United States: SEC Reopens Comment Period (again) For Proposal On Stock Buyback Disclosure

Yesterday, the SEC announced that it was reopening (again) the public comment period for its proposed rule on stock buyback disclosure modernization, a rule proposed at the end of 2021. (Remember that the comment period for this proposal was previously reopened in October because of the "technical glitch." See this PubCo post.) The proposal is focused on enhancing disclosure by requiring more detailed and more frequent and timely disclosure about stock buybacks. (See this PubCo post.) Why did the SEC reopen the buyback proposal comment period? Because, at the time the proposal was issued, the Inflation Reduction Act of 2022 had not yet been enacted, which meant that the implications of that Act could not be considered as part of the proposal's original cost/benefit analysis. However, as demonstrated in a new memo from the SEC's Division of Economic and Risk Analysis, the excise tax on stock buybacks imposed under the IRA could affect that analysis, and consequently, the public's evaluation of the proposal. As a result, the SEC determined to make the DERA memo part of the comment file and to reopen the comment period for an additional 30 after publication of the reopening release in the Federal Register.

(Note that, at the same time as it issued the original buyback disclosure proposal, the SEC proposed new rules on Rule 10b5-1 plans, which the SEC has announced will be considered for adoption on Wednesday, December 14, along with a slew of proposals to overhaul the market. See this PubCo post.)

Under the proposed rules on share repurchase disclosure modernization, a company would be required to report, on new Form SR, using Inline XBRL, any purchase made by or on behalf of the company (or any affiliated purchaser) of shares or other units of any class of the company's equity securities registered under Section 12 of the Exchange Act, before the end of the first business day following the day on which the company executes a share repurchase. The proposal would also amend Item 703 of Reg S-K to require the company to disclose in periodic reports the rationale for its share repurchases and the criteria used to determine the repurchase amount, the company's policies and procedures relating to purchases and sales by officers and directors during a repurchase program, and whether repurchases were made under Rule 10b5-1(c) or in reliance on Rule 10b-18.

The DERA memo explains that, with specified exceptions (such as a $1 million threshold), the IRA imposes on domestic public companies a nondeductible excise tax equal to 1% of the fair market value of any stock repurchased by the company during the taxable year (after December 31, 2022), reduced by the fair market value of any stock issued during the same year. DERA estimates that, based on data for 2020, of the approximately 3,300 issuers engaged in repurchases and subject to the proposed amendments, approximately 2,300 issuers would be impacted by the excise tax, which could affect whether these companies engage in repurchases. DERA indicates that the number of issuers that would be subject to the proposal would likely decrease "to the extent that issuers eliminate share repurchases or replace those share repurchases with dividends. Whether repurchases can be viewed as the issuer's attempt to purchase the company's shares when they are relatively undervalued, or a method of distributing free cash flow to shareholders, the excise tax would essentially represent a cost to the company and its shareholders akin to transaction costs, which have been shown to reduce share repurchases." In addition, some issuers may continue engaging in buybacks, but reduce the level of the repurchase activity. Some companies, DERA suggests, "may reduce share repurchases after the excise tax takes effect but not increase dividends, resulting in a decrease in total payout to shareholders."

Nevertheless, in a choice between dividends and repurchases, DERA suggests, some companies may continue to favor repurchases because of the tax preferences of their investor base. In addition, DERA notes, dividends "are generally viewed as a less flexible form of payout than repurchases because companies generally experience a negative market reaction to dividend (but not repurchase) cuts and therefore seek to maintain smooth or steadily increasing dividends (compared to more variable repurchases). Consequently, companies with uncertain cash flows may favor repurchases to initiating or raising dividends.... Some issuers that decide to switch to dividends after the excise tax takes effect may opt for special dividends over regular dividends in an attempt to preserve some financial flexibility." DERA also notes that in "one theoretical model, repurchases convey a stronger signal that the firm's shares are undervalued than dividends do."

DERA indicates that it expects the categories of costs and benefits described in the proposal to remain the same, but the magnitude may change as a result of the excise tax (e.g., fewer filings of Form SR).

In the reopening release, the SEC asks for comment on, among other issues, the impact of the new excise tax on the potential economic effects of the proposal, the qualitative analysis in the DERA memo of the likely directional effects of the new excise tax on share repurchases, the likelihood that companies will replace share repurchases with dividends and the administrative costs of each, and if other costs and benefits should be considered.

In a statement, SEC Commissioner Mark Uyeda expressed his support for the inclusion of the DERA memo in the comment file and the reopening of the comment period generally, but expressed disagreement with the brevity of the 30-day comment period, especially given the timing during major holidays: "One might ask: what is the purpose of the comment period? Is it merely an item to be checked off to satisfy the lowest acceptable standard of process required by the Administrative Procedures Act? Or is it a vital component of a discussion between an administrative agency and the public in order to better understand the effects of a proposed rule, especially under a changed factual scenario? I believe it is the latter. A longer period, such as 45 days, would increase the likelihood that the Commission receives more thoughtful responses." Uyeda has taken a number of opportunities to chide the SEC about the duration of its public comment periods. (See this PubCo post, this PubCo post and this PubCo post.)

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