In a recent speech, Commissioner Robert Jackson launched a broadside against stock buybacks by corporate America. Based on data from 385 buybacks during 2017-18, the Commissioner came away with three findings:
- In half of the buybacks, at least one executive sold shares in the month following the announcement.
- Twice as many companies had insiders selling in the eight days following the buyback announcement than on a normal day.
- During the eight days following the announcement, executives sold in amounts that were five times greater than in the period preceding the announcement.
Armed with this data, Commissioner Jackson called for an open comment period on the Rule 10b-18 safe harbor for stock buybacks, with a view toward restricting the safe harbor and denying its availability to a company whose executives sell following the announcement. He also called for corporate boards and their counsel to pay closer attention to the implications of stock buybacks on the link between pay and performance. If executives think that company shares are undervalued so as to justify a buyback, they should, in the Commissioner’s view, “put their money where their mouth is” and not sell their own shares.
Stock buybacks and the optimal allocation of a company’s capital are topics worthy of serious study and debate. Unfortunately, this speech advances neither the study of buybacks nor the debate. Although we learn that in half the companies that conducted a buyback at least one insider sold shares in the month after announcement, we know then that in half of the companies there was no insider selling. We know that at least one insider sold shares. Was one the statistical mode for the number of sellers? What was the median number of sellers? How much of their holdings did the insiders sell? Were the sellers in compliance with their company share ownership guidelines that are the norm in most well-run public companies? Were the sales the result of prearranged instructions under a Rule 10b5-1 plan? There are a lot of unanswered questions that this data simply does not address.
Based on the data, we learn that following a buyback announcement insiders sold in amounts that were five times greater than in the period before the announcement. What should we take from this fact? One might express surprise that there was any selling in the period before the announcement. It is generally the case that companies treat the adoption of a buyback program as material information and thus selling in advance of the public announcement could be problematic. There is also the possibility that insider selling following the announcement of a stock buyback is preferable from the standpoint of reducing informational asymmetry. Because of potential liability concerns, companies purchasing their stock in the market pay particular attention to the accuracy and completeness of their public disclosures. It just may be that insider transactions at this time are preferable to times at which potential informational asymmetries can be greater.
Although there may have been more and bigger insider transactions at a micro level, the data give us no sense of how much the aggregate selling was in relation to the overall buyback programs. What were the sale proceeds as a percentage of the amounts bought back? The speech would almost have you believe that buybacks are engineered to return all of the cash to insiders. One wonders if the data would support that belief.
The suggestion that executives who think it is good for the company to buy shares should not sell their own seems misguided. A decision one makes as a fiduciary about how best to deploy the company’s excess cash is quite different than how one approaches his or her own financial affairs. It is frequently the case that insiders have a significant amount of their net worth in company equity. Decisions to diversify that concentration make financial planning sense even when an insider believes the shares are undervalued. So long as an insider complies with the company’s share ownership guidelines and has earned the equity that is to be sold, why should the insider be penalized because the company is buying shares?
Other references in the speech suggest something deeply nefarious is going on. We learn that executives cashed out billions while Bear Stearns and Lehman Brothers were collapsing – which is certainly alarming – without any sense of how that fact relates to stock buybacks and Rule 10b-18. Commissioner Jackson characterizes the post-announcement trading by executives as “not necessarily illegal,” yet fails to identify a single way in which it might have been. And the assertion that boards and their counsel need to pay closer attention to the link between stock buybacks and pay for performance suggests that sufficient attention is not currently being given to the connection. Yet here again there is no data to support that assertion other than the fact that buybacks are occurring.
Whether insiders should be able to sell shares they have earned is a corporate governance matter for the board of directors to decide. Investors surely have a keen interest in equity compensation, and they frequently engage with companies on it. The SEC can appropriately require disclosure about all aspects of the issue – share retention policies, pay versus performance, whether executives can sell shares after a buyback announcement, and prompt disclosure of sales. But Rule 10b-18 was designed to prevent market manipulation and facilitate companies conducting legitimate buyback activity. To limit its availability to enforce Commissioner Jackson’s view of appropriate corporate governance would be bad public policy.
Keith Higgins is a member of Ropes & Gray’s corporate department and chair of the securities & governance practice. He served as Director of Corporation Finance at the U. S. Securities & Exchange Commission from 2013-2017 and has for more than 30 years been counseling public companies in securities offerings, mergers and acquisitions, compliance and corporate governance.