Petition for Rulemaking to Revise Rule 10b-18

Heather Slavkin Corzo is Director of Capital Markets Policy for the AFL-CIO. This post is based on a rulemaking petition submitted by AFL-CIO and others to the Securities and Exchange Commission. Related research from the Program on Corporate Governance includes Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay by Jesse Fried (discussed on the Forum here) and  Short-Termism and Capital Flows by Jesse Fried and Charles C. Y. Wang (discussed on the Forum here).

Petitioners signed below respectfully submit this petition for rulemaking pursuant to Rule 192(a) of the Commission’s Rules of Practice.

In 1982, the Securities and Exchange Commission (“SEC” or “Commission”) finalized Rule 10b-18, 17 C.F.R. § 240.10b-18, (“Rule 10b-18” or “the Rule”). Rule 10b-18 provided companies with a “safe harbor” to undertake stock repurchase (or “buyback”) programs without being subject to liability for manipulation under the Securities and Exchange Act of 1934. Stock repurchase programs have grown in size and importance since Rule 10b-18 went into effect. In particular, the use of the practice skyrocketed after the enactment of President Trump’s Tax Cuts and Jobs Act. The tax bill provided significant tax benefits to large corporations, such as a lower corporate tax rate and an incentive to repatriate offshore cash, and led to a 64 percent increase in stock repurchases while real wages for workers remained flat. Indeed, analysts estimate that in 2018 corporations used nearly 60 percent of their corporate tax cut to repurchase stock. In other words, at a time when wages for average workers have failed to keep up with inflation, corporations have used the corporate tax break to collectively pay $1 trillion to executives, boards of directors, and large share sellers. Instead firms could dedicate this capital to worker wages, training, hiring, and other investments necessary for innovation and growth.

The impact of the Tax Cuts and Jobs Act makes clear that repurchase programs under Rule 10b-18 are subject to significant abuse. The Rule’s safe harbor conditions—which firms must meet to benefit from its protection from manipulation charges—have failed to prevent executives from using repurchases to boost a company’s stock price or meet other performance goals at the expense of investing in its workers. And the inadequate disclosure requirement in Rule 10b-18 frustrates oversight by investors and the Commission. The SEC now has the opportunity to address these recently heightened concerns. Petitioners therefore respectfully requests the Commission initiate a rulemaking to revise Rule 10b-18 to curb manipulative practices by firms and encourage corporations to fairly compensate American workers.

Petitioners are organizations with a vested interest in promoting investor protection, sound capital formation and a strong, stable, and ethical financial system.

I. Background

Under the Securities and Exchange Act, it is unlawful “[t]o effect, alone or with 1 or more other persons, a series of transactions in any security […] creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.” 15 U.S.C. § 78i(a)(2). On the face of the Act, a stock or share repurchase, where a firm buys its own stock, could open a firm to charges of market manipulation. Such a repurchase generates trading activity, decreases outstanding shares, increases the stock price—and is often announced explicitly for this purpose.

In 1982, the SEC enacted Rule 10b-18, which provides a “safe harbor” from liability for manipulation under the Securities and Exchange Act if a firm performs its stock repurchase consistent with the conditions of the Rule. At the time of its enactment, consistent with the anti-manipulation provisions of the Securities and Exchange Act, the Commission intended what became the Rule to be “a scheme of regulation that limits the ability of an issuer *** to control the price of the issuer’s securities.”

The conditions of the Rule concern the volume, manner, price, and timing of a repurchase. Failure to conform to the conditions of the safe harbor “remove[s] all of the issuer’s repurchases from the safe harbor for that day.” Id., Preliminary Note. The safe harbor also “is not available for repurchases that, although made in technical compliance with the section, are part of a plan or scheme to evade the federal securities laws.” Id.

The adoption of Rule 10b-18 represented a sea change in corporate finance, after which stock repurchases became more common. Prior to its adoption, repurchase programs were relatively rare due to the threat of a manipulation charge; after the Rule took effect, the aggregate value of stock repurchases rose significantly. Now, many firms allocate nearly all their profits (net income) to repurchases and other forms of shareholder compensation rather than reinvesting in the productive capabilities of the firm. For the 449 publicly listed companies in the S&P 500 between 2003 and 2012, 97 percent of profit went to shareholders—with 54 percent of profit used for repurchases. This is fungible capital that could be retained by the corporation to be used elsewhere, including worker wages, training, hiring, and other investments necessary for innovation and growth.

II. Specific Concerns with Current Rule 10b-18

Despite Rule 10b-18’s ostensible limits on the scope of the safe harbor, the history of stock repurchases—exacerbated by the recent effects of the Tax Cuts and Jobs Act—shows that the Rule has failed to meet the purpose behind its promulgation: limiting the ability of the firm to manipulate its stock price and volume. Specifically, firms retain the ability to artificially inflate stock prices or meet performance goals through repurchases that benefit executives without corresponding improvements to the real value of the firm. This manipulative redirection of capital comes in part at the expense of American workers.

A. Executives retain a strong financial incentive to use repurchases to artificially inflate stock prices and boost their own compensation without real firm improvement.

Rule 10b-18’s safe harbor neither prevents firms from manipulating stock prices and volume through repurchase on the open market, nor guards against the strong personal financial incentive for executives to do so.

Stock repurchase programs artificially increase stock prices without altering the real value of the firm, or achieving improvements in profit, the quality of goods, customer relations, or efficiency. Repurchases decrease the availability of stock supply on the open market, increasing the value of each available share. The SEC has recognized the intent and effect of repurchases, noting that repurchases are often used “[d]uring mergers and acquisitions *** to support or raise the market price of the issuer’s securities for the purpose of making exchange ratios appear more favorable to target company security holders,” as well as “[a]fter mergers and acquisitions, *** to support or raise the market price of the issuer’s securities for the purpose of reducing the number of shares required to be issued pursuant to contingent obligations owed to former shareholders of the target company.” The mere announcement of repurchases, even without execution by the firms, has been shown to have a positive effect on a business’s stock price.

Rule 10b-18 also does not address the strong financial incentive of executives to use these effects of repurchases to increase their own compensation. The SEC intended Rule 10b-18 to prevent abusive “purchases designed to support the price of the issuer’s securities in order to assist inside[r]s in disposing of their holdings at or above the pegged price.” But the Rule has not kept up with the times. First, in today’s market, the majority of executive compensation is often performance-based, tied to stock price or earnings per share. This presents executives with a direct, personal financial incentive to increase the short-term stock price or decrease the volume of outstanding shares to meet performance goals.

Repurchase programs offer a direct lever to achieve those goals. Indeed, empirical analysis of firm behavior has revealed that the likelihood of repurchases is higher at firms that would have just missed analyst earnings expectations without the effect of the repurchase. This strongly suggests that firm executives rely on repurchases to meet earnings targets and thus increase their own performance-based compensation. Rule 10b-18 does not account for the incentives for executives to use repurchases to increase their own compensation.

Second, research by Commissioner Robert Jackson has revealed that executives often time the sale of their personal equity to take advantage of the price increase created by repurchases and their announcement. In half of the repurchase programs in the study, at least one executive at the repurchasing firm sold shares in the month following the announcement. During each of the eight days following an announcement, executives are twice as likely to sell shares as any other day and sell on average five times the volume of stock. As executives are not required to disclose their trading intentions to shareholders in advance of a repurchase program, shareholders are less able to scrutinize repurchase programs for conflicts of interest.

The lack of effective disclosures also obscures whether repurchase programs conform with the conditions of the Rule 10b-18 safe harbor. Firms disclose quarterly information about repurchase programs, but only after the fact and tabulated by month. The Commission therefore cannot effectively compare firm repurchase activity (reported by month) against the daily conditions, such as the daily limit on repurchase volume, of the safe harbor. As then-Chair of the Commission Mary Jo White recognized, “data analyses for issuer stock repurchases presents significant challenges because detailed trading data regarding repurchases is not currently available.” Addressing that challenge is within the power of the SEC.

B. The Tax Cuts and Jobs Act of 2017 exacerbated the harm to worker wages caused by repurchase programs.

When firms use stock repurchase programs to “downsize-and-distribute” capital to executives and shareholders for short-term gain rather than “retain[ing]-and-reinvest[ing]” in the firm for longer term innovation and growth, workers often lose out in the process. The Tax Cuts and Jobs Act handed companies a massive tax windfall that many used in exactly that way with precisely that result.

The Tax Cuts and Jobs Act became law in December 2017 and provided significant tax benefits to large corporations, such as a lower corporate tax rate and an incentive to repatriate offshore cash. As a result, firms enjoyed a windfall worth hundreds of billions of dollars. But instead of raising wages as promised by the Trump Administration during the debate over the tax bill, firms raced to repurchase their own stock. In 2018, the first full year after the tax cut, repurchases surged 64 percent over the previous year and topped $1 trillion overall. Yet real wages for typical workers remained flat. A survey of top firms revealed that only 7 percent of the tax windfall will go to workers, while almost 60 percent will be paid to shareholders.

Several examples illustrate how corporations have used the Tax Cuts and Jobs Act to reward executives and large shareholders at the expense of workers:

  • Walmart authorized $20 billion for stock repurchases in 2018 and 2019, enough money to give 1 million employees a $10,000 raise. Walmart is America’s largest corporate employer, with an $11 per hour, or $19,448 per year, starting wage in many states. Its CEO, Doug McMillon, earned nearly $24 million last year—1,076 times the pay of the median worker at Walmart. Despite this disparity, Walmart authorized $20 billion for stock repurchases in 2018 and 2019. By contrast, Walmart’s announcement of a one-time bonus for employees of up to $1,000 per worker is expected to total just 0.02 percent of the money distributed to shareholders through repurchases. According to an analysis by the Roosevelt Institute, had Walmart reallocated those repurchase funds to workers, it could have raised 1 million hourly workers’ wages by $5.66/hour for the year. That could bring Walmart’s starting wage to over $16.00/hour, an extra $10,000 per year for a full-time worker. Alternatively, the retail giant could have used the funds to retain some of the thousands of workers laid off in 2018.
  • In October 2018, Sears Holding Company, which owns Sears and Kmart, filed for bankruptcy with about $5.6 billion in outstanding debt after having spent $6 billion on stock repurchases since 2005. Rather than investing in the firms’ core retail business, Sears opted for bankruptcy after years of layoffs and store closures by firm management amidst massive stock repurchases. When Sears and Kmart combined in 2005, they had approximately 3,500 stores and over 300,000 employees. Sears shuttered 700 stores between 2016 and 2018 alone. As of last year, only about 1,000 stores and 89,000 employees remained. Store closures and employee layoffs have continued since the bankruptcy announcement.
  • Wells Fargo authorized more than $40 billion in stock repurchases since President Trump’s tax bill was passed despite continuing to lay off workers across the country. In September 2018, Wells Fargo announced that it intends to lay off between 5 and 10 percent of its workforce, or 13,250 to 26,500 employees, over the next three years. It began the process by laying off 1,636 employees in 2018. Yet Wells Fargo expended over $20 billion on share repurchases in 2018, a 108% increase over the previous year. And between the passage of President Trump’s tax bill and November 2018, Wells Fargo authorized $40.6 billion in future stock repurchases. Although Wells Fargo has claimed the layoffs are part of efforts to make the firm “more streamlined and efficient” by eliminating $4 billion in expenses, the then-CEO has explained that the repurchases are driven by an “excess of capital” at the firm. According to an analysis by the Roosevelt Institute, if Wells Fargo invested the same $40.6 billion in its workers, instead of authorizing a stock repurchase, the company could have provided each of its 262,700 employees a raise of $154,000. Or if Wells Fargo had saved only one-tenth of the $40.6 billion that it authorized for spending on stock repurchases, all the positions it plans to eliminate could be saved.
  • AT&T reaped over $20 billion from the tax cuts and has spent billions on buybacks while continuing to outsource jobs. AT&T vocally supported the tax cuts, which increased its cash profits by $ 3 billion annually and reduced tax liabilities by another $ 20 billion. But despite proclaiming itself a job-creator, during 2018 alone AT&T eliminated 10,700 union jobs and closed call centers, continuing a previous seven-year trend that has resulted in 44 closed call centers and 16,000 laid off call center workers nationwide. These layoffs come amidst record stock repurchases by AT&T. The company, which has spent $16. billion on stock buybacks since 2013, spent more on buybacks in the second quarter of 2018 than it has spent in any quarter since 2004.

The tendency toward repurchase programs at the expense of workers is of a piece with a faulty program of short-term shareholder primacy. The management theory of shareholder primacy relies on the false presumption that firms should maximize immediate shareholder value without regard for other stakeholders, like workers and others with long-term interests. As described by Blackrock CEO Larry Fink, shareholder primacy can emphasize short-term returns over re-investment, “sacrifice investments in employee development, innovation, and capital expenditures that are necessary for long-term growth,” and fail “employees, customers, and the communities in which they operate.” Large repurchase programs further this trend, as firms suppress wages even for educated and experienced workers to shift capital to short-term shareholders. Long-term shareholders, alternatively, may lose out as firms fail to make strategic long-term re-investments to improve their market position in the future. Initiating a rulemaking to reform Rule 10b-18 would provide the SEC an opportunity to address these concerns with respect to repurchase programs.

III. Proposal to Repeal Rule 10b-18 and Develop a New Framework That Bans Manipulative Buybacks and Protects American Workers

Petitioners respectfully request that the Commission initiate a rule change to ban manipulative repurchases and protect American workers.

First, we ask the Commission to repeal Rule 10b-18 and reset the regulatory landscape to the pre-1982 regime. Prior to Rule 10b-18, repurchase programs were relatively uncommon because the potential for a market manipulation charge inhibited their abuse. Repealing the current safe harbor would re-set incentives by keeping firms subject to the deterrent effect of market manipulation charges for abusing repurchase programs, consistent with the anti-manipulation and anti-fraud provisions of the Securities and Exchange Act.

Second, we ask the Commission to undertake a rulemaking to develop a more comprehensive framework for regulating stock repurchase programs that would deter manipulation and protect American workers.

The Commission’s own history provides a potential starting point for such a regulatory regime. Proposals by the SEC between 1970 and 1980 set out to “prevent an issuer from effecting repurchases which may have a manipulative or misleading impact on the trading market in the issuer’s securities.” Recognizing the potential for manipulation through repurchase programs, particularly by incumbent management, the proposals would have placed conditions “designed to ensure that an issuer neither leads nor dominates the trading market in its securities” on repurchase programs. The proposals differed substantially from Rule 10b-18. In particular, the following were proposed:

  • Limiting repurchases to 15 percent of the average daily trading volume for that security.
  • Creating a narrower safe harbor and allowing repurchases that fall outside this safe harbor to be reviewed and approved on an individualized, case-by-case basis.
  • Providing that repurchases inconsistent with the safe harbor are expressly “unlawful as fraudulent, deceptive, or manipulative.”
  • Requiring various disclosures, including whether any officer or director is purchasing or disposing of the issuer’s securities, the source of funds to be used to effect the repurchases, the impact of the repurchases on the value of the remaining outstanding securities, and specific disclosures for large repurchases.

These proposals, none of which are reflected in Rule 10b-18, should now be considered anew by the Commission in light of the demonstrated impacts under the current version of the Rule, particularly given market behavior after the Tax Cuts and Jobs Act of 2017.

Further, the SEC should also draw from the experience of foreign countries. Among the ten countries with the largest capital markets, the U.S. is the only country without clear limitations on repurchase programs. Other countries require immediate disclosure, have bright-line trading limits, require shareholder rather than board approval, and prohibit executive trading during repurchase program periods. For example, Japan and the United Kingdom require daily disclosure of repurchases. Though not a substitute for regulation, immediate disclosure provides the market and regulators an opportunity to supervise repurchase activities. Several countries, including France, Germany, Italy, Switzerland, and the Netherlands, enforce a bright-line limit volume limit of 10 percent of outstanding shares within an eighteen-month period. These and other regimes are an instructive basis for future SEC rulemaking.

In conclusion, Petitioners respectfully request that the Commission promptly initiate a rulemaking to repeal and reform Rule 10b-18 to address manipulative repurchase programs that harm workers.

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The complete publication, including footnotes and the complete list of signatories, is available here.

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