SEC Regulation of Share Buybacks and Insider Dealing: A Lost Opportunity

Share buybacks have surged following the COVID-19 pandemic. My article, ‘The Regulation of Share Buybacks and Insider Dealing: A Comparative Analysis’ evaluates the recent reforms by the Securities and Exchange Commission (SEC) to the Rule 10b5-1 safe harbour in comparison with the position under the Market Abuse Regulation (MAR). Although the SEC’s reforms serve to improve the informational efficiency of US securities markets, a key shortfall in its approach is the absence of prospective disclosure requirements for buyback programmes.

Rule 10b5-1 establishes affirmative defences for insider trading by issuers that repurchase securities under non-discretionary trading arrangements which comply with the prescribed price, volume, and timing requirements (‘Rule 10b5-1 Trading Arrangements’). The SEC had stated in 2021 that this safe harbour has led to ‘real cracks’ in the US insider trading regime due to the lack of mandatory disclosure requirements.

SEC Reforms to Rule 10b5-1 for Share Buybacks

The SEC adopted new rules on 14 December 2022 with respect to the Rule 10b5-1 safe harbour, with companies (other than smaller reporting companies) required to comply with the new disclosure requirements in their filings starting from 1 April 2023. The new amendments include:

1. A cooling-off period for directors and officers of 90 days after adopting a Rule 10b5-1 Trading Arrangement or 2 business days after filing a Form 10-Q or 10-K (whichever is later), subject to a maximum of 120 days.
2. The requirement for directors or officers adopting a written trading plan to certify that he or she is unaware of material non-public information, and is adopting the plan in good faith.
3. Restricting single-trade plans within any 12-month period and overlapping Rule 10b5-1 Trading Arrangements for persons other than the issuer, except in certain circumstances.
4. The requirement that Rule 10b5-1 Trading Arrangements be entered into in ‘good faith’.

Issuers are now required to make quarterly disclosures in their Form 10-Q and Form 10-K filings of prescribed details of trading arrangements adopted by directors or officers, such as the date of adoption and duration of the trading arrangement, and the aggregate number of securities to be traded (other than pricing terms). Issuers must also disclose their insider trading policies in their annual reports in Form 10-K.

Many of these amendments have been watered down from the SEC’s proposed rules for share buybacks. In particular, the SEC has decided not to require corresponding quarterly disclosures and a cooling-off period for Rule 10b5-1 Trading Arrangements conducted by the issuer. In a separate proposal yet to be finalised, the SEC has also proposed that issuers disclose:  

1. any repurchases made by the following business day, including the average price paid and aggregate shares repurchased under a new Form SR.
2. the issuer’s objective for its repurchases, the date of adoption of trading arrangements, and whether the issuer’s officers or directors traded in securities subject to the buyback programme within 10 business days of its announcement on a quarterly basis under Item 703 of Regulation S-K.

Shortcomings of the SEC’s Reforms

The key shortcoming of the SEC’s reforms is the absence of prospective disclosure requirements for buyback trading arrangements, despite its stated purpose of mitigating information asymmetries between the issuer and the market. Information asymmetries arise from inside information possessed by the issuer, which may be broadly divided into two categories:

• Transaction-specific inside information refers to inside information that the issuer knows about a prospective transaction that it intends to undertake, such as its decision to conduct a buyback programme. Such knowledge that has not been publicly disclosed is highly price-sensitive and may be exploited by the issuer’s management for financial benefit.
• Issuer-specific inside information refers to inside information that the issuer knows about itself and that might have influenced its decision to conduct a buyback programme, such as its knowledge of the undervaluation of its shares. The risk of insider trading arises where the issuer repurchases its shares before disclosing such information to the market.

Thus, the benefit of the additional retrospective disclosures proposed by the SEC are negated by the absence of prospective disclosures as the issuer may benefit from trading on the basis of its own knowledge of its proposed buyback programme, thereby profiting from the subsequent increase in share price following the retrospective disclosures of the repurchases.

A Comparison with the Market Abuse Regulation

The SEC’s proposals would have benefited from a comparative analysis of similar safe harbours in other jurisdictions. Under Article 5 of the MAR, for example, the safe harbour for share buybacks requires the issuer to publicly disclose full details of its buyback programme before trading. For ‘time-scheduled’ buyback programmes, the issue must disclose the dates and volume of shares to be traded. The European Commission noted that buybacks ‘must be carried out transparently in order to avoid insider trading or giving misleading signals to the markets.’

By requiring prospective disclosures of buyback programmes under the MAR safe harbour, issuers provide investors with important information about the likely direction of the share price, which facilitates price discovery. Importantly, the MAR safe harbour requires buybacks to be conducted only for restricted purposes such as reducing the issuer’s capital and implementing convertible debt instruments.

In comparison, while US issuers typically disclose buyback programs upon board authorisation, the SEC has noted that issuers are not required to and typically do not disclose specific details of the programme, such as trading dates, under the Rule 10b5-1 safe harbour. These differences stem from the US system of ‘periodic’ disclosure instead of ‘continuous’ disclosure.

Suggestions for Reform

It is argued that ongoing reforms to the Rule 10b5-1 safe harbour should require buyback disclosures to be made on a prospective basis following board approval under Form 8-K, for which disclosure of specified events must be made by issuers ‘on a more current basis’. Such disclosures should not be discretionary, but mandatory. This would be consistent with the prohibition against selective disclosures under Regulation Fair Disclosure, which states that ‘events regarding the issuer’s securities’ such as ‘repurchase plans’ are potentially price-sensitive. This would also be consistent with the disclose-or-abstain requirement for issuers when conducting share repurchases, as affirmed by the courts. Such prospective disclosures should include details of the purpose and duration of the buyback programme, the maximum number of shares to be repurchased and the dollar amount allocated for the programme. This would ensure that inside information relating to buyback programmes are priced into the issuer’s share price accordingly and reduce any unfair trading advantage by the issuer and other insiders.

Lance Ang is a Hong Leong–Fitzwilliam Masters Scholar, 1912 Senior Scholar, Fitzwilliam College, University of Cambridge.

A version of this post first appeared on Columbia Law School’s Blue Sky blog (here).