A thing that I learned recently1 and sort of couldn’t believe is that some politicians, like Senators Elizabeth Warren and Tammy Baldwin, think that stock buybacks are bad and that the Securities and Exchange Commission should forbid them as market manipulation. I mean the first part of that did not surprise me. Lots of people think that stock buybacks are bad. Larry Fink thinks it! It’s a totally respectable position.
But the second part is super weird. The SEC is not especially in the business of regulating what companies do with their money. If you are a public company and you want to spend your money on paying your employees or developing a new car or building a big headquarters or giving it back to your shareholders, that is up to you, not the SEC. All the SEC asks is that you disclose whatever you’re doing. What to do is for you to decide, however corporations decide things. In practice, mostly managers and boards of directors decide, but sometimes shareholders get involved. To the extent the shareholders and managers disagree — generally because shareholders want their money back and managers prefer to keep it – the SEC does sometimes get involved: Proxy fights are subject to proxy rules, management discussions with shareholders are covered by fair disclosure rules, and even conversations among shareholders might implicate shareholder disclosure rules.2
Assuming a company wants to give money back to shareholders, though, the SEC is generally not in the business of stopping it. A company can give money back to shareholders in the form of a dividend and that is pretty much none of the SEC’s business, though of course it will want the company to disclose it properly. On the other hand, if a company decides to give the money back in the form of a stock buyback, the SEC does have some more interest. Buying stock requires trading on the stock market, and the SEC regulates stock-market trading. So, for instance, companies that want to buy back a lot of stock sometimes do public tender offers, and a tender offer is a very regulated SEC thing where you have to file documents and give everyone lots of notice and treat them all fairly and so forth.
But tender offers are relatively uncommon, and the more usual way for companies to buy stock is what is called an “open market repurchase,” which is just, you know, you repurchase stock in the open market.3 The open market is very much subject to SEC regulation. One way that the SEC regulates open markets is that it forbids insider trading. Since companies are in a sense insiders in themselves, they are subject to the same insider-trading rules as anyone else, and aren’t generally allowed to buy back their own stock when they have material undisclosed information.4 This seems sort of weird on first principles — don’t companies almost always have more information about themselves than the rest of the market does? — but it is not much of a practical problem. Companies tend to buy back stock not because they have private information that prices will go up but because they are full of money and enthusiasm.5 This means they are mostly terrible at it: They have an unfortunate and consistent tendency to spend more on buybacks when prices are high than when they are low.
Another way that the SEC regulates open markets is that it forbids market manipulation. This is a tough one because no one really knows what market manipulation means. If you buy a lot of stock, that will tend to push up the price of the stock, and so the stock you bought will be worth more. Did you buy the stock to make its price go up (maybe manipulation), or because you wanted to own the stock (not manipulation)? Whatever. This is particularly acute for companies buying their own shares, where the objective of making shareholders happy by giving them cash is intimately bound up with the objective of making them happy by increasing the stock price. (Also: the objective of making executives’ stock-based compensation worth more by increasing the stock price.) Because this is vague stuff, the SEC has a simple rule to clarify it. The rule is called Rule 10b-18, and the oversimplified gist of it is that if a company’s purchases make up no more than a quarter of its stock’s volume, then it won’t get in trouble for manipulating its stock.6 Why a quarter and not, like, a third or a fifth? I don’t know, whatever, it’s a nice easy number, not too restrictive but also not too much of the volume. There doesn’t seem to be much more to it than that.7
Anyway that is the world we live in, but not the world we always lived in. Rule 10b-18 was only enacted in 1982. Baldwin:
In 1982, when the Securities and Exchange Commission (SEC) issued a rule to provide ‘safe harbor’ from manipulation liability, buybacks were near zero. Last year, over $500 billion was spent on share repurchases.
Nor is it the world that everyone would prefer to live in. Warren:
“These buybacks were treated as stock manipulation for decades because that is exactly what they are,” she said. “The SEC needs to recognize that.”