SEC’s Jackson urges buyback rules review

A senior regulator has called for curbs on company executives using share buybacks to cash out – and for boards to keep tabs on the impact of a buyback on the link between pay and performance.

The issue of corporate buybacks has re-entered the spotlight since Congress passed a tax law overhaul in December. Supporters say it will encourage US companies to bring overseas cash back into the country. Among other things, critics argue that executives will simply use the cash inflows for buybacks rather than to invest in training, development or employee wages.

In prepared comments for a speech this past Monday, SEC commissioner Robert Jackson says US companies in the first quarter of 2018 bought back a record $178 billion in stock. He urges the commission to update SEC rules to limit executives from using stock buybacks to cash out from US companies. He also calls for an open comment period to re-examine agency rules to ensure they protect employees, investors and communities from the ill effects of buybacks.

In addition, Jackson urges boards and their counsel to pay closer attention to the implications of a buyback for the link between pay and performance. In particular, he says, the company’s compensation committee should be required to carefully review the degree to which the buyback will be used as a chance for executives to turn long-term performance incentives into cash.

‘If executives will use the buyback to cash out, the committee should be required to approve that decision and disclose to investors the reasons why it is in the company’s long-term interests,’ he says. ‘It is hard to see why a company’s buyback announcement shouldn’t be accompanied by this kind of disclosure.

‘On too many occasions, companies doing buybacks have failed to make the long-term investments in innovation or their workforce that our economy so badly needs. And because we at the SEC have not reviewed our rules governing stock buybacks in more than a decade, I worry whether these rules can protect investors, workers and communities from the torrent of corporate trading dominating today’s markets.

‘Even more disturbing, there is clear evidence that a substantial number of corporate executives today use buybacks as a chance to cash out the shares of the company they received as executive pay.’ Jackson argues that although executives are given stock as incentive to create long-term value, ‘what we are seeing is that executives are using buybacks as a chance to cash out their compensation at investors’ expense.’

Buybacks can be the right long-term strategy for a company but, if they are, executives should want to hold the stock over the long run, not cash it out once a buyback is announced, he says. ‘If corporate managers believe buybacks are best for the company, its workers and its community, they should put their money where their mouth is,’ he adds.

TRACK RECORD
Jackson asked his staff to take a look at how buybacks affect how much skin executives keep in the game by studying 385 buybacks over the last 15 months. ‘What [surprised us] was how commonplace it is for executives to use buybacks as a chance to cash out,’ he says. ‘In half of the buybacks we studied, at least one executive sold shares in the month following the buyback announcement. In fact, twice as many companies have insiders selling in the eight days after a buyback announcement as sell on an ordinary day – so right after the company tells the market the stock is cheap, executives overwhelmingly decide to sell.

‘Now, let’s be clear: this trading is not necessarily illegal. But it is 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. It’s one thing for a corporate board and top executives to decide a buyback is the right thing to do with the company’s capital. It’s another for them to use that decision as an opportunity to pocket some cash at the expense of the shareholders they have a duty to protect, the workers they employ or the communities they serve.’

The SEC last revised its rules governing buybacks in 2003. The rules give companies a safe harbor from liability when pursuing buybacks, but there are no limits on boards and executives using the buyback – and the safe harbor – as an opportunity to cash out.

‘I cannot see why a safe harbor to the securities laws should subsidize this behavior,’ Jackson comments. ‘Instead, SEC rules should encourage executives to keep their skin in the game for the long term. That’s why our rules should be updated, at a minimum, to deny the safe harbor to companies that choose to allow executives to cash out during a buyback.’