This week, the new Democrat SEC Commissioner, Robert J. Jackson, Jr., gave a speech in which he presented the findings of his staff’s research into how “buybacks affect how much skin executives keep in the game.” Commissioner Jackson was a law professor who liked to conduct research before joining the SEC. Commissioner Jackson said that he often asked his students two questions when thinking about how to give corporate managers incentives to create sustainable long-term value:
- Are we making sure that executive pay gives managers reason to invest in the long-term development of their workforce and their communities?
- Or are we paying executives to pursue short-term stock-price spikes rather than long-term growth?
Commissioner Jackson noted that the theory behind paying executives in stock is to give them incentives to create long-term sustainable value. But, as he also pointed out, that only works when executives are required to hold the stock over the long term.
So when the Tax Cuts and Job Act was signed into law, Commissioner Jackson worried that we would see a repeat of what corporations did when the last corporate tax holiday was enacted in 2004–use the cash influx for stock buybacks and not necessarily invest in long-term value creation. The first quarter of 2018 saw corporations buyback $178 billion in stock. So Commissioner Jackson and his staff studied 385 buybacks over the last 15 months and matched them to information on executive stock sales. They found:
- A buyback announcement leads to a big jump in stock price–typically more than 2.5% during the 30-days after the announcement;
- In half the buybacks studied, at least one executive sold shares in the month following the buyback announcement.
- In the days before a buyback announcement, executives trade in relatively small amounts (less than $100,000 worth daily), but during the 8 days following a buyback announcement, executives on average sell more than $500,000 worth of stock each day.
Commissioner Jackson did acknowledge that this stock trading by executives is not necessarily illegal. However, he finds it troubling as he see it as more evidence that executives are spending more time on short-term stock trading than long-term value creation.
Commissioner Jackson pointed out that, “Executives often claim that a buyback is the right long-term strategy for the company, and they’re not always wrong. But if that’s the case, they should want to hold the stock over the long run, not cash out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”
Commissioner Jackson then called for the SEC to update its rules to limit executives from using stock buybacks to cash out from America’s companies. He also called for an open comment period to reexamine the SEC’s rules in this area to make sure they protect employees, investors, and communities given today’s unprecedented volume of buybacks.
At the very least, any company that has undertaken a stock buyback during the past 1 to 2 years, should know how their executives traded stock shortly after the announcement of their buyback. Companies should know which executives made these stock sales and the rationale for the sales. Companies should be prepared to answer questions about such transactions from their investors and the media. It also might be a good idea to review whether peers undertook stock buybacks during the past 1-2 years and how much stock was sold by their executives shortly after their buybacks were announced. Companies should review this data and know how they compare to their peers, and, if relevant, larger market players. Companies contemplating adopting a stock buyback should consider this emerging view as an additional point in their deliberations.
Executives should ensure that they are utilizing a Rule 10b5-1 stock trading plan, and have established such a plan when they do not have any material non-public information (such as the fact that the company is considering adopting a stock buyback plan). While a Rule 10b5-1 plan does not offer full protection to executives, it is the best currently available to protect them from allegations of illegal stock trading, assuming the plan is set up as required by the rule. If stock sales were made after a buyback announcement that did not utilize a Rule 10b5-1 plan, executives should ensure that all preclearance procedures were followed. To the extent that stock sales increased after a buyback announcement, executives should review the reason for such action and be prepared to discuss with their Boards or internal compliance officer.