By Soyoung Ho
SEC Commissioner Robert Jackson, who has been critical about the significant increases in corporate stock buybacks in recent years, is concerned by the commission’s inaction on the matter.
Jackson has been especially concerned with the effect of buybacks at a time when companies are enjoying lower tax rates under the American Jobs Creation Act passed into law in December 2017, and he believes that the capital market regulator should update its rules governing stock repurchases.
“I continue to present the evidence to my colleagues about why I think it’s time to take another look at those rules,” Jackson said in a January 9, 2020, interview with Thomson Reuters. “My own view is doing nothing on buybacks doesn’t make any sense for the commission. It’s an enormously important transaction that’s dominated the stock market for the last two years. And the idea that the SEC would do nothing but make an occasional comment in the space is very strange to me.”
Reform groups and some Democrats on the Capitol Hill believe the practice promotes a short-term mindset at the expense of long-term growth. The short-term focus is worsened when a large portion of executive compensation is based on stock. Executives are motivated to promote spending that lifts the share price but undercuts capital investments in product development or market share gains. Jackson’s research shows that a substantial number of executives use buybacks as a chance to cash out the shares they received for compensation.
To fix misaligned incentives, Jackson in a June 2018 speech said that the SEC should revise Rule 10b-18 of the Securities Exchange Act of 1934 that protect companies from lawsuits if the pricing and timing of a share repurchase meet certain conditions.
The market regulator adopted Rule 10b-18 in 1982 because when a company announces it is buying its own stock, it is signaling to the world that it thinks its own stock is cheap. That announcement and the company’s open-market buying activities often cause the stock price to jump, and so the SEC has put in the safe harbor rule.
However, after it was proven that buybacks could be used to take advantage of less-informed investors, the SEC updated its rules in 2003. But critics noted that several gaps remained, still affording companies too much flexibility while not giving investors enough protection. The commission in response issued a proposal in 2010 to update the rules but never adopted it.
In his speech, Jackson said another fix is to require the company’s compensation committee to review the link between buybacks and cash outs.
“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,” he said. “It is hard to see why a company’s buyback announcement shouldn’t be accompanied by this kind of disclosure.”
However, in recent public remarks, the top official of the SEC division that is responsible for drafting disclosure rules, signaled that there were no rulemaking plans.
While William Hinman, director of the SEC’s Division of Corporation Finance, was speaking about non-GAAP metrics that publicly traded companies use for disclosures in Compensation Discussion and Analysis (CD&A), he touched upon broader buyback practices.
“In terms of disclosure that we sort of have seen—some but not everyone do, but I think many more people are doing this than are necessarily writing about it—is how the comp committee takes into account the impact of buybacks on the targets that they are establishing,” Hinman said at an AICPA conference in December 2019 in Washington. “I think there’s been a lot of criticisms [that] buybacks tend to make it easier to achieve certain targets in the comp system that may be set. Almost every company that we meet with in this area says that the comp committee is very thoughtful about that and takes it in to account. Not every CD&A actually discloses that. And so, people on the outside sometimes have the impression that by doing the buyback you are making it easier for execs to reach their goals. But what we have seen in practice is a lot more companies are actually taking into account, factoring out the impacts of the buyback either on the EPS [earnings per share] calculation or however it may affect the target.”
Jackson believes the SEC ought to step in so all boards would be required to provide the disclosures.
“My view is that we should not speculate about what boards might be talking about,” Jackson said in the interview. “The whole purpose of the disclosure regime is to have boards disclose to investors what they are talking about.”
While some estimates indicated that the pace of buybacks slowed in 2019, the amounts have been staggering. A Harvard Business Review article by three academics said 500 largest public companies bought back a combined $806 billion of their own stocks in 2018. “When companies do these buybacks, they deprive themselves of the liquidity that might help them cope when sales and profits decline in an economic downturn,” the January 7 HBR article said. Only 43 percent of companies in the Standard & Poor’s 500 Index spent on research and development (R&D), with only 38 companies accounting for 75 percent of all R&D spending of the 500 companies, according to the article.
“Whether or not a firm spends on R&D, all companies have to invest broadly and deeply in the productive capabilities of their employees in order to remain competitive in global markets,” the Harvard article stated.
But SEC Chairman Jay Clayton has been hesitant. During a Senate Banking Committee hearing in December last year, he said limits should not be placed on stock buybacks.
“I agree with the premise in your question, which is capital allocation decisions, whether to buy a company, whether to invest in a new line, whether to pay a dividend, or whether to buy back stock, those are board of director decisions, understanding the idiosyncrasies of the company and what they believe what’s the long-term best interest for the company. I am not qualified to make that decision for them,” Clayton said in response to a question by Sen. Thom Tillis, a Republican from North Carolina.
There are also no rulemaking plans listed on the SEC’s near- or long-term agenda. Under Clayton’s leadership, the commission has largely pursued a business-friendly agenda as directed by President Donald Trump. Clayton has focused more on cutting back requirements to reduce compliance burdens and encourage more companies to go and stay public. And businesses have been strongly opposed to any attempt to further regulate buybacks.
In response to a bill introduced by Democratic lawmakers last year, Executive Vice President Tom Quaadman of the U.S. Chamber of Commerce, an influential business lobby group, said it “is similar to failed policies of the past that have cut off hope, opportunity and innovation for American workers and Main Street business owners.”
Quaadman also said that companies do not choose stock buybacks over reinvesting in the company; stock buybacks do not just benefit company executives and the wealthy; and stock buybacks help the broader economy by delivering cash to companies that need capital.
Nineteen reform and consumer groups, however, dispute the business group’s argument. In a June 2019 petition that asked the SEC to revise Rule 10b-18, they noted that for example, Walmart Inc. authorized $20 billion for stock repurchases in 2018 and 2019. This is enough money to give 1 million employees a $10,000 raise. But Walmart instead announced a one-time bonus for employees of up to $1,000 per worker—just 0.02 percent of the money distributed to shareholders through repurchases.
This article originally appeared in the January 17, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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