Stock Buybacks. SEC Hot Topics Institute November 28, Robert L. Kimball, Vinson & Elkins L.L.P. Janet Wright, Dell Inc.

Transcription

1 Stock Buybacks SEC Hot Topics Institute November 28, 2012 Robert L. Kimball, Vinson & Elkins L.L.P. Janet Wright, Dell Inc.

2 These materials are intended for educational and informational purposes only and do not constitute legal advice. These materials represent the views of and summaries by the authors and do not necessarily reflect the opinions or views of their employers.

3 Agenda Reasons for buybacks Corporate considerations Basic buyback programs Special buyback programs SEC regulation of buybacks Checklist 3

4 Reasons for Buybacks

5 Reasons for Buybacks To use for employee benefit plans (offset dilution) To use for future acquisitions (offset dilution) To provide cash to investors For example, after an asset sale or spinoff To take advantage of stock undervaluation for the benefit of other stockholders To increase debt/equity ratio Debt-financed share buyback program may lower a company s weighted cost of capital (low-cost debt replaces high-cost equity) To address activist demands 5

6 Corporate Considerations

7 Corporate Power Delaware Section 160 of the Delaware General Corporation Law permits a corporation to repurchase shares of its outstanding stock so long as the corporation s capital is not impaired and the purchase will not cause an impairment of capital. A repurchase impairs capital if the funds used exceed the corporation s surplus, which is the excess of net assets over the par value of the issued stock. A decision to purchase a company s own stock is within the discretion of its board of directors. Resolutions define parameters of buybacks and scope of delegated authority to implement the program. 7

8 Basic Buyback Programs

9 Basic Buyback Programs Open Market Purchases A company repurchases its shares through open market repurchase transactions. Most widely used technique Great degree of flexibility Typically, the least expensive way to buy back shares Might include 10b5-1 plan to continue purchases when trading window is otherwise closed 9

10 Basic Buyback Programs Private Transactions A company repurchases its shares through one or more privately negotiated transactions. In the 1980s, a number of companies engaged in private repurchase transactions to fend off unwanted overtures ( greenmail ). The company often has to pay a premium. 10

11 Basic Buyback Programs Dutch Auction A company defines the number of shares it intends to buy, an expiration date, and a price range that it is willing to pay (generally, there is a premium). Stockholders may tender stock at any price in the range. Starting at the bottom of the range, the company adds up the cumulative number of shares necessary to fulfill the program. All tendering stockholders at or below the clearing price receive the clearing price for their stock. 11

12 Basic Buyback Programs Fixed Price Tender Offer A company offers to repurchase a set number of shares at a fixed price (generally, there is a premium) through an expiration date. Stockholders elect whether to tender their shares. Usually the tender offer is for a substantial percentage of shares outstanding. 12

13 Special Buyback Programs

14 Odd-Lot Buybacks Odd-lot buybacks target stockholders who own fewer than 100 shares of stock. Reduces expenses of dealing with small stockholders, which often were created by mergers or reverse stock splits. Boosts the price-to-earnings ratio by reducing outstanding shares without the negative perceptions created when large stockholders sell. Typically provides market pricing with no brokerage commissions. Instead of issuer buying the shares, might arrange with a brokerage firm to buy and aggregate shares, then resell in round lots. Modest brokerage fees, which company might pay. 14

15 Accelerated Share Repurchase Programs Accelerated share repurchase programs ( ASRs ) are usually accomplished by a company purchasing shares of its stock from an investment bank. The investment bank borrows the shares from clients or share lenders and requires the company to enter into contract to protect the bank s short position. The shares are returned to the client through purchases in the open market, often purchased over a period that can range from one day to several months. If share prices increase, the company will owe the investment bank money. If share prices decrease, the company will be owed money. The company can settle the forward contract with the investment bank with either cash or shares. 15

16 Benefits of ASRs Can buy shares back at a faster pace and reduce the amount of shares outstanding right away. Traditional buybacks on the open market can take weeks or months. May allow the company to transfer some or all of the market risk of the stock buyback to the investment bank (usually in return for a premium), depending on how forward contract or other derivatives are structured. Recognize accretive earnings per share benefits immediately (because of the reduction in outstanding shares), while gains or losses on the forward contract bypass income (see slide on ASR accounting considerations). 16

17 Structured ASRs Most ASRs use the average price of the applicable stock to determine the final settlement of the upfront share purchase. Highly structured variants may provide for flexible pricing periods discounted average pricing favorable to the company, or embedded caps or collars. These limit the range of the average settlement price. 17

18 ASRs Accounting Considerations (Balance Sheet) ASRs are accounted as two separate transactions under EITF Issue 99-7: First, the share purchase is treated as a treasury stock acquisition. This results in immediate EPS accretion. Second, the share price protection is accounted as a forward sale contract. Because the derivative is tied to the company s stock, the company has the option to settle by issuing shares, and the fair value of the forward contract at inception is zero, the company is not required to mark the recorded value of the derivative to its fair value over the duration of the derivative (EITF Issue 00-19). Any amount paid or received at the time of the final settlement is recorded as an adjustment to stockholders equity. As a consequence, during the term of the forward sale agreement, the balance sheet does not reflect the potential ASR asset or liability before settlement. Diluted EPS must include the effects of settlement of the forward contract (if dilutive) 18

19 ASRs Accounting Considerations (Income Statement) Gains and losses resulting from transactions that may be settled with a choice of cash or the company s own equity shares are not reflected in earnings under current accounting standards. Gains and losses at settlement of the forward sale agreement are recorded as adjustments to equity and thus bypass income completely. 19

20 FASB and IASB Currently Studying ASR Framework The accounting treatment for ASRs is the subject of an ongoing Financial Accounting Standards Board and International Accounting Standards Board project (since 2007) to develop a framework for reporting for these instruments. The likely result, if adopted, is that a liability (asset) should be recorded when the ASR forward contract is initiated and then measured at fair value with unrealized gains and losses recognized at each reporting date. 20

21 SEC Regulation of Buybacks

22 SEC Regulation of Buybacks Exchange Act Section 9 and Regulation M prohibit the manipulation of stock prices and specific acts during a distribution. Section 10(b) and Rule 10b-5 prohibit fraud or manipulation in connection with purchases. Rule 10b5-1 plans may create an affirmative defense for some purchases. For open market buybacks, Rule 10b-18 of the Exchange Act provides a non-exclusive safe harbor for manipulation claims based on the timing, price or amount of the purchases or the number of brokers or dealers used in effecting buybacks. Not applicable to ASRs (not open market buybacks). Tender offer and going-private rules may apply. 22

23 Rule 10b-5 Material Nonpublic Information In general, issuers may not buy back stock while in the possession of material nonpublic information. Disclose or abstain rule: Refrain from buybacks (even those that comply with Rule 10b-18) when the company possesses material nonpublic information, including financial results, significant acquisition negotiations or other significant business developments. It is usually advisable for company to avoid purchasing stock when an insider is selling stock, and for insiders to avoid selling their stock when the issuer is purchasing its own stock. Insiders should also avoid front running company purchases. Company can create an affirmative defense to insider trading liability by implementing a plan or agreement (compliant with Rule 10b5-1) to continue buybacks when trading would otherwise be shut down. 23

24 Rule 10b-18 in General Issuer buyback transactions that comply with the provisions of Rule 10b-18 will not be considered manipulative for purposes of Sections 9(a)(2) or 10(b) or Rule 10b-5 solely by reason of the time, price or amount of such purposes or the number of brokers or dealers used to effect such buybacks. Failure to comply with Rule 10b-18 does not create any presumption that the buyback was manipulative. Nevertheless, there are no established guidelines for market buybacks outside of the Rule 10b-18 parameters. Compliance with Rule 10b-18 is determined on a daily basis. Failure to meet any portion of Rule 10b-18 on a day will deprive the issuer of the protections of the safe harbor for all buybacks made that day. 24

25 Rule 10b-18 Condition #1 (Number of Brokers/Dealers) Buybacks must be made through only one broker or dealer on any single day.. A different broker or dealer may be used during any after-hours session. 25

26 Rule 10b-18 Condition #2 (Timing) Buybacks cannot constitute the opening purchases of the day. Buybacks cannot be made during the 10 minutes (if the issuer s securities have an average daily trading volume of $1 million or more and a public float value of $150 million or more) or 30 minutes before the scheduled close of trading on the principal market for the stock (e.g., NYSE, NASDAQ) or the market where the buyback is effected. After-hours trading is permissible so long as (a) the buybacks are made at prices that do not exceed the lower of (i) the closing price of the primary trading session on the principal market for the issuer s stock and (ii) any lower bids or sale prices subsequently reported in the consolidated system and (b) the buyback is not the opening purchase of the after-hours session. 26

27 Rule 10b-18 Exception to Condition #2 (Timing) In case of a market-wide trading suspension, Condition #2 may be disregarded with respect to purchases effected 1. from the reopening of trading until the scheduled close of trading on the day that the market-wide trading suspension is imposed; or 2. if a market-wide trading suspension was in effect at the closing of trading on the preceding day, at the opening of trading on the next trading day until the scheduled closing of trading that day. 27

28 Rule 10b-18 Condition #3 (Price) The price may not exceed the highest independent bid or the last independent transaction price for the stock, whichever is higher, on the principal market for the stock. 28

29 Rule 10b-18 Condition #4 (Volume) Daily purchases may not exceed 25% of the average daily trading volume for the 4 calendar weeks preceding the week of the trade. 29

30 Rule 10b-18 Exception to Condition #4 (Volume) Exception to the volume restriction: one block purchase is allowed one day each week if (a) no other Rule 10b-18 purchases are made on that day and (b) the block purchase is not included when calculating the stock s 4 week average daily trading volume for purposes of Condition #4. A block is a quantity of stock that 1. Has a purchase price of $200,000 or more; or 2. Is at least 5,000 shares and has a purchase price of at least $50,000; or 3. Is at least 20 round lots and totals (a) 150% or more of the trading volume for the stock or (b) if the trading volume is unavailable, totals at least 0.001% of the outstanding shares of stock, excluding shares owned by any affiliate. A block does not include Any amount a broker or dealer, acting as a principal, has accumulated for the purpose of sale or resale to the issuer if the issuer knows or has reason to know that such amount was accumulated for such purpose. Any amount a broker or dealer has sold short to the issuer if the issuer knows or has reason to know that the sale was a short sale. 30

31 Proposed Amendments to Rule 10b-18 On January 26, 2010, the SEC proposed amendments to Rule 10b-18 intended to clarify and modernize the safe harbor provisions of the Rule. The proposed amendments would, among other things: Allow repurchases at volume-weighted average price per share (which currently run the risk of not meeting the price condition (#3) discussed above) Ease price condition (#3) so that if a repurchase is made at a price too high due to fast-moving price quotations, other repurchases on that day will not disqualified from using the safe harbor Not clear whether the proposed amendments will be adopted. SEC also asked for comment on whether ASRs raise manipulation concerns and what types of limitations should apply. Note: ASRs are not eligible for the Rule 10b-18 safe harbor, although issuers/banks often apply many of the 10b-18 standards to the bank. 31

32 Regulation M Regulation M prohibits issuers and affiliated purchasers from purchasing stock during the restricted period near and during a distribution. Distribution means an offering of securities, whether or not subject to registration under the Securities Act, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods (e.g., an underwritten or Rule 144A offering). Restricted period means: For any security with an average daily trading volume value of $100,000 or more of an issuer whose common equity securities have a public float value of $25 million or more, the period beginning on the later of 1 business day prior to the determination of the offering price or such time that a person becomes a distribution participant (an underwriter, prospective underwriter, broker, dealer or other person who has agreed to participate or is participating in a distribution), and ending upon such person s completion of participation in the distribution; and For all other securities, the period beginning on the later of five business days prior to the determination of the offering price or such time that a person becomes a distribution participant, and ending upon such person s completion of participation in the distribution. Regulation M permits an issuer to engage, during the restricted period, in transactions in odd-lots or to offset odd-lots in connection with an odd-lot tender offer conducted pursuant to Rule 13e-4(h)(5). 32

33 Tender Offer A buyback program that is a tender offer must comply with Rule 13e-4 (issuer self-tender offer rule), including filing of Schedule TO. Tender offer is not defined in the Exchange Act or rules. Courts consider whether: There was active and widespread solicitation of public stockholders; A solicitation was made for a substantial percentage of the company s stock; The offer was at a premium over the prevailing market price; The terms of the offer were firm rather than negotiable; The offer was contingent on the tender of a fixed number of shares; The offer was open for a limited time period; The offeree was subjected to pressure to sell stock. 33

34 Going Private Transactions Purchases, tender offers or proxy solicitations by the issuer or affiliates that would result in the company s stock ceasing to be listed on a stock exchange or ceasing to be required to be registered under the Exchange Act are going private transactions and must comply with Rule 13e-3. 34

35 Going Private Transactions (Continued) If any stock buyback program constitutes a going private transaction, then 1. A Schedule 13E-3 must be filed with the SEC and additional disclosure must be made to the company s stockholders Schedule 13E-3 contains substantial disclosure requirements, including requiring detailed disclosure on the background of the board s purposes for the stock repurchases. As a practical matter, the disclosures may necessitate engagement of an investment banker for fairness opinions. 2. The company s board s decision to effect the buybacks may be subject to a more stringent entire fairness standard. 35

36 Checklist

37 Checklist Before a Buyback Board of directors should deliberate and fully inform itself concerning the buyback, relying on independent financial advice where appropriate. Carefully consider the effect on the company s earnings, liquidity, investor relations and credit ratings and other uses for the company s resources. Confirm statutory requirements (e.g., surplus) are met. Consult with legal, accounting and tax advisors about the implications and structure of buyback program. Review indentures, credit agreements and other contracts to determine whether they prohibit or limit the company s purchase of its stock. 37

38 Checklist Before a Buyback Adopt resolutions defining the buyback program, typically including size (number of shares or dollar amount), duration, method and delegation. If effecting a buyback via the open market, Inform the company s broker that the company intends to comply with Rule 10b-18. Ensure that all material information has been made public. Consider use of Rule 10b5-1 plan or plan to shut down buybacks when potentially material information arises until the information is made public or proves not to be material. Consider whether to shut down buybacks when insiders are subject to closed trading windows under company policy. 38

39 Checklist Immediately Before a Buyback Notify the principal market for the stock shortly before a press release is issued regarding the buyback program. Issue an initial press release regarding the buyback program when the company s board authorizes the program. The press release should disclose the following: the principal purposes for the buyback; the amount authorized (in terms of number of shares or maximum dollar amount) to be purchased; the estimated time period, if known, during which the purchases are anticipated to occur; the manner in which the shares will be repurchased and the company s plans with respect to the disposition of the shares once purchased; the source of funds to be used for the repurchases; any existing buyback arrangements; and any previously undisclosed material developments. Consider whether to file or furnish the press release on Form 8-K. 39

40 Checklist During a Buyback If effecting a buyback via the open market, designate one person at the company to monitor the buyback program to ensure that any buybacks comply with Rule 10b-18. Issue press releases if there are material changes in the buyback program (e.g., number of shares) or if the program is discontinued or completed. Consider whether to file or furnish the press releases on Form 8-K. Consider whether ASR contracts or 10b5-1 plans constitute material contracts for Form 8-K, Item 1.01, or for exhibits to periodic reports. 40

41 Checklist During a Buyback Include a statement regarding ongoing buyback plans in MD&A of 10-Qs and 10-Ks. Report buyback activity, broken out by each month of the applicable quarter, in 10-Qs and 10-Ks, under Item 703 of Regulation S-K. Consider effect (including disclosure) on large stockholders as a result of buyback because their percentage ownership is likely to increase. 41

42 Questions?