Following the enactment of corporate tax cuts at the start of 2018, announced stock buybacks topped $1 trillion for the year, an all-time high. Research from the Securities and Exchange Commission (SEC) is now fueling a movement to give some fresh scrutiny to buyback transactions.
The rationale underlying a corporate buyback starts with a simple premise: Executives believe the market is undervaluing their company’s stock. When there’s cash on hand (or cheap debt to be had) and management thinks the stock price will appreciate, it makes sense for a company to buy back its shares. (A buyback also has a side benefit of reducing the number of shares of a company’s stock on the market, inflating the stock’s key ratio of earnings per share.)
Now put yourself in the shoes of a stockholder during a buyback. If your company is signaling that it believes its stock price is going up in the near future, does it make sense to sell your shares now? No. But strangely enough, research from SEC Commissioner Robert J. Jackson Jr. indicates that buyback announcements are actually triggering sell-offs by insiders. His suspicions about the driving force behind the buybacks may shock you.
“If executives believe a buyback is the right thing to do, they should hold their stock over the long term,” Jackson wrote last week in a letter to Sen. Chris Van Hollen (D-Maryland). “Instead, we found that many executives use buybacks to cash out. That creates the risk that insiders’ own interests — rather than the long-term needs of investors, employees and communities — are driving buybacks.” Jackson further determined that insider selling on buybacks often presaged weak long-term stock performance.
His correspondent, Van Hollen, is one of a number of lawmakers now taking aim at buyback rules. Last week, he cited Jackson’s research as proof that regulators should re-evaluate the existing guidelines. Van Hollen intimated that a blackout period for insider sales following buyback announcements would be appropriate.
Joining Van Hollen in calling for new buyback rules are Senate Minority Leader Chuck Schumer of New York and presidential candidate Bernie Sanders, the senator from Vermont. In a jointly authored op-ed piece in The New York Times, the pair said that buybacks should be outlawed for companies that cannot prove they are meeting a number of employee-friendly standards, such as paying workers at least $15 an hour and providing them with “decent pensions and more reliable health benefits.” A MarketWatch analysis of the Sanders-Schumer proposal revealed that it would have put the brakes on most major buybacks in 2018.
In a sign that buyback reforms are truly picking up traction, Florida Republican Senator Marco Rubio has released a proposal that would end some of the incentives for companies to engage in buybacks. Rubio’s plan calls for taxing buybacks at the same rate as dividends and allowing companies to immediately write off more capital asset investments and research and development expenses. Given that Rubio chairs the Senate Committee on Small Business and Entrepreneurship, his opinion on the matter carries plenty of weight on Capitol Hill.
Ultimately, Jackson’s assessment of the role of buybacks seems to sum up a growing opinion among policymakers, and it raises the possibility of big changes.
If you are interested in learning more about share buybacks, including legislative proposals and other recent developments related to Rule 10b-18 (safe harbor), I encourage you to participate in our upcoming, free webinar on Wednesday, March 20, 2019 at 1pm EDT. The webinar qualifies for CLE credit and will feature attorneys Anna T. Pinedo and Remmelt Reigersman of Mayer Brown LLP.