SEC Revises Rule 10b-18 – The Safe Harbor for Purchases of Certain Equity Securities by the Issuer – and Adds New Disclosure Requirements for Issuer Repurchases

Contributing authors: Edward S. Best, Michael T. Blair, James B. Carlson, Robert E. Curley, Scott J. Davis, Jeffrey I. Gordon, Robert A. Helman, Michael L. Hermsen, James J. Junewicz, Kenneth E. Kohler, Philip J. Niehoff, Elizabeth A. Raymond, Laura D. Richman, David A. Schuette, Frederick B. Thomas, Mark R. Uhrynuk and James R. Walther

On October 22, 2003, the Securities and Exchange Commission amended Rule 10b-18 under the Securities Exchange Act of 1934. Rule 10b-18 provides a non-exclusive safe harbor from liability from the antimanipulation provisions of the Exchange Act when an issuer or an affiliated purchaser repurchases common stock of the issuer in the United States in accordance with the rule’s provisions. An "affiliated purchaser" is a person acting in concert with the issuer for the purpose of acquiring the issuer’s securities or an affiliate who controls the issuer’s purchases of such securities, whose purchases are controlled by the issuer, or whose purchases are under common control with those of the issuer. The revisions update the safe harbor to reflect market developments since the rule’s adoption in 1982. At the same time, the SEC adopted new disclosure requirements for all repurchases of common stock whether or not the purchases are subject to Rule 10b-18. See Release No. 33-8335; 34-48766; IC-26252.

Revised Rule 10b-18 is effective December 17, 2003. For domestic issuers other than registered closed-end management investment companies, the new disclosures must be provided in any periodic report filed with the SEC for periods ending on or after March 15, 2004. For registered closed-end management investment companies, the new disclosures must be provided in reports provided by registered management investment companies to their shareholders for periods ending on or after June 15, 2004. For foreign private issuers, the new disclosures must be provided in annual reports filed with the SEC for fiscal years ending on or after December 15, 2004.

The SEC has revised the rule to clarify that repurchases of all common equity securities are eligible for the safe harbor. Rule 10b-18(a)(13). For example, the rule covers units of beneficial interest in trusts and limited partnership interests, in addition to common stock and depositary shares relating to common stock. The SEC has made clear that an issuer repurchasing its common stock using forward contracts or accelerated share repurchase programs or through the writing of puts or calls is not able to use the safe harbor for the purchases and sales resulting from those transactions. This does not mean that those transactions manipulate the issuer’s stock price, only that they are not eligible for the protection of the safe harbor.

A Rule 10b-18 purchase means a purchase, or any bid or limit order that would effect a purchase, of an issuer’s common stock by or for the issuer or any affiliated purchaser. However, it does not include any purchase of such security:

• effected during the applicable restricted period of a distribution that is subject to Rule 102 of Regulation M;
• effected by or for an issuer plan by an agent independent of the issuer;
• effected as a fractional share purchase evidenced by a script certificate, order form or similar document;
• effected during a merger, acquisition or similar transaction involving a recapitalization as described above;
• effected pursuant to a going private transaction subject to Section 13(e)(1) of the Exchange Act and the rules promulgated thereunder;
• effected pursuant to a tender offer that is subject to Rule 13e-4 under the Exchange Act or that is specifically exempted from Rule 13e-4; or

Securities Update .effected pursuant to a tender offer that is subject to Section 14(d) of the Exchange Act and the rules promulgated thereunder.

As part of the revisions, the SEC has made clear that, for purchases on any day to come within the safe harbor provided by Rule 10b-18, the repurchases on that day must satisfy each of the rule’s four conditions (manner of purchase, timing, price and volume).

The SEC did not make any substantive changes to the requirement that all purchases on a single day that are solicited by or on behalf of the issuer or its affiliated purchasers must be made through a single broker or dealer, except to make clear that an issuer can choose to use either a broker or an electronic communications network – ECN – or other alternative trading system – ATS – to conduct its purchases on a single day, but not both. Rule 10b-18(b)(1)(iii). If the broker chooses to use a broker to conduct its repurchases, that broker is permitted to access ECN or ATS liquidity on behalf of the issuer on that day. The ECN or ATS is simply acting in its capacity as an execution venue or market center, rather than as a broker in this situation.

The SEC has revised the rule to add an average daily trading volume value and public float value test to determine the time when an issuer must be out of the market before the scheduled close of trading in order to qualify for the safe harbor. Rule 10b-18(b)(2). To qualify for the safe harbor, issuers of securities having an average daily trading volume of less than $1 million or a public float value of less than $150 million may not bid for or purchase their securities during the last 30 minutes before the scheduled close of the primary trading session in the principal market for the security, and during the last 30 minutes before the scheduled close of the primary trading session in the market where the purchase is made. All issuers meeting one of these two tests can conduct repurchases until 10 minutes before the scheduled close.

Average daily trading volume can be calculated by any reasonable and verifiable method. For example, it may be derived from multiplying the number of shares by the price in each trade, or from multiplying each day’s total volume by the closing price on that day. Public float value should be taken from the issuer’s most recent Form 10-K or based upon more recent information made available by the issuer. In addition, the Rule 10b-18 purchase cannot be the opening (regular way) purchase reported in the consolidated system.

The SEC has revised the rule to apply a uniform price condition that limits all issuers to repurchasing their securities at a price that does not exceed the greater of the highest independent bid or the last independent transaction price quoted or reported in the consolidated system. Rule 10b-18(b)(3).

For those securities that are not quoted or reported, the issuer will need to look to the greater of the highest independent bid or the last independent transaction price that is displayed and disseminated on any national securities exchange or inter-dealer quotation system that displays at least two independently priced quotations for the security. For all other securities, the issuer will need to look to the highest independent bid obtained from three independent dealers.

The consolidated system is a consolidated transaction or reporting system that collects and publicly disseminates basis transaction or quotation information in common equity securities on a current and continuous basis pursuant to an effective transaction reporting system or a national market system plan.

For riskless principal transactions, the safe harbor only applies if both "legs" of the transaction – the broker purchase in the market for its own account and the broker sale to the issuer – are effected at the same price and only one leg is reported to the market, provided that the first leg meets all of the conditions of the safe harbor, all as described in greater detail below under "Purchases for the Issuer."

The SEC has revised the rule relating to the treatment of block purchases. To qualify for the revised safe harbor, all of an issuer’s purchases on a single day, including any block-size purchases by or on behalf of the issuer for that day, must not exceed 25% of the average daily trading volume in the security. Rule 10b-18(b)(4). Issuers may, however, include their block-size purchases when calculating the security’s four-week average daily trading volume. Previously, block purchases were excluded from the calculation of the applicable volume limits. In addition, issuers may also, within the safe harbor, make one block purchase per week outside of the volume limits, provided that the issuer does not make any other Rule 10b-18 purchases on that day. Shares purchased in reliance on this one-day block purchase exception may not be included when calculating the security’s four-week average daily trading volume. The one-day block purchase exception cannot be used to purchase securities that a broker or dealer, acting as principal, has accumulated for the purpose of selling to the issuer, if the issuer knows or has reason to know that these securities were accumulated to sell to the issuer. The same is true if the broker or dealer has sold short to the issuer, if the issuer knows or has reason to know that the sale was a short sale.

The SEC has revised the rule to extend the safe harbor to issuer repurchases effected after the markets’ regular trading sessions ("after-hours trading"), while the consolidated system is still open, that are effected at prices that do not exceed the lower of:

• the closing price of the primary trading session on the principal market for the security; and
• any lower bids or sale prices subsequently reported in the consolidated system by other markets.

In addition, the issuer may use a different broker or dealer for its after hours trading than the one it used during normal trading hours. As with purchases during normal trading hours, an issuer cannot make the opening purchase transaction of the after-hours trading session, but the issuer can repurchase until the termination of the period in which last sales prices are reported in the consolidated system. The other provisions applicable to trades during normal business hours will continue to apply to purchases in an after-hours trading session.

The SEC has revised the rule to clarify that the rule is not available from the time of public announcement of a merger, acquisition or similar transaction involving a recapitalization until the earlier of the completion of the transaction or the completion of the vote by the target’s shareholders on the transaction (including any subsequent period during which the market price of a security will be a factor in determining the consideration to be paid pursuant to a merger, acquisition or similar transaction – a valuation period). Rule 10b-18(a)(14)(iv). This prohibition does not extend to:

• transactions in which the consideration is solely cash and for which there is no valuation period;
• ordinary repurchases following the public announcement of a merger, acquisition or similar transaction so long as the total amount of the issuer’s Rule 10b-18 purchases effected on a single day does not exceed the lesser of 25% of the security’s four-week average daily trading volume or the issuer’s average daily Rule 10b-18 purchases during the three full calendar months preceding the date of the public announcement of the merger, acquisition or similar transaction; or
• block purchases, provided that the issuer does not exceed the average size and frequency of block purchases effected pursuant to Rule 10b-18(b)(4) during the three full calendar months preceding the date of the public announcement of the merger, acquisition or similar transaction (for this purpose, "block purchases" are purchases that involve a quantity of stock that has a purchase price of $200,000 or more, is at least 5,000 shares and has a purchase price of at least $50,000, or is at least 20 round lots and totals 150% or more of the trading volume for that security, or if trading volume information is unavailable, at least 1/10 th of one percent of the outstanding shares of common stock).

The SEC has revised the definition of "Rule 10b-18 purchase" to clarify that purchases for the issuer include riskless principal transactions. A riskless principal transaction is a transaction in which a broker or dealer, after having received an order from an issuer to buy its security, buys the security as principal and then sells the security to the issuer to satisfy the issuer’s buy order. To qualify, the issuer’s purchase must be effected at the same price per share as that at which the broker or dealer bought the shares to satisfy the issuer’s buy order, exclusive of any explicitly disclosed markup or markdown, commission equivalent or other fee. In addition, only the first leg of the transaction – when the broker or dealer purchases the shares in the open market – must be reported under the rules of the applicable self-regulatory organization or under the Exchange Act. Finally, a broker or dealer must have written policies and procedures in place to assure that, at a minimum, the issuer’s order is received prior to the offsetting transaction, the offsetting transaction is allocated to a riskless principal account or the issuer’s account within 60 seconds after the execution, and the broker or dealer has supervisory systems in place to produce records that enable the broker or dealer to accurately and readily reconstruct, in a time-sequenced manner, all orders effected on a riskless principal basis.

During a trading session following a market-wide trading suspension, an issuer is not subject to the volume limitation of 25% of the four-week average daily trading volume, but can purchase up to 100% of a security’s four-week average daily trading volume. Rule 10b-18(c)(2). The issuer would still have to comply with the other applicable provisions of Rule 10b-18 during this trading session. A market-wide trading suspension is a trading halt of 30 minutes or more that is imposed pursuant to the rules of a national securities exchange or association in response to a market-wide decline during a single trading session or as otherwise declared by the SEC.

The SEC has adopted a new Item 703 of Regulation S-K and S-B and revised Forms 10-K, 10-KSB, 10-Q, 10-QSB, 20-F and N-CSR to require that an issuer provide tabular disclosure of all issuer repurchases, whether or not the purchases were made pursuant to Rule 10b-18, of its equity securities that are registered pursuant to Section 12 of the Exchange Act during the reporting period covered by the form (the last quarter only in the case of a Form 10-K and 10-KSB, or semi-annual period in the case of a closed-end fund). The table must include all issuer repurchases of its equity securities during the reporting period, including:

• the total number of shares purchased on a monthly basis;
• the average price paid per share;
• the total number of shares purchased as part of a publicly announced repurchase program; and
• the maximum number or dollar value of shares that may yet be purchased under the program.

The table must include footnotes that briefly describe the nature of the transaction for purchases made other than pursuant to a publicly announced repurchase program (e.g., open market or privately negotiated purchases, issuer tender offers or purchases by the issuer upon the exercise of a redemption or put right).

In addition, each issuer that has publicly announced a stock repurchase program must include a footnote to the table describing the principal terms of the publicly announced repurchase program, including:

• the date of the announcement;
• the share or dollar amount approved for repurchase;
• the expiration date of the program, if any;
• each program that has expired during the period covered by the table; and
• each program that the issuer has decided to terminate prior to its expiration or under which the issuer does not intend to make further purchases.

This Mayer, Brown, Rowe & Maw LLP article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

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