Following the adoption of the Tax Cuts and Jobs Act, the debate regarding the use of stock repurchase programs by companies seems to have gotten more politicized than ever. Senator Tammy Baldwin has introduced a bill, S. 2605 titled the “Reward Work Act,” for consideration that would, among other things, rescind the safe harbor under Rule 10b-18 for issuer repurchases, and would prohibit companies from repurchasing their shares on the open market. Commentators seem to disagree regarding the merits of stock repurchase programs.
A recent article in the Harvard Business Review, “Are Buybacks Shortchanging Investment?” written by Jesse M. Fried and Charles C.Y. Wang, looks at the allocation of capital by S&P 500 firms as between R&D and capital expenditures, or internal investments, and payouts to their shareholders. The authors find that the levels of investment are on a historic basis quite high. The authors note that the measuring tools used in calculating shareholder payouts are flawed. Critics of stock repurchases fail to consider the effect of equity issuances and do not look at net payouts to shareholders, that is, dividends and repurchases minus equity issuances.
Based on the authors’ calculations, the percentage of income available for investment that went to shareholders of the S&P 500 (dividends and repurchases) over the past 10 years was 41.5%, which is significantly less than the amount claimed by critics of repurchase programs. Whether or not one agrees with this analysis, it is worth noting that Rule 10b-18 has not undergone any significant change in many years despite the significant changes in market structure and in the ways in which companies choose to execute buybacks. This was recently highlighted by a rulemaking petition from Investors Exchange LLC, or IEX. IEX has petitioned the Securities and Exchange Commission to amend Rule 10b-18. The Commission last proposed amendments, which were not adopted, to the rule in 2010. The request relates to allowing executions priced at the midpoint of the National Best Bid and Offer to qualify for the Rule’s safe harbor. Currently, the rule requires that a broker buying stock for an issuer buy at a price that is no greater than the higher of the last independent bid price or the last sale price in order to ensure that the repurchase activity is not manipulative. The request for an amendment notes that this current requirement makes it easy to detect repurchase orders and for others in the market to manipulate the stock price artificially pushing it up. This has the effect of making it more expensive for companies to effect repurchases.
In light of all of this controversy, wouldn’t it make sense to revisit the safe harbor at least to account for changes in the marketplace?