Stock Repurchases in an Uncertain Market

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1 The M&A Journal The independent report on deals and dealmakers Volume 12 Number 1 in an Uncertain Market The authors at Fried Frank: Stuart H. Gelfond (partner); Jessica Forbes (partner); John E. Sorkin (partner); Zach A. Firestone (associate). In today s uncertain financial, economic and geopolitical environment, companies with available cash may wish to take advantage of depressed stock prices and reevaluate their stock repurchase programs or consider initiating a form of stock repurchase program. For some companies, buying back stock may be their best use of cash or simply a good investment. Other companies may view repurchasing their shares as the best use of available cash if they see limited prospects for strong returns on capital expenditures or research and development. In addition, companies which are subject to possible delisting from the NYSE or Nasdaq due to declining stock prices may consider aggressive stock buybacks while they seek to reorganize or revamp their businesses. Of course, many companies may choose to conserve cash in these uncertain times, even if they enjoy favorable liquidity and notwithstanding that they may view their stock as significantly undervalued. Before initiating or amending a stock repurchase program, companies should consider certain legal ramifications in light of the nature, scope and timing of the proposed repurchases. Relevant laws and rules include: Sections 9(a) and 10(b) of the Securities Exchange Act of 1934 (the Exchange Act ), which prohibit fraudulent and manipulative practices, and the Rule 10b-18 safe harbor under the Exchange Act; Regulation M, which prohibits purchases while the issuer or its affiliates are engaged in a distribution; Rules concerning the use of material, non-public information and insider trading; and Rules relating to tender offers or going private transactions. The rationale for each repurchase program is different and the underlying facts may lead to different conclusions under these rules depending on the circumstances. I. Manipulation Issues and Rule 10b-18 Sections 9(a) and 10(b) of the Exchange Act prohibit fraudulent and manipulative practices in connection with the purchase and sale of securities. Section 9(a) prohibits actions taken to create a false or misleading appearance of active trading in an exchange-traded security. Section 10(b) makes it unlawful to use or employ, in connection with the purchase or sale of a security, any manipulative or deceptive device or contrivance in contravention of SEC rules. Rule 10b-5, promulgated pursuant to Section 10(b), states that it is unlawful to, among other things, make any untrue statement of a material fact or omit to state a material fact necessary in order to make statements made not misleading, or engage in any act which operates or would operate as a fraud or deceit upon any person, Reprinted with permission

2 continued in either case in connection with the purchase or sale of a security. Rule 10b-5 is commonly used in actions involving insider trading. Rule 10b-18 under the Exchange Act provides a non-exclusive safe harbor against allegations of market manipulation under Section 9(a)(2) and Rule 10b-5 for issuer repurchases of common equity securities which are effected in accordance with the four conditions set out in the Rule. In order for a company to avail itself of Rule 10b-18, purchases of an issuer s common equity securities by the issuer and the issuer s affiliated purchasers 1, taken together, must meet all of the following four conditions: 1. Single Broker. All bids and purchases must be made through only one broker or dealer on any single day. This condition is designed to prevent the false appearance of widespread trading activity and purchasing interest in the stock through the use of numerous brokers or dealers and also to promote compliance with the volume limitations described in clause 4 below. Brokers can be switched day to day, although the practice generally is to use only one broker-dealer throughout the stock repurchase program. This condition applies only to Rule 10b- 18 purchases that are solicited by or on behalf of the issuer. Therefore, the issuer may purchase shares from more than one broker or dealer if the issuer does not solicit those transactions. Issuers can effect repurchases directly through electronic communication networks ( ECNs ) or other alternative trading systems ( ATSs ) that are registered as broker-dealers, but cannot use both an ECN (or others ATSs) directly and a non- ECN broker dealer on any single day. If an issuer chooses to use a non-ecn broker dealer to conduct its repurchase activity on a particular day, however, that broker dealer can access ECN liquidity on behalf of the issuer on that day. 2. Timing. Purchases must not constitute the opening transaction or occur during the last half hour of trading, or the last 10 minutes of trading for issuers who have an average daily trading volume ( ADTV ) of $1 million or more and a public float value of $150 million or more. This condition is designed to prevent the issuer from affecting the opening price or the closing price of its stock. 3. Price. Purchases must not be effected at a price that is higher than the highest independent bid or the last independent transaction price, whichever is higher, quoted or reported in a consolidated system at the time the purchase is effected. 2 This condition is designed to prevent the issuer from purchasing its stock at a price above the market price and thus supporting the price at a level that would otherwise not be maintained by independent market forces. 4. Volume. The aggregate purchases on any given day must not exceed 25% of the ADTV for that security during the four calendar weeks preceding the week in which the purchases take place. This condition is designed to prevent the issuer from dominating the market for its 1. An affiliated purchaser is defined as (1) a person acting in concert with the issuer for the purpose of acquiring the issuer s securities or (2) an affiliate who, directly or indirectly, controls the issuer s purchases of such securities, whose purchases are controlled by the issuer or whose purchases are under common control with those of the issuer. An officer or director of the issuer can be an affiliated purchaser under both prongs of the definition. However, an officer or director of the issuer is not deemed an affiliated purchaser solely by reason of his or her participation in the decision to authorize Rule 10b-18 purchases by or on behalf of the issuer. See Rule 10b-18(a)(2). 2. Issuers whose securities are not quoted or reported in a consolidated system may purchase at a price that does not exceed the highest independent bid or the last independent transaction price, whichever is higher, displayed and disseminated on any national securities exchange or on any inter-dealer quotation system that displays at least two priced quotations for the security. For all other securities, issuers must effect a purchase at a price no higher than the highest independent bid obtained from three dealers. 2 Reprinted with permission

3 stock by purchasing a large amount of its common equity relative to purchases in the independent market. Block purchases made by or on behalf of the issuer will generally count towards an issuer s 25% volume limitation and will be included in calculating the average daily trading volume for its stock. However, once each week, an issuer will be permitted to make one block purchase of its common stock without regard to the 25% volume limit, provided that the issuer does not make any other 10b-18 purchases that day. Shares purchased under this block exception may not be included in calculating a stock s four-week ADTV. 3 Block trades are defined in Rule 10b- 18 to include: (i) purchases of at least $200,000; (ii) purchases of at least 5,000 shares that have a purchase price of at least $50,000; or (iii) purchases of at least 20 round lots of the security where the quantity of stock purchased totals 150% or more of the trading volume for that security (if trading volume data is available). 4 The Rule 10b-18 safe harbor is not available from the time a merger, acquisition or similar transaction is publicly announced until the transaction is completed. 5 However, the merger exclusion will not apply, and the Rule 10b 18 safe harbor will be available: (1) if the consideration in the merger, acquisition or similar transaction is solely cash and there is no valuation period; (2) for ordinary Rule 10b 18 purchases effected after the announcement of a merger or covered transaction (subject to Regulation M 6 and any other applicable restrictions) so long as the volume purchased in any one day does not exceed the lesser of 25% of the four-week ADTV or the issuer s average daily Rule 10b-18 purchases during the three full calendar months preceding the announcement of the merger or other covered transaction; (3) for block purchases provided the issuer does not exceed the average size and frequency of block purchases effected during the three full calendar months preceding the date of the announcement of the covered transaction; or (4) if the purchase is effected by or for an issuer plan by an agent independent of the issuer. The anti-fraud provisions of the Exchange Act, including the insider trading restrictions of Rule 10b-5, will continue to apply even if the safe harbor conditions of Rule 10b-18 are met. The Rule 10b-18 safe harbor does not permit issuers or affiliated purchasers to trade while in possession of material, non-public information. To ensure compliance with Rule 10b-18, we recommend that the following guidelines should be followed: 1. The company s broker should be made aware that the company intends to comply with the Rule 10b-18 safe harbor. All of the major brokerage firms are familiar with the operation of Rule 10b 18 programs. 2. One person at the company should carefully monitor the program to ensure that the share repurchases fall within the Rule 10b-18 safe harbor. 3. Since the Rule 10b-18 safe harbor covers share purchases not only by the company, but also by directors and officers acting in concert with the company, a company intending to comply with Rule 10b-18 should carefully monitor, and require advance notification of, purchases by its directors and officers and report these purchases to its broker. Also, depending on trading volume and liquidity, purchases by insiders during the pendency of a stock repurchase program may impact 3. All other Rule 10b-18 conditions apply to block trades. 4. A block under paragraphs 10b-18(a)(5)(i), (ii), and (iii) does not include any amount which a broker or dealer, acting as principal, has accumulated for the purpose of sale or resale to the issuer or to any affiliated purchaser of the issuer if the issuer or such affiliated purchaser knows or has reason to know that such amount was accumulated for such purpose, nor does it include any amount that a broker or dealer has sold short to the issuer or to any affiliated purchaser of the issuer if the issuer or such affiliated purchaser knows or has reason to know that the sale was a short sale. 5. The merger exclusion ends on the earlier of the completion of the transaction or the completion of the vote by target shareholders (including any subsequent valuation period). Thus, the safe harbor would be available after the shareholder vote is completed in instances where the only pending issue is regulatory approval or other action that could not affect the price of the issuer s security. 6. In the case of a distribution involving a merger, acquisition, or exchange offer, Regulation M s restricted period begins on the day the proxy solicitation or offering materials are first disseminated to securities holders, and ends upon the completion of the distribution (i.e., the time of the shareholder vote or the expiration of the exchange offer), and includes any post-vote valuation or election period. Reprinted with permission 3

4 continued the availability of shares for repurchase by (or the price available to) the company. 4. It is customary to issue a press release publicly announcing the commencement of a stock repurchase program. See VI. Other Considerations Disclosure of Stock Repurchase Programs below. 5. Rule 10b-18 provides a safe harbor only for purchases in the United States and not for offshore purchases. 6. Counsel should be available to the company s broker and to company personnel to answer any questions that arise. II. Regulation M Notwithstanding the Rule 10b-18 safe harbor 7, Regulation M generally prohibits the purchase of securities by an issuer or an affiliate of an issuer while the issuer or an affiliate is engaged in a distribution of the issuer s securities and during a period of time immediately prior to the distribution. Under Regulation M, distribution is defined as 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. 8 Since the definition of a distribution may not be entirely clear based on a specified set of facts, issuers should carefully consider all relevant facts in determining whether a company is in the middle of a distribution before engaging in a stock repurchase program. In addition to public equity offerings, transactions which should be analyzed on a case-by-case basis to determine whether the company is engaged in a distribution include tender offers for stock, exchange offers, mergers involving the issuance of stock, stock acquisitions and offerings registered under the Securities Act of convertible or non-convertible securities, as well as unregistered offerings of equity or equity-linked securities. If an issuer is engaged in a distribution under Regulation M, the restricted period during which stock repurchases are prohibited varies based on the nature of the distribution. 1. In the case of a primary or secondary offering, the restricted period generally begins either one or five business days (depending on trading volume and public float 9 ) prior to the determination of the offering price and ends upon completion of the distribution. 2. In the case of shares issued in connection with a merger, acquisition or exchange offer, the restricted period begins on the day proxy solicitation or offering materials are first disseminated to security holders and continues until the security holder vote or expiration of the offer. Unsolicited, privately negotiated purchases by the issuer are permitted during distributions as long as these purchases are not effected from or through a broker or dealer, on a securities exchange, or through an inter-dealer quotation system or ECN. 10 However, any transaction, whether or not effected pursuant to Regulation M, remains subject to the anti-fraud and antimanipulation provisions of the securities laws. 11 III. Material, Non-Public Information Generally, issuers who repurchase their own stock while in possession of favorable, material non-public information can be found liable under Section 10(b) of the Exchange Act and Rule 10b-5 for illegal insider trading. 12 Accordingly, (1) the issuer should disclose any such non-public information prior to initiating a repurchase, (2) repurchases should occur only when the issuer does not possess any material non-public information or (3) repurchases should only be made under a 10b5-1(c) plan Rule 10b-18 specifically provides that purchases made during a Rule 102 (under Regulation M) restricted period will not qualify for the Rule 10b-18 safe harbor. See Rule 10b-18(a)(3)(i). 8. See Rule 100 of Regulation M, 17 C.F.R (definition of distribution ). 9. Where the ADTV value of the security is $100,000 or more and the issuer s common equity securities have a public float value of $25 million or more, the restricted period begins one business day prior to the determination of the offering price. For all other securities, this period begins five days prior to the determination of the offering price. 10. See Rule 102(b)(6) of Regulation M, 17 C.F.R (b)(6). 11. See Rule 100(a) of Regulation M, 17 C.F.R (Preliminary Note). 12. See, e.g., McCormick v. The Fund American Companies, Inc., 26 F.3d 869, 876 (9th Cir. 1994) ( Numerous authorities have held or otherwise stated that the corporate issuer in possession of material nonpublic information, must, like other insiders in the same situation, disclose that information to its shareholders or refrain from trading with them. ). 4 Reprinted with permission

5 Issuers should also consider the timing of any repurchase in relation to anticipated public disclosures, such as earnings reports, to avoid situations in which they might appear to have taken advantage of non-public information. For example: In connection with quarterly earnings announcements, issuers typically suspend repurchases beginning at a point in time either before or following the end of the quarter when management has assembled sufficient information about results such that it may be deemed in possession of material non-public information. This could be different for different quarters. Companies may consider engaging in open market repurchase programs only during trading windows when they permit trading by their directors and officers, so long as they are not aware of any material nonpublic information. 14 It would be permissible for a company to purchase its shares outside of the trading window if it did not have material nonpublic information. Companies should take precautions to ensure that repurchases are not later viewed as having been made while in possession of material nonpublic information. Unfortunately, the question of whether information is material will often be reviewed in hindsight. Therefore, companies should develop policies and procedures to help them determine when it is necessary to shut down their repurchase program. IV. Tender Offers (Rule 13e-4) The majority of issuer share repurchases are effected over time through open market purchase programs. Companies may also buy one or more significant blocks of shares in private transactions. Sometimes, issuers choose to make a tender offer for their own shares. Such tender offers are frequently structured as Dutch auction tender offers, in which the issuer offers to repurchase up to a specific number of shares within an identified range of prices. The issuer pays each tendering stockholder the price which results in the issuer acquiring the maximum number of shares specified in the offer (subject to proration if more than the maximum number of shares are tendered at or below the market-clearing price). In addition, issuers from time to time conduct odd-lot tender offers to repurchase lots of less than 100 shares. Issuer tender offers (but not odd-lot tender offers) must comply with Rule 13e-4 of the Exchange Act, which includes significant disclosure and substantive requirements, including the requirement that the offer must remain open for not less than 20 business days, the requirement that all tendering shareholders receive the highest price paid for any share tendered in the offer and the requirement of a 10 business day cooling off period after the closing of the offer before the issuer may repurchase any other shares. It is important that any share repurchase that is not effected by means of a tender offer in accordance with the applicable SEC rules be conducted in a manner that will not inadvertently be deemed to constitute a tender offer. There is no bright line test under the U.S. securities laws to determine whether open market or privately negotiated purchases of securities constitute a tender offer. In fact, neither the SEC nor Congress has defined the term tender offer. An eight factor test initially proposed by the SEC is now used by the majority of courts in addressing this question. 15 The eight factors are: 13. Rule 10b5-1(c) permits corporate insiders, and the company itself, to adopt a written plan for trading securities at a time when the insider or the company is not aware of material non-public information. After adopting a 10b5-1(c) plan, the plan participant (including an issuer) may trade shares on a regular basis pursuant to the plan, regardless of any subsequent material non-public information it possesses or receives. 14. The NYSE rules do not expressly address issuer stock repurchases (other than redemptions of redeemable securities). However, the guidelines applicable to purchases by officers and directors may apply by analogy. NYSE Rule 309 suggests that officers and directors may only buy shares during window periods commencing one week after the release of the annual report to shareholders or following the release of quarterly results which includes an adequate comment on developments during the period (provided, in all cases, that the officer or director knows of no developments pending which need to be made public before an insider could properly participate in the market). In addition, NYSE Rule 309 suggests that purchases could be made when there is relative stability in the company s operations and the market for its securities. When a major development or important press release is expected within the next few months, transactions should be avoided. After a release, transactions in securities should not be made until the information is widely disseminated (generally, 1-3 business days depending on the trading volume of the stock and the materiality of the information). 15. See Wellman v. Dickinson 475 F. Supp 783 (S.D.N.Y. 1979), aff d 682 F.2d 355 (2d Cir. 1982) and Brascan Ltd. v. Edper Equities, Ltd. 477 F. Supp 773 (S.D.N.Y. 1979). Reprinted with permission 5

6 continued 1. active and widespread solicitation of public shareholders; 2. solicitation made for a substantial percentage of the issuer s stock; 3. offer to purchase made at a premium over the prevailing market price; 4. terms of the offer are firm rather than negotiable; 5. offer contingent on the tender of a fixed number of shares, often subject to a fixed maximum number to be purchased; 6. offer open only for a limited period of time; 7. offeree subjected to pressure to sell his stock; and 8. public announcements of a purchasing program precede or accompany rapid accumulation of large amounts of the target company s securities. The eight factors were advanced by the SEC as characteristic of a typical tender offer. However, the courts have consistently held that the presence or absence of one or more of these factors will not be dispositive, stating that depending on the circumstances involved in the particular case, one or more of the eight features may be more compelling or determinative than others. An open market repurchase program that complies with the Rule 10b-18 safe harbor should not constitute an issuer tender offer because the purchases are made at prevailing market prices and without any solicitation of sellers. 16 A repurchase program conducted outside the safe harbor would need to be planned and monitored so as not to trigger the tender offer rules by avoiding the characteristics of tender offers. Issuers and their affiliated purchasers routinely engage in stock repurchase programs without triggering the disclosure and substantive protections of Rule 13e-4. Typically in these stock repurchase programs: issuers generally announce only an intention to purchase from time to time up to a specified number of shares or a specified aggregate dollar limit in open market or privately negotiated transactions, no purchase price is specified, the number of shares purchased generally is less than 10% to 15% of the class, and shares are purchased at market prices which change throughout the program. V. Going Private Transactions (Rule 13e-3) Rule 13e-3 under the Exchange Act applies to a purchase of any equity security by the issuer or an affiliate of the issuer if the purchase has either a reasonable likelihood or a purpose of, either directly or indirectly, causing (a) any class of equity securities of the issuer which is subject to sections 12(g) or 15(d) of the Exchange Act to be held of record by less than 300 persons (based on record holders, not beneficial holders), or (b) any class of equity securities of the issuer to be delisted. Regardless of its intent, if an issuer determines to engage in stock repurchases that are reasonably likely to result in a class of its securities being delisted or becoming eligible for de registration, the issuer must comply with Rule 13e-3. If a transaction or series of transactions constitute a going private transaction within the meaning of Rule 13e-3, the purchase is subject to significant additional disclosure and timing requirements. 17 A typical open market repurchase program that complies with the Rule 10b-18 safe harbor generally should not constitute a going private transaction under Rule 13e-3 (either a reduction to below 300 shareholders or causing a delisting) unless, of course, there is a reasonable likelihood that the number of shareholders (based on record holders, not beneficial holders) will be reduced below 300. VI. Other Considerations A. Disclosure of Stock Repurchase Programs Companies typically make certain disclosures regarding their stock repurchases pursuant to specific line item disclosure requirements when the tender offer or going private rules apply. In 16. See Rule 13e-4, 17 C.F.R e If Rule 13E-3 applies, the issuer would be required to file a Schedule 13E-3 with the SEC 30 days before any purchase and would be required to distribute the Schedule 13E-3 applies to shareholders 20 days before the issuer s first stock purchase. 6 Reprinted with permission

7 addition, Item 703 of Regulation S-K requires that issuers disclose in a table in their quarterly and annual reports all open market and private repurchases of equity securities in the preceding fiscal quarter, regardless of whether those repurchases are implemented pursuant to Rule 10b-18. The required disclosure includes: the total number of shares (or units) purchased (reported on a monthly basis); the average price paid per share; the number of shares (or units) purchased as part of a publicly announced plan or program; and the maximum number of shares (or approximate dollar value) that may yet be purchased under the plans or programs. Additionally, the SEC rules require disclosure of the principal terms of publicly announced repurchase plans including: the date of announcement; the share or dollar amount approved; the expiration date (if any) of the plans or programs; each plan or program that has expired during the period covered by the table; and each plan or program that the issuer has determined to terminate prior to expiration or under which the issuer does not intend to make further purchases. The table must also include disclosure of the nature of any purchases made other than pursuant to a publicly announced repurchase program. Companies typically also disclose the status of the stock repurchase program in the capital resources and liquidity section of management s discussion and analysis of financial condition and results of operations ( MD&A ). Although there is no specific rule that requires it, as a general matter the company should issue a press release publicly announcing the commencement of a stock repurchase program and file this press release with the SEC on a Form 8-K. Companies may also announce a program in their quarterly or annual reports. The company should issue the press release sufficiently in advance of the first repurchase so that the market has time to absorb the information before the repurchase plan actually commences. At a minimum, the release should state the program s material terms, including price, timing, and the maximum number of shares or dollar value of shares that can be purchased. B. Registration Requirements Shares that have been repurchased, whether held in treasury or reinstated to the status of authorized but unissued, cannot be reissued or resold by the issuer except in compliance with, or pursuant to an exemption from, the registration requirements of the Securities Act of Following repurchase, the registration requirements of the Securities Act apply to any reissuance of such shares to the same extent as if the shares had never been publicly traded. C. Restrictions on Share Repurchases Issuers should ensure that they have the authority to engage in a share repurchase program and confirm that their program is not prohibited by state law or any of the company s organizational documents or contractual obligations. Therefore, issuers should review: the laws of the company s state of incorporation (including laws relating to the adequacy of capital and surplus to repurchase shares), and bankruptcy and insolvency laws; the company s certificate of incorporation and by-laws or other similar organizational documents; and any of the company s contracts that may contain share repurchase restrictions, particularly credit agreements, indentures, shareholder agreements, warrants, convertible securities, and other similar documents. Convertible securities (including options) may not prohibit repurchases, but the repurchase may result in adjustments to the conversion price or option exercise price. D. Approval by the Board of Directors When an issuer proposes to implement a stock repurchase plan, the plan should be submitted to the board of directors for review. The Delaware General Corporation Law ( DGCL ) contains certain restrictions regarding the availability of funds with respect to repurchases of shares of capital stock. Under DGCL 160, a Delaware corporation cannot redeem or purchase shares of Reprinted with permission 7

8 continued its capital stock when the redemption or purchase would cause any impairment of the capital of the corporation. Under Delaware law and the laws of numerous other states 18, directors may have personal liability for an unlawful share repurchase, and accordingly it is especially important in this context to ensure that the board has all the information it requires to make an informed decision. 19 In order to ensure that directors are protected, the information presented to the board of directors should include the reasons for engaging in the repurchase program, the total number of shares to be repurchased (or total amount to be spent), the method of repurchase (including time or price limitations), the impact of the repurchase program on the issuer s liquidity and financial results, the availability of adequate capital and surplus, compliance with applicable indenture and contract provisions, and tax and accounting ramifications. In some cases, it will be desirable to engage an appraisal or solvency firm to opine that the company has adequate capital and surplus and will not be rendered insolvent by the proposed repurchase. The board process should be carefully documented and the minutes and related documents should reflect the board s deliberations. E. Tax Ramifications Issuers should discuss the tax ramifications of any stock repurchase program with their tax consultants. Generally speaking, a shareholder who sells all or a portion of his shares to the company as part of a share repurchase will recognize capital gain or loss equal to the difference between the basis in the sold shares and the amount received for those shares. If the sold shares were held for more than a year, the gain or loss will be long-term capital gain or loss. For individuals, long-term capital gains are attractive because the rate of federal income tax on those gains is significantly less than the rate imposed on ordinary income. Corporations cannot avail themselves of favorable capital gain rates. There are a few instances where the proceeds a shareholder receives in a share repurchase will be treated as a dividend. One instance is when the shareholder owns a substantial percentage of the company and, following the repurchase, his percentage interest is reduced by an insignificant amount. For example, a shareholder whose interest is reduced from 18% to 17.9% likely would have dividend treatment. A second instance is when a shareholder s percentage interest in the company, regardless of the size of that interest, is not reduced at all (or in fact increases) following the share repurchase. A corporation is not taxed when either repurchasing its shares or paying a dividend. However, shareholders are taxed in both instances and there may be significant differences in tax consequences between the two. From a tax perspective, a share repurchase is often more efficient than a dividend because the tax basis of the shares redeemed is an offset to the amount of income otherwise recognized. For example, if an individual receives a $100 dividend, he or she is taxed on the entire $ But if an individual receives $100 in a share repurchase, he or she is taxed only on the portion of the $100 that exceeds the individual s basis in the sold shares. Thus, if the individual has a $90 basis in the sold shares, he or she is only taxed on $10. This rule relating to basis recovery applies equally to corporations. In the case of an individual, a share repurchase would also be more efficient in the case of a dividend that is taxed as ordinary income rather than as capital gains. However, under current law, for taxable years ending on or before December 31, 2012, dividends received by individuals from domestic corporations, and certain foreign corporations, are generally taxed at capital gains rates. F. Applicable Listing Rules Major exchanges have conditions that must be satisfied for continued listing of stock, including minimum numbers of shareholders and minimum numbers of publicly held shares. The issuer must ensure that after the stock repurchase plan, 18. Other states have similar or more restrictive laws restricting share repurchases. 19. Under Delaware law, in the case of any willful or negligent violation of the statutory requirements applicable to a share repurchase or dividend, the directors are jointly and severally liable for the full amount paid to repurchase stock or the full amount of the dividend, as the case may be. DGCL 174. This liability cannot be eliminated by the adoption of the charter exculpation clause authorized by DGCL 102(b)(7). However, directors will be protected if they rely in good faith upon records of the company and upon information, opinions, reports or statements of the company s officers or employees, committees of the board or other persons as to matters the directors believe are within those persons expert competence and who have been selected with reasonable care. DGCL 141(e). 20. Because of a special rule, corporations generally are taxed on only 20% to 30% of the amount of a dividend. In view of this rule, in some cases, dividends may be more efficient for corporate shareholders than a share repurchase. 8 Reprinted with permission

9 the company is still in compliance with these conditions. In addition, issuers should comply with any applicable notification and filing requirements of their particular exchange. G. Margin Rules If the issuer borrows money to repurchase its shares, the margin rules might limit the amount of financing to 50% of the purchase price. There is an exception that allows unlimited financing if the issuer intends to immediately retire the stock. 21 As always, please feel free to call your Fried Frank contact or any of the individuals listed below to discuss any of these matters. MA This memorandum is not intended to provide legal advice, and no legal or business decision should be based on its contents. If you have any questions about the contents of this memorandum, please call your regular Fried Frank contact or the authors. 21. Federal Reserve Board Staff Opinion of Sept. 17, 1977, FRRS 5-935; Federal Reserve Board Staff Opinion of Nov. 7, 1980, FRRS ; Federal Reserve Board Staff Opinion of May 27, 1993, FRRS Copyright Policy: The Copyright Act of 1976 prohibits the reproduction by photocopy machine, or any other means, of any portion of this issue except with permission of The M&A Journal. This prohibition applies to copies made for internal distribution, general distribution, or advertising or promotional purposes. Website: Editorial Office: Orders & Subscriptions: For individual subscriptions, discounted multi-copy institutional sub scrip tion rates, or additional copies, please call or fax The M&A Journal the independent report on deals and dealmakers Editor-in-Chief John Close Design and Production John Boudreau Director of Publishing Paul Cecere Contributing Editor Susan Pender Senior Writers Gay Jervey, R. L. Weiner Writing/Research Frank Coffee, Jeff Gurner, Terry Lefton Circulation Dan Matisa Printing AlphaGraphics Web Production John Boudreau The M&A Journal, 25 Prospect Drive, Yonkers, NY Reprinted with permission 9

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