SEC Commissioner Robert J. Jackson Jr. recently gave his views on stock buybacks. Much of the speech focused on Rule 10b-18 which is used by public companies when conducting stock buybacks. Rule 10b-18 provides a safe harbor from securities-fraud liability if the pricing and timing of buyback-related repurchases meet certain conditions.
Among other things, Commissioner Jackson described a study undertaken by his staff:
So we dove into the data, studying 385 buybacks over the last fifteen months. We matched those buybacks by hand to information on executive stock sales available in SEC filings. First, we found that a buyback announcement leads to a big jump in stock price: in the 30 days after the announcements we studied, firms enjoy abnormal returns of more than 2.5%. That’s unsurprising: when a public company in the United States announces that it thinks the stock is cheap, investors bid up its price.
What did surprise us, however, was how commonplace it is for executives to use buybacks as a chance to cash out. In half of the buybacks we studied, at least one executive sold shares in the month following the buyback announcement. In fact, twice as many companies have insiders selling in the eight days after a buyback announcement as sell on an ordinary day. So right after the company tells the market that the stock is cheap, executives overwhelmingly decide to sell.
And, in the process, executives take a lot of cash off the table. On average, in the days before a buyback announcement, executives trade in relatively small amounts—less than $100,000 worth. But during the eight days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day—a fivefold increase. Thus, executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement . . .
Commissioner Jackson noted the trading was not necessarily illegal. However, Commissioner Jackson expressed his view that the safe harbor provided by Rule 10b-18 should not subsidize this sort of trading by executives. According to the Commissioner, SEC rules should encourage executives to keep their skin in the game for the long term. Thus, Commissioner Jackson believes Rule 10b-18 should be revised so that the safe harbor is not available to a public company that allows executives to sell stock during a buyback.
Commissioner Jackson also stated his view that corporate boards and their counsel should pay closer attention to the implications of a buyback for the link between pay and performance. In particular, the company’s compensation committee should be required to carefully review the degree to which the buyback will be used as a chance for executives to turn long-term performance incentives into cash. If executives will use the buyback to cash out, the committee should be required to approve that decision and disclose to investors the reasons why it is in the company’s long-term interests, according to Commissioner Jackson.