This practice note includes 10 practice tips that may help you, as counsel to a public company or a repurchase agent, in implementing a stock repurchase program on behalf of your client. A stock repurchase program enables a company to buy back a certain number of its outstanding securities. In recent years, the repurchase activity undertaken by U.S. public companies has significantly increased, in part as a result of the tax reforms implemented in 2018. When considering adoption of a share repurchase program, companies should consider the sharp public criticism of such programs, which has become more heightened mmediately after the commencement of the COVID-19 pandemic. Nonetheless, share repurchase activity increased substantially in 2021. Many companies that have completed recent significant strategic transactions have concurrently undertaken sizeable share repurchases. Shares repurchased by a company are either canceled or kept as treasury stock, which thereby reduces the number of outstanding shares and usually has the effect of increasing the company's earnings per share.
For additional information on stock repurchase programs, see Share Repurchase Programs and Dividends, Redemptions, and Stock Repurchases.
- Understand applicable legal requirements. Rule 10b-18 (17 C.F.R.§ 240.10b-18), which was adopted in 1982 and amended in 2003, provides public companies with a voluntary, nonexclusive safe harbor from liability for manipulation under Sections 9(a)(2) and 10(b) of the Securities Exchange Act of 1934, as amended (Exchange Act), and Rule 10b-5 (17 C.F.R.§ 240.10b-5) under the Exchange Act when the company bids for or purchases shares of its common stock in accordance with the Rule's manner, timing, price, and volume conditions. As a result, most repurchases of common stock in the open market are made in reliance on the Rule 10b-18 safe harbor in order to avoid manipulations claims. The safe harbor does not immunize the company and its insiders from making repurchases at a time when they are in possession of material nonpublic information. The Rule 10b-18 safe harbor is only available for repurchases of common stock (or the equivalent) and is not available, for example, in connection with repurchases of preferred stock, warrants, or convertible debt securities (or other nonvoting securities). Nonetheless, many companies implement a repurchase program for equity-linked securities subject to conditions analogous to those set forth in Rule 10b-18.
To come within the safe harbor, a company's repurchases must satisfy (on a daily basis) each of the rule's four conditions (manner of purchase, timing, price, and volume) summarized below:
- Manner of purchase condition. Open-market repurchases may be undertaken by the company directly or by a repurchase agent (a broker-dealer) on the company's behalf. However, pursuant to the manner of purchase condition, the company is only permitted to engage one repurchase agent per day to bid for or purchase its common stock. Nonetheless, a company may use a different repurchase agent during an afterhours trading session from the repurchase agent used during regular trading hours. The company may make repurchases if these repurchases are not solicited by or on behalf of the company or its repurchase agent (such as following a shareholder reverse inquiry).
- Timing condition. The company's repurchase may not be the opening transaction on its principal trading market. The company may not conduct the repurchase during the 10 minutes before the scheduled close of the primary trading session in the principal market for its common stock or the last 10 minutes before the scheduled close of the primary trading session in the market where the repurchase is effected. These 10-minute restrictions are extended to 30 minutes if shares of the company's common stock do not have an average daily trading volume ("ADTV") of at least $1 million and a public float of at least $150 million. Under certain circumstances, a repurchase can be effected by the company or its repurchase agent following the close of the primary trading session in the principal market.
- Price condition. Repurchases of listed shares must be made at a price per share not exceeding the highest independent bid or last transaction price, whichever is higher. For shares that are not listed, the company must use the highest independent bid obtained from three independent dealers. The offer price is irrelevant for purposes of determining the maximum permissible price.
- Volume condition. Daily repurchases may not exceed 25% of the ADTV during the preceding four weeks (as a result, a new public company must wait at least four weeks after its shares begin trading in order to claim the safe harbor). However, a company may include its block-size purchases when calculating its four-week ADTV. Rule 10b-18 provides companies with a choice when making any particular block purchase. Either the block purchase must comply with the 25% ADTV volume condition, like any other repurchase, or the block purchase need not comply with the volume condition, but the company can make no other repurchases on that day, and all other block purchases effected during that week must comply with the 25% volume condition.
Failure to meet any of the four conditions will render the safe harbor unavailable for repurchases that day. Certain types of repurchases are not covered by Rule 10b-18 due to the heightened risk of manipulation, such as repurchases made by or for an employee benefit plan by an independent agent or repurchases made in connection with a merger or a tender offer. Repurchases by an affiliated purchaser may be attributable to the company under Rule 10b-18 if the affiliate controls the company's Rule 10b-18 purchases or the affiliate and the company are under common control. Repurchases made by persons (even if unaffiliated) acting in concert with the company for the purpose of acquiring the company's outstanding shares will also be attributed to the company. All purchases made by such persons will be aggregated with the company's direct purchases to determine compliance with the Rule 10b-18 safe harbor. This is an important consideration for a financial institution that has an affiliated broker-dealer that is consummating repurchases on behalf of the institution. In addition to the federal securities laws, counsel should consider whether a proposed repurchase program complies with applicable state law. For a Delaware corporation, Section 160 (8 Del. C. § 160) of the Delaware General Corporation Law allows a company to repurchase or redeem its outstanding securities from shareholders so long as its capital is not and would not become impaired. A determination by the company's board of directors is typically sufficient. The board of directors must also consider whether the proposed repurchase program, if fully implemented, would cause the company to become insolvent.
Finally, counsel should also consider the applicability of any share repurchase restrictions imposed by the Coronavirus Economic Stabilization Act of 2020 under the Coronavirus Aid, Relief, and Economic Stability Act (CARES Act), which was enacted in connection with the onset of the COVID-19 pandemic. Under the CARES Act, the federal and state governments offered relief and financing programs to assist businesses contingent on an agreement to restrict any share repurchase activity. Recipients may not execute share repurchases if a loan or guarantee was obtained under such a program and for the 12 months after the loan or guarantee is no longer outstanding. However, the share repurchase restrictions are not applicable for recipients with existing contractual share repurchase obligations that precede the enactment of the CARES Act.
- Consider repurchase authority. Any purchase of
a company's securities, including a repurchase program, must be
approved by the company's board of directors. The authorization
should include an affirmation of the repurchase program's
intended objective and a determination that the program is in the
best interest of the company and its shareholders. In order to
arrive at this conclusion, the board of directors should assess the
company's capital position. The board of directors should also
consider the repurchase alternatives available to the company and
the impact of the repurchase program on the company. The company
should identify any provisions in its organizational documents or
contractual agreements that limit its ability to repurchase its
securities and obtain any required third-party consents prior to
undertaking any repurchase. As part of this repurchase
authorization, the board of directors should impose specific
parameters with respect to the timing, dollar amount, and/or share
size of any repurchases that are to be conducted. Generally, the
board of directors should consider how repurchases will be
monitored and reported. For a form of board resolutions that can be
used by a company seeking to repurchase outstanding company
securities pursuant to a stock repurchase plan, see Board Resolutions: Stock Repurchase Plan
Approval.
- Consider potential repurchase structures.
Companies have significant flexibility with respect to choosing a
particular repurchase structure ranging from open market
repurchases to repurchases that are subject to tender offer rules.
A company may structure its repurchase as an accelerated stock
repurchase (ASR). An ASR may result in faster execution and more
price certainty; however, repurchases made pursuant to an ASR do
not benefit from the Rule 10b-18 safe harbor. An ASR is a privately
negotiated transaction, usually documented as a forward contract,
in which a repurchase agent agrees to sell a predefined amount of
stock to a company at a price per share based on the
volume-weighted average price during the specified period. A
repurchase agent acts as the seller of the company's shares in
an ASR, and the company acts as the purchaser buying back its own
shares. ASRs provide numerous benefits, including transaction
efficiency, an immediate share count reduction, certainty as to the
timing and quantity of the repurchase, and possible accounting
advantages. Notwithstanding these benefits, ASRs have been the
subject of some criticisms. As a result, a company should consider
carefully its alternatives.
- Understand how an ASR works. At the beginning
of the ASR, the company generally pays a predefined dollar amount
to the repurchase agent for a specified number of securities. The
repurchase agent generally borrows securities from stock lenders
and delivers those securities to the company. Over time, the
repurchase agent will buy securities in the market to cover its
borrow and has the option to complete the ASR at any time within a
pre-agreed period. The purchase period will have fixed starting and
end points, though the repurchase agent will have the right, upon
notice to the company, to shorten the period. An average price is
determined for the purchase period, which is typically based on the
Rule 10b-18 pricing condition minus an agreed discount or price
adjustment. At the ASR's final settlement, the total number of
securities purchased by the company generally equals the ASR dollar
size divided by the discounted average price. If the repurchase
agent did not deliver a sufficient number of securities at
inception, it must deliver incremental securities to the company at
the end of the term. Conversely, if the repurchase agent delivered
too many securities, the company must settle with the repurchase
agent in cash or stock on the settlement date.
- Understand disclosure obligations. Public
companies must announce repurchase programs and report their
repurchase activity in accordance with Item 703 (17 C.F.R.§
229.703) of Regulation S-K. The securities exchange on which the
company's securities are listed will require public disclosure
if the company's board of directors authorizes a repurchase
program. The company may satisfy these public disclosure
requirements by filing a Current Report on Form 8-K under Item
7.01. The filing must disclose the authorization date, the number
of shares that were authorized to be repurchased, and the
expiration date of the program, if any. Going forward, the company
will also be required to disclose repurchases in its Exchange Act
filings, including the total number of shares purchased, the
average price paid per share, the total number of shares purchased
as part of the repurchase program, and the maximum number of shares
yet be purchased under the repurchase authority. For additional
information regarding the disclosure requirements of Form 8-K,
see Form 8-K Drafting and Filing.
- Consider potential impact on upcoming issuances of
securities. A company should generally avoid purchasing
its outstanding securities at any time that its insiders
(directors, officers, and affiliated shareholders) are selling the
company's securities other than through a Rule 10b5-1 program
as described below. Similarly, insiders should consider and discuss
with the company and counsel whether it is prudent to sell the
company's securities they hold when the company is purchasing
its securities. The company also will want to consider the
applicability of Regulation M to the extent that the company is
engaged in activity that would be considered a distribution under
the Regulation and the company has an active repurchase program.
Repurchase agreements typically include provisions to the effect
that the company is not engaged in any issuance of securities that
would cause the repurchase agent to violate any securities law and
that at all relevant times during the repurchase program the
company will not make any such issuance of securities. The
representations and covenants in the repurchase agreement generally
place the burden on the company to monitor its activities during
the term of the repurchase program.
- Address insider transaction concerns.
Repurchase programs have recently been at the center of some
controversy, and there have been calls by members of Congress to
rescind or significantly amend Rule 10b-18, as well as to address
insider transactions in proximity to announced repurchases. In
March 2020, nowPresident Joe Biden tweeted: "I am calling on
every CEO in America to publicly commit now to not buying back
their company's stock over the course of the next year. As
workers face the physical and economic consequences of the
coronavirus, our corporate leaders cannot cede responsibility for
their employees." Although no new laws have been passed
limiting a public company to repurchase their own shares, it has
become the subject of intense political debate and Congress is
currently considering imposing a federal tax on repurchase
activity. Critics of repurchase programs argue that they primarily
benefit the company's senior management and that the cash used
for repurchases should instead be used to grow the company's
business or increase the wages of the company's employees. As a
result of the heightened scrutiny, a company's management and
board of directors should consider closely the types of concerns
that may be raised. The company also can consider establishing a
Rule 10b5-1 trading plan for a repurchase agent to buy its
securities at a time when the company is not aware of any material
nonpublic information. For example, Andeavor LLC, a U.S refiner,
recently agreed to pay $20 million in penalties to the SEC for
inadequate controls over a stock buyback plan. Andeavor's
internal accounting controls failed to ensure that the buyback
adhered to a company policy prohibiting repurchases while it held
material non-public information. The company would provide the
repurchase agent with specific timing and size parameters for
buying its securities at the outset of the program, and the
repurchase agent would thereafter consummate repurchases on the
company's behalf. The company would not have any subsequent
influence over how, when, or whether the repurchase agent effects
purchases of securities. For further information on Rule 10b5-1
plans, see Rule 10b5-1 Plans.
- Consider restrictions on use of cash for
repurchases. The company and its counsel should ensure
that there are no conflicts with loan agreements (or other similar
agreements) with respect to the proposed repurchase program or that
the repurchase program is compliant with a permissible bucket under
an applicable loan agreement. Additionally, the company and its
counsel should assess the impact that a repurchase program can be
expected to have on any applicable financial ratios or covenants to
which the company is subject. A restricted payments covenant in a
loan agreement limits the borrower's (or its parent
company's) ability to make payments in the form of dividends,
distributions, equity redemptions, and repurchases from its
shareholders. The provision is designed to ensure that a
company's shareholders are not paid before the loans are repaid
to the company's creditors. Nonetheless, loan agreements
typically include a negotiated basket that permits the borrower to
make share repurchases up to a certain specified amount based upon
a fixed dollar amount per year or over the life of the loan
agreement. Carry -overs of unused amounts may typically be used by
the borrower to increase the size of the basket for subsequent
years. While creditors have historically limited the ability of
companies to make share repurchases through the imposition of these
covenant restrictions, as a result of heightened competition in the
credit markets, many recent loan agreements only include a
covenant-lite package that does not restrict a company's
ability to make share repurchases.
- Consider applicable tax and accounting issues.
Companies should involve tax counsel and its accountants when
considering a share repurchase program. Share buybacks may have tax
and accounting impacts and these should be well understood before a
decision is taken.
- Negotiate the repurchase agreement. Repurchase agreements that document traditional open market purchases are typically short -form agreements. Most repurchase agents have a form of repurchase agreement that will serve as a starting point. The form repurchase agreement will incorporate the applicable Rule 10b-18 provisions in setting out the mechanics of the repurchase. The repurchase agreement appoints the repurchase agent and authorizes it to make open market purchases on the company's behalf in accordance with the terms and conditions set forth in the agreement. As part of the agreement, the repurchase agent agrees to use commercially reasonable efforts to purchase the company's outstanding shares and comply with the pricing, timing, and volume guidelines that are provided to the repurchase agent by the company. The repurchase agent typically disclaims responsibility for complying with Rule 10b-18(b)(4) (volume of purchases) to the extent that the company or any affiliated purchaser of the company has separately purchased securities without informing the repurchase agent. The agreement will include customary company representations and warranties. Unlike the repurchase agreement for traditional open market repurchases, the documentation for ASRs has not become fully standardized. A company typically pre-negotiates forms of ASR documents with members of its lending syndicate. Typically, either a master confirmation or agreement is used with supplemental confirmations containing economic terms for individual transactions or stand-alone long-form confirmations that incorporate or reference an International Swaps and Derivatives Association, Inc. (ISDA) Master Agreement are used. The master confirmation structure is more prevalent as it allows for multiple transactions to be consummated using the same legal terms.
Originally published by Lexis Nexis - Practice Guidance.
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