New SEC Commissioner Robert J. Jackson Jr. (sworn in last January) delivered an interesting speech last week at the Center for American Progress highlighting an apparent connection between corporate stock buybacks and insider stock sales – and calling for remedial regulatory and governance action.
Commissioner Jackson said that his long-standing interest in stock buybacks was rekindled by the new tax law, which provided a tax holiday for international corporations to repatriate billions of dollars of overseas cash. But rather than make long-term investments in innovation or their workforces, many of these corporations, according to Commissioner Jackson, instead bought back a record $178 billion of their own stock in the first quarter of 2018.
He then noted with express disapproval that “a substantial number of corporate executives today use buybacks as a chance to cash out the shares of the company they received as executive pay.” In his own study of 385 buybacks over the last 15 months, he found that not only did a company’s stock price jump abnormally following the buyback announcement (as he had expected), but also that insider sales of company stock jumped in both number and average dollar amount.
Commissioner Jackson notes that this trading “is not necessarily illegal” but is nevertheless “troubling.” He believes this type of “cashing out” is inconsistent with a typical pre-buyback determination that the company’s stock is undervalued – if that were the case, why would executives immediately sell? He also said this breaks the “pay-performance link” contemplated by most long-term equity incentive plans.
Commissioner Jackson called for regulatory reform that should “at a minimum” deny the Rule 10b-18 buyback safe harbor to companies that “choose to allow executives to cash out during a buyback.” Because most companies conduct their buybacks in accordance with Rule 10b-18 to minimize potential market manipulation liability, denial of this safe harbor would be a powerful cash-out deterrent.
Also interesting is his view that compensation committees should be required to review the degree to which a buyback “will be used as a chance for executives to turn long-term performance incentives into cash,” specifically approve any such decision, and then disclose the reasons why that would be in the company’s long-term interests. He believes that “a level playing field requires that shareholders selling into a buyback know what managers are doing with their own money.” Form 4 filings, he contends, are not helpful in this regard since they come after the executive has already sold and, therefore, “too late for shareholders to price the executive’s decision into their own determination whether to sell their shares.”
It’s an intriguing perspective. And one could make a good argument that, in fact, compensation committees already have a fiduciary duty to analyze the extent to which stock buyback announcements followed by executive sales might impact their carefully crafted performance compensation and risk management structures. Furthermore, current rules might already require that the committee’s analysis and reasoning then be disclosed in the proxy statement’s compensation disclosure and analysis section.
It’s a well-reasoned speech, complete with a 14-page “data appendix,” and is worth a read. Because it is typical for new SEC commissioners to arrive with a shortlist of regulatory concerns and initiatives of interest, it would not be surprising to see more from the SEC on this topic in the coming months. If nothing else, Commissioner Jackson appears to be a fresh, thought-provoking addition to the SEC.