On December 15, the same day it proposed amendments to Rule 10b5-1 under the Securities Exchange Act of 1934 (Exchange Act) that may blunt the use of the affirmative defense for insider trading, the Securities and Exchange Commission (SEC) also proposed new disclosure rules concerning share repurchases, or buybacks, which have long attracted critical political and media attention. By a 3-2 vote, over the dissents of Commissioners Elad L. Roisman and Hester M. Peirce, the SEC proposed two significant amendments to its current rules regarding disclosures about an issuer’s repurchases of its equity securities: (1) a new Form SR to be furnished the first business day following a buyback and (2) amendments to current Regulation S-K Item 703 that would increase companies’ periodic disclosure obligations regarding share repurchases. The proposed rules apply to purchases made by or on behalf of issuers or any “affiliated purchaser” (as defined under Exchange Act Rule 10b-18(a)(3)) of securities registered under Section 12 of the Exchange Act, including purchases by foreign private issuers and certain registered closed-end funds. Commenting on the rule proposal, Chair Gary Gensler noted that the proposed rules would serve to “lessen the information asymmetries between issuers and investors through enhanced timeliness and granularity of disclosures that today’s proposal would provide.”

Comments are due within 45 days after publication in the Federal Register.

Background

Buybacks are one way in which companies return capital to shareholders. As acknowledged in the proposing release, companies may conduct buybacks for any number of reasons, including “in a manner aligned with shareholder value maximization, such as to offset share dilution after new stock is issued, to facilitate stock- and stock option-based employee compensation programs, to help signal the issuer’s view that its stock is undervalued, or because the issuer’s board has otherwise determined that a repurchase program is a prudent use of the issuer’s excess cash.” Critics of buybacks have raised concerns that management may conduct buybacks for insider benefits, such as for purposes of earnings management (i.e., through decreasing the denominator for earnings per share (EPS) calculations), to satisfy short-term earnings objectives or to effect short-term upward price pressure to maximize share price– or EPS-tied executive compensation arrangements. However, both Commissioner Peirce and Commissioner Roisman noted in their dissenting statements that an SEC study issued last year questioned whether most buybacks were designed to enhance executive compensation and insider stock value.

Buybacks are already subject to significant disclosure—whether voluntary, as a result of stock exchange listing requirements,¹ or as a result of SEC rules. Companies currently tend to disclose (though not in response to a bright-line reporting requirement) approval of a share repurchase authorization by a company’s board of directors. Further, under exchange listing standards, companies are required to promptly disclose material new developments, and board authorization of a buyback is generally treated as requiring disclosure under these standards.

Companies are also required to disclose specific information about share repurchases on Forms 10-K and 10-Q by virtue of Item 703 of Regulation S-K and applicable generally accepted accounting principles. This includes reporting repurchase activity in their periodic reports after the repurchases have occurred (i.e., total number of shares purchased, the average price paid per share, the number of shares purchased as part of a publicly announced program and the maximum number of shares that remain available for repurchase under a program) as well as information on any publicly announced programs (i.e., the date the program was authorized, the share or dollar amount approved by the board of directors, the expiration date (if any) of the program, each program that has expired during the last fiscal quarter, and each program that the company has determined to terminate prior to expiration or under which the company does not intend to make further purchases). The Regulation S-K Item 703 disclosure dates back to 2003, at which time the disclosure requirement was intended to inform investors as to whether and to what extent an issuer “had followed through on its original [buyback] plan.” This delayed disclosure via Regulation S-K Item 703 is the purported source of the information asymmetry giving rise to the rule proposal.

New Form SR

Most notably, the proposed rules would require companies to furnish a new Form SR before the end of the first business day following the day when a company “executes” a buyback, including through open market purchases, tender offers, private negotiated transactions, and accelerated share repurchases. Without much elaboration, the proposing release states that “execution” has a “commonly understood meaning.” Citing a prior 1998 interpretation, the proposing release notes (at footnote 23) that “[t]he date of execution (i.e., the trade date) marks an earlier point of a securities transaction at which the parties have agreed to its terms and are contractually obligated to settle the transaction.”

Information to be disclosed on the new Form SR includes:

• Class of securities purchased;
• Total number of shares (or units) purchased, including all company repurchases whether or not made pursuant to publicly announced plans or programs;
• Average price paid per share (or unit);
• Aggregate total number of shares (or units) purchased on the open market;
• Aggregate total number of shares (or units) purchased in reliance on the safe harbor in Rule 10b-18;² and
• Aggregate total number of shares (or units) purchased pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c).

The proposed Form SR disclosure must be presented in a tabular format, presented by date for each class or series of securities. The proposed Form SR would be furnished, rather than filed, meaning that companies would not be subject to liability under Section 18 of the Exchange Act for the disclosure in the form, and the information would not be deemed incorporated by reference into filings under the Securities Act of 1933 (Securities Act) and thus would not be subject to liability under Section 11 of the Securities Act, unless the company expressly incorporated such information.

The proposing release requests comment on a number of potential alternatives, including reporting less frequently on Form SR, requiring reporting on Form 8-K as opposed to a new Form SR, requiring disclosure of a proposed share repurchase program at least 30 days in advance and continuing to require periodic reporting of share repurchase activity, adding a new exhibit requirement to report share repurchase activity, applying a de minimis reporting exception, and excluding certain smaller issuers from the reporting requirement.

Amended Regulation S-K Item 703 Disclosures

In addition to the new Form SR, the proposed rules would amend Regulation S-K Item 703, thereby expanding companies’ periodic disclosure obligations regarding share repurchases in Forms 10-Q and 10-K (and Form 20-F for foreign private issuers). Specifically, a company’s disclosure obligations would be expanded to include:

• The objective or rationale for the company’s share repurchases and process or criteria used to determine the amount of repurchases;
• Any policies and procedures relating to purchases and sales of the company’s securities by its officers and directors during a repurchase program, including any restriction on such transactions;
• Whether the company made repurchases pursuant to a plan that is intended to satisfy the affirmative defense conditions of Rule 10b5-1(c), and if so, the date that the plan was adopted or terminated; and
• Whether purchases were made in reliance on the Rule 10b-18 nonexclusive safe harbor.

Consistent with the concerns described above regarding potential managerial self-interest, the proposed rules also would require companies to check a box above the Regulation S-K Item 703 share repurchase table indicating whether any of the company’s Section 16 officers or directors purchased or sold shares or other units of the class of the company’s equity securities that is the subject of a company share repurchase plan or program within 10 business days before or after the announcement of such plan or program.

Both the disclosures on new Form SR and under amended Regulation S-K Item 703 would be required to be reported using Inline XBRL.

The SEC is of the view that, taken together, the additional daily detail proposed with respect to the new Form SR and the additional disclosure in periodic reports, along with other information available about the company (e.g., existing executive compensation, Section 16 and financial statement disclosures), “would help investors to assess whether the issuer or its insiders are potentially engaged in self-interested or otherwise inefficient repurchases and thereby help mitigate some of the potential harms associated with issuer repurchases.” The proposing release also solicits comments on how investors would benefit from the proposed rules as compared with existing disclosures. Commissioner Roisman specifically raised concerns about the efficacy of the rule as proposed, especially compared with burdens inherently associated with such granular and frequent disclosure obligations. As part of the economic analysis, the SEC notes that to the extent buyback decisions predict future price changes, more timely information about these decisions may better guide investors’ buy or sell decisions. However, the SEC concedes that such “benefits would be more modest to the extent that many issuers already make public announcements of repurchase plans, which alleviate some information asymmetries, and there is evidence that investors on aggregate draw accurate inferences about the likely program completion rate.”

Potential Implications for Companies

Companies would be required to implement a number of changes to comply with the proposed requirements if adopted as proposed. For example, reporting systems and controls would need to be implemented to track and timely report information required on the new Form SR, which might require amendments to existing repurchase plans and modifications to existing reporting systems. Similarly, additional processes and controls would be required to prepare the augmented disclosures proposed under Regulation S-K Item 703.

In general, the proposed rule’s daily reporting obligation would dramatically change the regulatory landscape for buybacks, increasing costs for companies and potentially causing market reactions that are unwarranted and that make use of buybacks much less attractive as a means of returning capital to shareholders. Companies looking to mitigate the additional reporting burden and potential market reactions to these disclosures might consider adopting other changes, including changes to the company’s use of share buybacks. As the proposing release discusses, the proposed rules could have any number of economic impacts on companies, depending on their share repurchase programs. As an example, the requirement to provide daily disclosure on a new Form SR could result in higher repurchase costs for some companies by boosting the price of their shares following disclosure on the new Form SR, which could be particularly impactful for companies that conduct open market repurchases over multiple days on a highly predictable periodic schedule (such as under a Rule 10b5-1 or similar trading plan) or that conduct recurring trades outside of a trading plan). Similarly, companies that conduct large repurchases over a compressed time period would likely experience greater price impact from large trades. By contrast, companies that conduct one-time repurchases outside the open market (such as in a privately negotiated transaction, an accelerated share repurchase or a tender offer) may be less affected by boosts in the stock price, as the trade would typically be executed at once before any such boost in share price would affect the cost of the trade. And, notably, if a company that typically repurchases daily stops its repurchase activity, the market could react in any number of ways based on pure speculation—for example, the price may jump because the markets assume the company has material positive information, leading it to stop repurchasing, or the price may drop because of concerns that there is negative news that has not been disclosed.

Other company reactions to the new disclosure requirements could affect the liquidity of the company’s shares. If companies sought to limit disclosure by limiting repurchase activity, liquidity in their shares could be reduced if the market had depended in part on company repurchases for liquidity. The proposed requirement to disclose the timing of transactions by Section 16 officers and directors in relation to buybacks likely would lead companies to consider further restrictions on transactions by officers and directors around the time companies announce repurchases. Since company repurchases and insider transactions are only permissible when the purchaser or seller does not have material nonpublic information, this could further reduce any opportunity for insiders to achieve liquidity in their securities.

We expect this proposal to garner significant comments from both the issuer and investor communities. The proposed move from quarterly to daily reporting—and the signaling that would be caused by this type of reporting—is a substantial shift that could materially impact company buyback activity. Companies should continue to monitor for rulemaking developments to assess whether new capital allocation strategies are necessitated by the SEC’s actions in this space.