Open Market Share Repurchase Programs

Overview of Share Repurchase Programs:

Many companies have programs in place to buy back their own shares from the marketplace. Companies should assess the various strategic considerations and legal implications involved before implementing a share repurchase program.

One common reason that a company may desire to buy back its own shares is in order to increase the company’s share price. When a company repurchases its own shares, it reduces the number of outstanding shares and thus boosts financial metrics such as earnings per share (EPS). A company generally must have excess cash on hand in order to effectuate a share repurchase program. A share buyback program may signal to the market that the company’s shares are undervalued and thus a good investment at current prices. It is also an advantageous method to return capital to shareholders that is more tax efficient than declaring a dividend.

There are four primary ways that a company can effectuate repurchases of its own shares. Most commonly, a company will implement an open market share repurchase program. Other share repurchase methods include issuer tender offers, privately-negotiated repurchases, and accelerated share repurchase programs.

There are a number of legal process steps that should be taken by the company to confirm that it is not subject to any limitations on its ability to repurchase shares. The company should check its certificate of incorporation and bylaws to confirm the company is not subject to restrictions on share repurchases. The company should also check relevant state law. Under Section 160 of the Delaware General Corporation Law, a corporation cannot repurchase its own shares if the purchase “would cause any impairment of the capital of the corporation.” The company should also check whether it has entered into any agreements that would impose restrictions on its ability to pursue a share repurchase program.

The share repurchase program should be discussed and approved by the company’s board of directors. There are also certain disclosure requirements for public companies. A company should publicly disclose basic information about the share repurchase program prior to its commencement, including the estimated timeframe for the repurchases, the approximate number of shares proposed to be acquired, and the objectives of the share buyback program. This public announcement of information about the program will help the company avoid insider trading liability.

Open Market Share Repurchase Programs:

There are a number of legal considerations that companies should keep in mind in connection with pursuing share repurchase programs. Under Sections 9(a) and 10(b) of the Securities Exchange Act of 1934, an issuer and its affiliates are prohibited from engaging in fraudulent and manipulative practices. There is a safe harbor under Rule 10b-18 that provides some protection from allegations of market manipulation.

In order to qualify for the protections provided by the Rule 10b-18 safe harbor, the company must satisfy the following conditions:

  • Manner: On any single day, the company must make all its purchases through only one broker or dealer.
  • Timing: The purchases must not be made during the 30 minutes before market closing. If during the preceding four weeks the company’s shares had an average daily trading volume (ADTV) of at least $1 million and a public float value of at least $150 million, then the purchases must not be made during the 10 minutes before market closing.
  • Volume: On any single day, the aggregate purchases must not exceed 25% of the ADTV of the purchased shares. Block trades are usually factored into the ADTV calculation.
  • Price: The purchases must not be made at a price that exceeds the highest independent bid or the last independent transaction price (whichever price is higher).

While compliance with Rule 10b-18 provides a company engaged in open market share repurchases with many protections, a company can still face violations of other securities law provisions. For example, a company can be found liable under the Exchange Act for trading while in the possession of material, non-public information (MNPI). A company, as well as its directors and executive officers, are considered “insiders” and there is increased scrutiny over whether they have traded shares while in possession of MNPI. This risk is pronounced near the company’s earnings season.

One common tool used by companies to protect themselves is to implement a 10b5-1 trading plan. Once a 10b5-1 plan is established, a broker will be instructed to effect share repurchases at a later date. This helps the company avoid allegations that it possessed MNPI when the share repurchases were executed. The 10b5-1 trading plan must meet certain conditions under Rule 10b5-1.

The SEC’s Regulation M establishes prohibitions on companies during a “distribution” of securities. Rule 100 of Regulation M defines a “distribution” of securities to include public equity offerings, private offerings, tender offers, exchange offers, mergers involving the issuance of shares of stock, and other related transaction types. A 10b5-1 plan can be drafted to automatically suspend share purchases during a restricted period in order to avoid violations of Regulation M.