Stock Repurchases in a Declining Market
Corporate & Finance Alert
November 11, 2008
In this troubled time of investor uncertainty and declining stock prices, some companies are considering the potential benefits of implementing a repurchase plan for their own securities. A company would typically implement such a repurchase plan where the market value of its stock is not increasing relative to its operating results. The benefits of repurchasing stock include a reduced equity base which results in increased earnings per share, and increased investor confidence (reflecting management’s belief that the current market price of the company’s stock represents a compelling value and investment of the company’s capital resources).
This alert sets forth certain considerations that a company should be aware of before implementing a repurchase plan to avoid inadvertently running afoul of securities laws, corporate law, or contractual provisions.
Market and Price Manipulation
Section 9(a)(2) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) makes it unlawful for a person to “effect … a series of transactions in any security registered on a national securities exchange … creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.” Furthermore, Rule 10b-5 under the Exchange Act makes it unlawful for “any person…by the use of any national securities exchange … to employ any device, scheme, or artifice to defraud.”
To reduce the risk of liability for market manipulation by reason of the manner, timing, price and volume of a company’s stock repurchases, a company can avail itself of a safe harbor under Rule 10b-18 of the Exchange Act. To fall within the safe harbor, such stock repurchases generally (i) must be made through one broker or dealer on any single day; (ii) must not be the opening purchase, or effected during the 10 or 30 minute period (depending on value and public float) before the scheduled close of the primary trading sessions in the principal market for the security, and the primary trading session in the market where the purchase is effected; (iii) must be effected at a purchase price that does not exceed the highest independent bid or last independent transaction quoted at the time of purchase; and (iv) cannot exceed 25% of the average daily trading volume per day.
Rule 10b5-1 under the Exchange Act further expands on Rule 10b-5 by expressly stating that “manipulative and deceptive devices” prohibited by Section 10(b) of the Exchange Act and Rule 10b-5 thereunder include, among other things, “the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed directly, indirectly, or derivatively, to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information.” Accordingly, care must be made by a company considering a repurchase of its securities that it is not aware of any material, nonpublic information.
Finally, before undertaking a securities repurchase, a company must ensure that it is not currently within a “restricted period” as defined by Regulation M. Regulation M, which is designed to prevent price manipulation of securities prior to the commencement of a securities offering, prohibits issuers from bidding for, purchasing, or attempting to induce any person to bid for or purchase, a covered security during the restricted period. Currently the restricted period begins one or five business days prior to determination of an offering price for the security and ends upon a person’s completion of participation in the distribution.
Tender Offer and Going Private Rules
Pursuant to Rule 13e-4 under the Exchange Act, an issuer with equity securities registered under Section 12 of the Exchange Act or that is required to file periodic reports with the Securities and Exchange Commission pursuant to Section 15(d) is required, in connection with any tender offer for its own equity securities, to file a tender offer statement (Schedule TO) to make certain disclosures. Rule 13e-4 is intended to prevent fraudulent, deceptive or manipulative acts in connection with issuer tender offers.
Companies should ensure that a stock repurchase plan does not inadvertently trigger the disclosure requirements of Rule 13e-4. The court in SEC v. Carter Hawley Hale Stores, Inc., 760 F.2nd 945, 950 (9th Cir. 1985), provided some guidelines on when a tender offer exists. The court asserted that the term “tender offer” implies (i) active and widespread solicitation of public shareholders for the shares of an issuer; (ii) that the solicitation is made for a substantial percentage of the issuer’s stock; (iii) that the offer to purchase is made at a premium over the prevailing market price; (iv) that the terms of the offer are firm, rather than negotiable; (v) that the offer is contingent on the tender of a fixed number of shares; (vi) that the offer is open only for a limited period of time; (vii) that the offeree is subjected to pressure to sell; and (viii) a public announcement of an acquisition program prior to the accumulation of stock by a purchaser.
Furthermore, as a means to prevent fraudulent, deceptive or manipulative acts or practices in connection with a going private transaction, it is unlawful for a company to effect a “Rule 13e-3 transaction” without disclosing certain information to its stockholders and filing a Schedule 13E-3 (Rule 13e-100). A Rule 13e-3 transaction is defined generally as a transaction (including the purchase of any equity security by the issuer of such security) which has either a reasonable likelihood or a purpose of causing any class of equity securities of the issuer which is subject to section 12(g) or section 15(d) of the Exchange Act to be held of record by less than 300 persons; or causing any class of equity securities of the issuer which is either listed on a national securities exchange or authorized to be quoted in an inter-dealer quotation system of a registered national securities association to be neither listed on any national securities exchange nor authorized to be quoted on an inter-dealer quotation system of any registered national securities association.
General Corporate Issues
While the corporate law differs on a state by state basis, most will contain some restrictions on the ability of a company to make distributions or repurchase shares while insolvent or otherwise capital impaired. As an example, Section 160 of the Delaware General Corporation Law provides that “every corporation may … redeem … its own shares; provided, however, that no corporation shall [p]urchase or redeem its own shares of capital stock for cash or other property when the capital of the corporation is impaired or when such purchase or redemption would cause any impairment of the capital of the corporation, except that a corporation may purchase or redeem out of capital any of its own shares which are entitled upon any distribution of its assets, whether by dividend or in liquidation, to a preference over another class or series of its stock, or, if no shares entitled to such a preference are outstanding, any of its own shares, if such shares will be retired upon their acquisition and the capital of the corporation reduced in accordance with §§ 243 and 244 of this title.”
Additionally, the organizational documents of a company may provide for certain restrictions against the repurchase of stock. As an example, it is a common feature of preferred classes of securities to restrict the redemption of any junior stock, such as common stock, while the preferred stock is outstanding.
Finally, a corporation should review its major contracts for restrictions on redeeming stock. Debt documents in particular will often contain negative covenants restricting share repurchases while the debt is outstanding.