United States: SEC Commissioner Jackson Calls For Restrictions On Executive Sales During Stock Buybacks

Last Updated: June 13 2018
Article by Cydney Posner

In remarks Monday before the Center for American Progress, SEC Commissioner Robert Jackson discussed his recent research on corporate stock buybacks, in the light of the substantial increase in buybacks following the 2017 Tax Cuts and Jobs Act. His focus: to call on the SEC to update its buyback rules "to limit executives from using stock buybacks to cash out from America's companies." If executives are so convinced that "buybacks are best for the company, its workers, and its community," Jackson suggested, "they should put their money where their mouth is."

Jackson began his address with a historical reference to the 2004 corporate tax holiday, which was designed to encourage American companies to repatriate "billions of dollars of overseas cash. But corporations didn't invest most of that money in innovation. They didn't invest it in retraining their workforce or raising wages. Instead, executives largely used the influx of fresh funds for massive stock buybacks." As widely predicted, Jackson continued, in the first quarter of 2018 after the new tax cuts were signed into law last year, American corporations spent a record $178 billion buying back their own stock instead of making "long-term investments in innovation or their workforce that our economy so badly needs." (And according to CNBC, May alone saw a record $171.3 billion in buybacks, with $51.1 billion announced so far in June. CNBC also reports that Wall Street analysts expect full-year buybacks to total as much as $800 billion.)

Given that the rules governing stock buybacks have not been reviewed in more than a decade, Jackson expressed concern over their adequacy and called for "an open comment period to reexamine our rules in this area to make sure they protect employees, investors, and communities given today's unprecedented volume of buybacks."

But Jackson's particular bête noire in this regard was the "clear evidence that a substantial number of corporate executives today use buybacks as a chance to cash out the shares of the company they received as executive pay, especially those shares designed to link executive pay with long-term performance. Jackson observes that grants of equity comp typically result in higher levels of pay, in exchange for which "investors—and the economy as a whole—tie executives' fortunes to the growth of the company." To Jackson, allowing executives to cash out—at prices often inflated by the company's buyback announcement and open-market purchasing activity—undermines the purpose of equity comp: to give executives "incentives to create long-term, sustainable value." If buybacks are really the right long-term strategy for the company, he contends, then executives "should want to hold the stock over the long run, not cash it out once a buyback is announced."

SideBar

Jackson is not alone in his efforts to draw attention to the connection between stock buybacks and executive comp. Others, however, have approached the issue from another direction: the impact of stock buybacks on compensation where performance metrics are stock-price- or EPS-related. In those cases, buybacks, which, as noted below, tend to increase the stock price, can juice executive compensation, irrespective of the operational success of the company. Both the AFL-CIO (see this PubCo post) and James MacRitchie (part of the Chevedden group) ( see this PubCo post) have in the past submitted shareholder proposals to exclude the impact of stock buybacks in determining performance for executive comp purposes. Given that the proposal has now become part of the repertoire of the prolific Chevedden group, it would not be surprising to see this type of proposal resurface more frequently, especially in light of the recent rise in the level of stock repurchases following the 2017 tax law change.

Concerned about the impact of the SEC's failure to complete the Dodd-Frank rulemaking mandate related to executive comp—clawbacks and pay-for-performance and hedging disclosures—Jackson and his staff undertook to study executive stock sales in the context of 385 buybacks over the preceding 15 months. To no one's surprise, they found that the announcement of a buyback led to abnormal returns of more than 2.5% in the subsequent 30 days. But the consistent behavior of executives did come as a bit of a shock:

"What did surprise us, however, was how commonplace it is for executives to use buybacks as a chance to cash out. In half of the buybacks we studied, at least one executive sold shares in the month following the buyback announcement. In fact, twice as many companies have insiders selling in the eight days after a buyback announcement as sell on an ordinary day. So right after the company tells the market that the stock is cheap, executives overwhelmingly decide to sell.

"And, in the process, executives take a lot of cash off the table. On average, in the days before a buyback announcement, executives trade in relatively small amounts—less than $100,000 worth. But during the eight days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day—a fivefold increase. Thus, executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement[. T]he evidence shows that buybacks give executives an opportunity to take significant cash off the table, breaking the pay-performance link. SEC rules do nothing to discourage executives from using buybacks in this way. It's time for that to change."

His recommendations:

  • At a minimum, update Rule 10b-18 to deny the safe harbor to companies that choose to allow executives to cash out during a buyback; and
  • Require the comp committee "to carefully review the degree to which the buyback will be used as a chance for executives to turn long-term performance incentives into cash. If executives will use the buyback to cash out, the committee should be required to approve that decision and disclose to investors the reasons why it is in the company's long-term interests. It is hard to see why a company's buyback announcement shouldn't be accompanied by this kind of disclosure."

Jackson asserts that deterring these cash-outs will leave executives with "far fewer incentives to manage to quarterly earnings and pursue the kind of short-term thinking that dominates our economy today....[A]t the SEC, it's time for our rules to require corporate managers who say they want to manage for the long term to put their money where their mouth is." Corporate boards and executives should be working to create long-term, sustainable value, Jackson concludes, "not cashing in on short-term financial engineering."

SideBar

In testimony in 2017 before the Senate Committee on Banking, Housing and Urban Affairs, SEC Chair Jay Clayton was asked whether, in light of concerns about companies' conducting buybacks with the short-term goal of increasing the stock price at the cost of other corporate investments, buyback disclosure should be required more often than quarterly. Clayton would not comment on the timing of disclosure, but expressed concern about potential abuses. Although he thought that buybacks can be an efficient and appropriate way to return capital in the right circumstances, he would be troubled by short-term motivation and would look at disclosure issues in that light. (See this PubCo post.)

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