Sean Mcbride

Associate Editor

Loyola University Chicago School of Law,  JD 2025

In December 2023, the Fifth U.S Circuit Court of Appeals vacated the new share buyback rules issued by Securities and Exchange Commission (SEC). The new rules placed higher scrutiny on companies engaging in share buyback programs. Under the new rules, businesses would need to disclose share buybacks more often and justify why the buyback occurred. While this is a win for the businesses hoping to upend these new rules, the SEC may not be ready to call it quits.

 

What are Share Repurchases?

 

Share repurchases – also known as share buybacks – occur when a publicly traded company repurchases its own shares held by outside individuals or entities.

 

Share Repurchases: Good, Bad, and Everything In Between

 

There are several reasons why companies engage in share repurchase programs. Companies that repurchase their own shares increase the overall degree of control over the company. If a company is fearful of an outsider amassing a certain percentage of their shares, repurchases can be an effective way to consolidate ownership as a defensive maneuver. Companies may also repurchase shares because of the perception that the shares are undervalued and will be a successful long-term investment.

 

There are also more controversial reasons to repurchase shares. Earnings-per-share is a key financial metric that is calculated by taking a company’s net earnings divided by the number of outstanding shares. A company can boost its earnings-per-share by generating higher profits or reducing the number of outstanding shares. Notably, earnings-per-share is only calculated using the shares held by outsiders. Meaning that when a company repurchases its own shares, it reduces the number of shares held by outsiders and lifts the earnings-per-share.

 

Depending on the volume and frequency of share repurchases, companies can also artificially create demand in the market to lift the share price temporarily. As executive compensation is largely tied to financial performance, share repurchases can be used to boost compensation among executives.

 

What Was Included in the SEC’s New Rules?

 

The new rules were released by the SEC in May 2023 and imposed greater restrictions on companies planning to engage in a share repurchase program. Instead of reporting monthly aggregates on share repurchases, companies would have been required to report the following either quarterly or semi-annually:

• The number of shares repurchased on each day a share was repurchased.
• The average price paid for the shares.
• Whether certain officers or directors traded in the relevant securities four days before or after the announcement of the repurchase program.

 

In addition to these reporting requirements, companies will be required to report the objectives and rationales behind the repurchase, the criteria used to determine the amount of shares to repurchase, and any policies and procedures relating to the share repurchase program. Notably, the SEC is interested in seeing what restrictions are in place to police share repurchase programs.

 

New Rules for a New World
 

According to the SEC, these new rules were designed to provide investors with enhanced information to assess the purpose and effects of share repurchases. The SEC also cited “informational asymmetry” as a reason for the new rules, arguing that the current reporting requirements are insufficient for both investors and issuers.

 

Share repurchases have become increasingly popular. Until recently, most investors likely weren’t aware that public companies had share repurchase programs in place. In 2021, share repurchases totaled $950 billion and in 2022 totaled $1.25 trillion. While data for 2023 is still being compiled, companies showed no signs of slowing down. In 2023, Chevron announced a $75 billion buyback program, Meta announced a $40 billion buyback program, and Goldman Sachs announced a $30 billion buyback program. All these announcements coincided with visible boosts to the share price.

 

Corporations Fought Back
 

Almost immediately after the SEC announced the new rules, a trio of business organizations led by the U.S Chamber of Commerce sued the SEC in the Fifth U.S Circuit Court of Appeals to block the new share repurchase rules. In November 2023, the Fifth Circuit Court of Appeals ruled that the SEC’s new requirements are not sufficiently justified and returned the rules to the SEC, giving the agency 30 days to correct the defects by showing that opportunistic or improperly motivated buybacks are a genuine problem.

 

On December 1, 2023, the SEC informed the Court that it was not able to resolve the identified defects in the rules, leading to the Court vacating the rules on December 19, 2023.

 

A Short-Term Win in a Long-Term Environment

 

While this is a win for corporations eager to launch robust share repurchase programs under the current regulatory structure, it speaks to the mindset of the SEC regarding repurchase programs. Even if the SEC decides against an appeal, it is free to propose new rules in the future that may proactively identify the defects at issue.

 

It’s notable that the SEC requested an extension to the timeline set by the Court in addressing the identified defects. Once this extension was denied, the SEC may have decided that the best course of action was to reintroduce the rules later with all the issues addressed. Risk averse companies should take steps now to prepare for the possibility that the SEC may attempt to reintroduce similar rules in 2024.

 

At a minimum, companies should create or update their share repurchase policies and procedures to implement clear guidelines that the company will use to justify a share repurchase program. Noted earlier, there are legitimate reasons for companies to engage in share repurchase programs. When companies are audited by the SEC, these policies and procedures will be necessary to demonstrate compliance.

 

Any company that has engaged in large-scale repurchase programs over the past few years should be especially cautious and conduct vigorous internal audits to clearly identify the reasons for the repurchases and document these reasons accordingly.

 

Finally – and most importantly – companies should investigate their compensation history to determine if the effect the share repurchase had on the share price was directly tied to bumps in executive compensation. If this is the case, these companies should be mindful of the uphill battle they may have in justifying these repurchase programs if they are audited by the SEC.