Regulation

Wary investors applauding SEC call to examine stock buybacks

BY HAZEL BRADFORD  •  JUNE 25, 2018

Securities and Exchange Commissioner Robert Jackson Jr.'s call for the agency to pay greater attention to corporate stock buybacks is being watched closely by institutional investors, including those who have been calling for at least more disclosure about companies' motives and methods.

Corporate stock buybacks are reaching record numbers: In the first quarter of 2018 alone, American corporations bought back a record $178 billion in stock, in part due to the cash they are accumulating following tax cuts enacted in 2017.

While that fact alone does not alarm Mr. Jackson, he does worry that stock buybacks increasingly are being used by executives to cash out, rather than to increase shareholder value or for corporate investments.

One reason for the growth in buybacks is that, through rules first adopted in 1982 and last updated in 2003, the SEC has offered corporate executives a safe harbor from securities-fraud liability if the pricing and timing of buyback-related repurchases meet certain conditions, Mr. Jackson and others have said.

"The problem is that we haven't touched them now for 15 years. The least you can do is update them," Mr. Jackson said in an interview. He has also called on SEC Chairman Jay Clayton to allow an open comment period to hear other views on whether the agency should revisit buyback practices.

That sounds like a good idea to executives of the Council of Institutional Investors in Washington, whose members — public, corporate and union retirement funds, foundations and endowments — have a combined $3.5 trillion in assets.

Welcomes the call

As major long-term shareholders, "CII welcomes Commissioner Jackson's call for the SEC to review its rules around stock buybacks to make sure investors are protected appropriately," said CII Deputy Director Amy Borrus. "The evidence that executives are taking advantage of bumps in the company's stock price after a buyback to cash out is unsettling. We don't want executive incentives to skew decisions about capital allocation that are not in the company's long-term interest. Executives should not be timing buybacks to benefit themselves at the expense of the company's shareholders. ... The evidence suggests opportunism could be playing a role."

Said Brandon Rees, deputy director of corporations and capital markets at AFL-CIO in Washington, with $653 in assets under management: "We strongly agree that we need to review the safe harbor. Stock buybacks do lead to share price increases over the short term … but that may not be in the long-term interests of the company. You certainly don't want to be incentivizing executives" at the company's expense, Mr. Rees said. "Retained earnings are how companies reinvest to grow."

As part of a continuing focus on executive compensation, officials at the AFL-CIO and its member pension funds have started talking about holding requirements for executives' stock, including through retirement age, "so they won't be tempted," said Mr. Rees, who notes that some European stock options are only exercisable after 10 years. "Shareholders want executives to have as much skin in the game as possible. There's always going to be that tension," he said.

While such trading is not necessarily illegal, Mr. Jackson does find it "troubling, because it is yet another piece of evidence that executives are spending more time on short-term stock trading than long-term value creation," he said.

To spur a closer look, Mr. Jackson's staff studied 385 buybacks over the past 15 months and matched those actions to executive stock sales available in SEC filings. They found a jump in stock price of more than 2.5% in the 30 days after the buyback announcements. In half of the buybacks studied, at least one executive sold shares in the month following the buyback announcement. They also found twice as many companies with insiders selling stock in the eight days after a buyback announcement compared with an ordinary day.

"The new research paints a troubling portrait, analogous to the stock option abuses we saw a couple of decades ago. It may be providing an undue incentive," said Mr. Rees.

Kurt Schacht, the New York-based managing director of the CFA Institute's division of standards and financial market integrity, is glad that Mr. Jackson "is taking on some of the sacred cows. I think active investors everywhere are very interested in this long debate about whether share buybacks are good long term. There is research on both sides, but I think there are so many things about it that could be manipulative," said Mr. Schacht, adding "there are more efficient ways to return capital to investors."

Not jeopardizing growth

In 2016, Tapestry Networks and the Investor Responsibility Research Center Institute asked corporate directors on the boards of 95 public U.S. companies worth $2.7 trillion about their buyback decisions. In their responses, directors said that buybacks do not jeopardize corporate growth, and they do not unjustly enrich top executives. The survey also found that, since the global financial crisis, buybacks hit a high in the first quarter of 2016.

Compensation is increased when performance metrics such as earnings per share or stock prices rise. But directors said they are aware of the potential conflict and that they take steps to ensure executives are not rewarded for financial manipulation of share prices. Still, the study found, only 20 S&P 500 companies disclose how they make buyback decisions.

That is something investors hope to change.

"At a market level, it's a black hole. Companies undertake these but we don't have any disclosure," said Maureen O'Brien, vice president and corporate governance director for Segal Marco Advisors, Chicago.

It is a company-by-company quest "because the SEC hasn't acted," said Ms. O'Brien. "I am glad the conversation is starting."

Rather than taking a broad-brush approach, Calvert Research and Management prefers to take it case by case. Calvert is part of a share buybacks disclosure initiative launched in 2016 by a coalition of 11 institutional investors representing $500 billion in assets seeking more disclosure and transparency about companies' buyback decisions.

"Calvert wants real information to understand the motivation for the buyback," said John Streur, president and CEO of Calvert, in Washington. While comfortable with buybacks, and opposed to restrictions on executives selling after buyback announcement periods, "if there is a pattern of abuse by executives, we support proposals to impose a holding period," Mr. Streur said.

Former SEC commissioner Paul Atkins, CEO of Patomak Global Partners LLC, a Washington financial consulting firm, said that post-tax reform, companies are supporting economic growth in several ways, such as distributing cash through buybacks to shareholders, including those in and saving for retirement. "Buybacks are a basic function of capital markets that drive reinvestment. Share buybacks benefit those very shareholders, seniors and the broader economy," Mr. Atkins said.

Congressional Democrats, including Sen. Charles Schumer of New York, are also watching closely, particularly when it comes to how the corporate tax cuts are paying off for workers and the economy overall, as Republicans promised it would. "We don't hear a peep now that they've been announcing an avalanche of corporate stock buybacks," Mr. Schumer said on the Senate floor in March.

Mr. Clayton, the SEC chairman, declined to respond directly to Mr. Jackson's call for the SEC to study, and do, more. But in several congressional hearings he has expressed concern about potential abuses. While buybacks can be an efficient and appropriate way to return capital, the potential for short-term motivations could be troubling, Mr. Clayton told the Senate Banking Committee in September.

Contact Hazel Bradford at hbradford@pionline.com ·

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