Appeals Court Sets Aside Share Repurchase Disclosure Rule

The U.S. 5th Circuit Court of Appeals Tuesday formally vacated the share repurchase rule that had been finalized by the Securities and Exchange Commission in May.

The rule required issuers to disclose their daily stock buybacks on a quarterly basis. The disclosures were to include the pricing and volume of the buybacks, as well as the rationale behind the buyback program. Additionally, the rule required issuers to disclose their policies regarding executives trading in company stock.

According to the SEC, the rule was primarily intended to reduce information asymmetry between the companies issuing stock and investors; reduce opportunistic buybacks and insider trading; and improve price discovery. The disclosure regime under the rule would have made it more difficult for corporations to initiate a buyback program on the basis that their stock was undervalued. Similarly, the rule would have revealed if buyback programs were motivated by executive compensation schemes related to stock pricing.

The rule was challenged by the U.S. Chamber of Commerce in May. On October 31, three judges from the 5th Circuit ruled that the SEC had not done a proper cost-benefit analysis during the finalization of the rule. According to the ruling, the SEC did not adequately consider comments that suggested the SEC should study how often buybacks triggered executive bonuses, the impact of incentive compensation related to stock prices, and the economic benefit of reduced information asymmetry. As such, the appeals court found that the SEC’s adoption of the rule was arbitrary and capricious and violated the Administrative Procedures Act.

The court gave the SEC 30 days to remedy the issues. When, on November 22, the SEC asked for an extension, the court refused. The SEC then filed a letter on December 1 stating it could not “correct the defects in the rule” on the court’s 30-day timeline. Accordingly, the 5th Circuit vacated the rule on December 19.

Jay Gould, a special counsel with Baker Botts LLC, explains that under the APA, a federal agency must consider the comments it receives. Adopting statements issued by the SEC generally explain how the commission considered the comments and which of the comments influenced changes between an initial proposal and a final rule and why other comments were not considered. If the SEC fails to do this, “the rulemaking is deemed arbitrary and capricious.”

If the SEC appealed the case to the Supreme Court, the SEC would likely lose, Gould says. Instead, the SEC will likely “go back to Square 1 and re-propose the rule.” The rule was vacated on procedural grounds but is otherwise “entirely consistent with the securities laws” and dealt with creating “orderly capital markets.” The SEC may be successful on a second try, but the process could take a year or longer, Gould says.

Absent the vacated rule, stock issuers must still disclose less-specific information about buybacks on forms 8-K and 10-Q, aggregated on a monthly basis, rather than a daily basis.

The SEC’s rule was part of a broader effort to reign in buybacks. The Inflation Reduction Act of 2022 implemented a 1% tax on buybacks, and some Democrats in Washington, including President Joe Biden, have suggested increasing that tax to 4%.

According to Standard & Poor’s, stock buybacks by companies in the S&P 500 are down this year. A report published Tuesday noted that “the 12-month September 2023 expenditure of $787.3 billion was down 19.8% from the $981.6 billion expenditure of September 2022” for buybacks among S&P 500 companies.