The Securities and Exchange Commission ("SEC") recently proposed amendments to Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the "Exchange Act").1 Rule 10b-18 provides issuers2 with a safe harbor from anti-manipulation liability under the Exchange Act when an issuer repurchases its common stock in the market in accordance with the Rule's manner, timing, price and volume conditions.

The SEC's proposed amendments are intended to clarify and modernize Rule 10b-18 in light of recent market developments. The SEC is soliciting comments on the proposed amendments through March 1, 2010.

Background

Rule 10b-18 was adopted in 1982 to provide issuers with a safe harbor from liability for manipulation under Section 9(a)(2), Section 10(b) and Rule 10b-5 of the Exchange Act when repurchasing its common stock for legitimate business purposes. Rule 10b-18's safe harbor conditions are designed to minimize the market impact of the issuer's repurchases, thereby allowing the market to establish the price of the security based on independent market forces without undue influence by the issuer.

Rule 10b-18 is intended to offer issuer guidance when repurchasing their securities in an open market and is not an exclusive means by which issuers may make non-manipulation repurchases of securities and there is no presumption that an issuer's bids or purchases outside of the safe harbor violate Sections 9(a)(2), Section 10(b) or Rule 10b-5. In addition, compliance with the Rule's manner, timing, price and volume conditions will not exonerate an issuer from liability under the anti-fraud rules of the Exchange Act where, for example, an issuer repurchases while in possession of favorable, material nonpublic information concerning its securities.

Proposed Amendments To Rule 10b-18

The proposed amendments to the current safe harbor rule include:

  1. Time Of Purchases. Currently, Rule 10b-18 provides that an issuer purchase may not be the opening regularway purchase reported in the consolidated system. The proposed amendment would also exclude the opening purchase(s) in both the principal market for the security and the market where the issuers repurchases are effected. The SEC notes that the opening transaction in the principal market for the security and in the market where the repurchase is effected can be a significant indicator of the direction of trading, the strength of demand and the current market value of the security. Therefore, the proposed amendment is designed to maintain reasonable time limits on the safe harbor while allowing the market to establish a security's price based on independent market forces without undue influence by the issuer.
  2. Pricing Condition. Currently, Rule 10b-18 requires that each repurchase by an issuer be made at a price that is no higher than the higher of (x) the highest independent bid and (y) the last independent transaction price, quoted or reported in the consolidated system at the time that the repurchase is effected.

    The proposed amendment would exempt from the Rule's price condition purchases made at a volume-weighted average price ("VWAP") if each of the following exist:

    • The security that is subject to the VWAP purchase qualifies as an "actively traded security;"3
    • The VWAP purchase is entered into or matched before the opening of the regular trading session;
    • The VWAP purchase price is determined based on a full trading day's volume, following a calculation procedure that uses only prices from regular way trades effected in accordance with Rule 10b-18 timing and pricing conditions that are reported in the consolidated system during the primary trading session for the security; The VWAP purchase does not exceed 10% ADTV4 for the security;
    • The VWAP purchase is not effected for the purposes of creating actual or apparent active trading in or otherwise affecting the price of any security;
    • The VWAP purchase must be calculated by (i) calculating the values, for every regular-way trade reported in the consolidated system during the regular trading session, excluding those not meeting the time and price conditions of the Rule, by multiplying each such price by the total number of shares traded at the price, (ii) compiling an aggregate sum of all values, and (iii) dividing the aggregate sum by the total number of trade-reported shares for that day in the security that represent such qualifying regular way trades; and,
    • The VWAP purchase is reported using a special VWAP trade modifier (".W") in order to indicate to the market that such purchases are unrelated to the current or closing price of the security.

    The SEC has also solicited comments with respect to other possible exceptions to the pricing condition for purchases effected using alternative passive pricing systems, such as the mid-point of the national best bid and offer or "mid-peg" orders.
  3. Flickering Quotes. Currently, Rule 10b-18 provides that any purchase that violates the pricing condition would disqualify all purchases by the issuers for that day. Due to the increased speed of the market, price quotations can change multiple times in very short periods of time (known as "flickering quotes") making it difficult for an insurer to ensure that every purchase of its common stock during the day will meet the Rule's pricing condition. The SEC, recognizing the increased speed of the market, has proposed that, to the extent that non-compliance is attributable to flickering quotes, such violation would not disqualify other purchases made by the issuer on the same day with respect to which all the conditions of the safe harbor were met.
  4. Merger Exclusion Provision And SPACs. Currently, Rule 10b- 18 precludes purchases effected during the period from the time of public announcement of a merger, acquisition or similar transaction involving a recapitalization until the earlier of the completion of such transaction or the completion of the vote by the target shareholders. This is referred to as the "merger exclusion".

    The proposed amendment would expand the merger exclusion in connection with an acquisition by a special purpose acquisition company ("SPAC")5 by extending the time period during which the safe harbor is unavailable until the earlier of the completion of the acquisition or the completion of the vote for the transaction by shareholders in both the SPAC and the target company.

    The SEC believes that, because of the special incentives for SPAC management to complete the acquisitions, management may attempt to rely upon the safe harbor to repurchase the SPAC's shares to reduce the risk that the SPAC's shareholders will vote against an acquisition or to otherwise ensure that the acquisition will be approved.

    Therefore, the proposed amendments would extend the merger exclusion to provide that, in the case of an acquisition by a SPAC, the exclusion applies until the earlier of the completion of the acquisition or the completion of the vote for the transaction by shareholders in both the SPAC and the target company.

Footnotes

1. Purchases of Certain Equity Securities by the Issuer and Others, Release No. 34-61414, available at http://sec.gov/rules/proposed/2010/34-61414.pdf

2. The safe harbor of Rule 10b-18 also includes "affiliated purchasers" of the issuers. Therefore, references in this Client Alert to "issuer" also include "affiliated purchasers."

3. As proposed, "actively-traded security" would have the same meaning as defined under Rule 101(c)of Regulation M, which provides that "actively-traded securities" have an ADTV of $1 million or more and a public float value of $150 million or more.

4. "ADTV" is defined in Rule 100(b) of Regulation M as the worldwide average daily trading volume during the full two calendar months immediately preceding, or any consecutive 60 calendar days ending with the 10 calendar days preceding the relevant measurement date, which for Rule 10b-18 would be the date of purchase.

5. As described in the SEC's release, SPACs are shell, developmental stage or blank-check companies that raise capital in initial public offerings generally for the purpose of acquiring or merging with an unidentified company or companies that will be identified at a later date. Typically, a SPAC must identify an appropriate target and complete its acquisition within an 18- to 24-month time period, and both the SPAC shareholders and target shareholders are entitled to vote on the proposed merger or acquisition.

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