manipulation under Sections 9(a)(2) and 10(b) and Rule 10b-5 of the Exchange Act. However, compliance with the Rule does not confer protection from liability for repurchases that violate other anti-fraud provisions of the Exchange Act (e.g., issuer repurchases effected while in possession of material nonpublic information concerning its securities).
Since the Rule’s adoption in 1982, market developments in automated trading systems and technology have dramatically changed how repurchases are effected and have made the Rule less effective as a meaningful safe harbor. Recognizing that fact, the proposed amendments are intended to provide issuers with greater flexibility to repurchase their securities, while still minimizing the market impact of the issuer’s repurchases.
Proposed Amendments to Rule 10b-18
As a general matter, the proposed amendments work within the Rule’s existing set of manner, timing, price and volume conditions and do not eliminate any category or introduce a new one. Rather, they would alter certain of the constituent factors of an existing condition or how such a factor is calculated.
- Timing Condition. The Rule’s safe harbor currently excludes from its coverage opening regular way purchases reported in the consolidated system. The proposed amendments would also exclude the opening purchase(s) in both the principal market for the common stock and the market where the issuer repurchases are effected. The SEC is proposing this amendment to curb the impact of an issuer’s opening transaction in the principal market for a security and in the market where the purchase is effected, because such opening transactions can be a significant indicator of the direction of trading, demand strength and the market value of a security.
- Price Condition. The price condition of the Rule requires that each purchase be made at a price that is no higher than the higher of (x) the highest independent bid and (y) the last independent transaction price, quoted or reported in the consolidated system at the time the purchase is made. The proposed amendment would except from the Rule’s price condition purchases made at a volume-weighted average price (“VWAP”) if each of the following exist:
- the securities purchased are “actively-traded securities” (i.e., an average daily trading volume (“ADTV”) value of at least $1 million and a public float at or above $150 million);
- the VWAP purchase is entered into or matched before the regular trading session opens;
- the VWAP purchase price is determined based on a full trading day’s volume, following a calculation procedure that uses only prices from regular way trades effected in accordance with Rule 10b-18 timing and price conditions that are reported in the consolidated system during the primary trading session for the security;
- the VWAP purchase does not exceed 10% of the ADTV in the security;
- the VWAP purchase is not made for the purpose of creating actual or apparent active trading in or otherwise affecting the price of any security; and
- the VWAP purchase is reported using a special VWAP trade modifier.
The proposed amendment is intended to provide issuers and their brokers with greater certainty and flexibility in effecting qualifying VWAP transactions within the safe harbor. The SEC is also considering (and seeking comment on) whether to except other passive pricing mechanisms from the Rule’s price condition, including repurchases through electronic trading systems that use passive or independently derived pricing mechanisms such as the mid-point of the national best bid and offer or “mid-peg” orders.
- Flickering Quotes. As currently formulated, any purchase that violates the pricing condition would disqualify all purchases by the issuer on the same day. The SEC has proposed that, to the extent that non-compliance with the pricing condition is attributable to flickering quotes (i.e., rapidly changing quotes that may change multiple times in a single second, making it difficult for the purchaser to comply with the pricing condition), such non-compliance would not disqualify other purchases made by the issuer on the same day with respect to which all the conditions of the safe harbor were met.
- Merger Exclusion. The Rule’s current “merger exclusion” provision precludes from the safe harbor an issuer’s purchase effected during the period from the public announcement of a merger, acquisition or similar transaction involving a recapitalization to the earlier of (i) the completion of the transaction and (ii) the vote by target shareholders on the transaction. The proposed amendment extends the time during which the safe harbor is unavailable in connection with an acquisition by a special purpose acquisition company (“SPAC”) until the earlier of (x) the completion of the acquisition and (y) the completion of the vote on the transaction by shareholders of both the SPAC and the target company.
As described in the SEC’s release, SPACs are shell, developmental stage or blank-check companies that raise capital in initial public offerings generally for the purpose of acquiring or merging with an unidentified company or companies that will be identified at a later date. Typically, a SPAC must identify an appropriate target and complete its acquisition within an 18- to 24-month time period, and both the SPAC shareholders and target shareholders are entitled to vote on the proposed merger or acquisition.