Legal Sidebari

Stock Buybacks: Background and Reform
Proposals
February 27, 2019
In 2018, U.S. corporations announced plans to buyback a record $1.08 trillion of their own stock—a trend
that has attracted scrutiny and generated a number of legislative proposals designed to curb the practice’s
prevalence. This Legal Sidebar provides a general overview of the regulatory framework surrounding
stock buybacks and these recent reform proposals. The Sidebar (1) reviews the debate over the social
value of stock buybacks, (2) discusses the regulatory regime surrounding buybacks, and (3) examines a
number of proposals to reform this framework that have been proposed in legislation, popular
commentary, and the academic literature.
The Debate
When publicly traded corporations seek to return money to their shareholders, they have two options:
(1) pay shareholders a cash dividend, or (2) repurchase shares of their own stock and thereby drive share
prices higher. The choice between paying a dividend and repurchasing stock involves a variety of
considerations. In theory, corporate managers may pay a dividend instead of initiating a buyback when
they believe their company’s stock is overvalued. Dividends also provide shareholders with the ability to
remain invested in a company while receiving a regular income stream. By contrast, corporate managers
may prefer stock buybacks over dividends because of tax considerations (dividends are taxable, while
unrealized capital gains are not), a belief that their company’s stock is undervalued, a desire to reorient
their company’s capital structure away from equity and towards debt financing, or (more controversially)
because buybacks can help managers meet short-term share price targets.
The use of stock buybacks to distribute excess cash has increased significantly since the early 1980s, both
in absolute terms and in comparison with the payment of dividends. In 1980, U.S. corporations
repurchased $6.6 billion of their own stock. By 2000, that amount had grown to roughly $200 billion—
still a far cry from the over $1 trillion in buybacks announced last year. Moreover, although 80 to 90
percent of cash payouts by publicly traded corporations took the form of dividends before the early 1980s,
S&P 500 companies spent 54 percent of their net income on buybacks between 2003 and 2012, while
paying out only 37 percent as dividends.
This surge in the volume of buybacks has generated scrutiny from a number of lawmakers, regulators, and
financial market professionals. Some critics have argued that buybacks represent a form of short-term
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financial engineering that harms long-term shareholder value. According to these observers, corporate
executives use buybacks to meet short-term financial targets instead of making long-term investments in
capital assets and research and development (R&D).
Other critics have contended that unlike the payment of dividends, buybacks redistribute a firm’s value
from public shareholders to corporate insiders. Specifically, some commentators have argued that because
corporate insiders often own a significant fraction of their firms’ equity, stock buybacks can function as a
form of “indirect” insider trading that, like traditional insider trading, redistributes a company’s value
from public investors to insiders. According to these observers, corporate insiders often initiate buyback
programs based on inside information suggesting that their company’s stock is undervalued, thereby
diverting value from public shareholders who sell their stock to non-selling shareholders, including the
insiders themselves. Other commentators have identified a different channel for this sort of redistribution,
arguing that corporate insiders often use buybacks to “cash out” their equity compensation by selling their
shares of a company’s stock shortly after buyback announcements. According to an analysis of stock
buybacks initiated between January 2017 and March 2018, corporate executives sold an average of
$500,000 of their company’s stock per day immediately following a buyback announcement, compared
with less than $100,000 in the days immediately preceding such an announcement.
Finally, some legislators and analysts have contended that increased levels of stock buybacks exacerbate
economic inequality by benefiting shareholders at the expense of workers, who they argue would receive
higher wages in the absence of such payouts.
However, these criticisms of stock buybacks are controversial. Defenders of buybacks have argued that
when a company repurchases its own stock, it promotes the efficient allocation of capital by redistributing
excess cash to more productive uses. Other commentators have rejected the argument that buybacks
promote unhealthy short-termism on the part of corporate management, contending that (1) U.S.
corporations have largely offset the effects of buybacks with new issues of low-interest debt (which offers
certain tax advantages), leaving their cash positions basically unchanged, (2) U.S. corporate R&D
spending is rising, and (3) recent declines in capital expenditures are the result of broader macroeconomic
trends, rather than an increase in the volume of buybacks. Finally, some observers have rejected the
argument that buybacks contribute to growing economic inequality, arguing that a healthy stock market
benefits the middle class by increasing the value of retirement portfolios, pension funds, and college
savings accounts. These commentators have further questioned whether a decline in buybacks would in
fact lead to higher wages, arguing that companies that do not repurchase their shares may instead pay out
excess cash as dividends or make long-term capital investments, neither of which necessarily increases
worker pay.
Regulatory Background
This policy debate takes place in the context of a regulatory framework surrounding stock buybacks
consisting of three general categories of rules: (1) disclosure requirements, (2) prohibitions on market
manipulation, coupled with SEC Rule 10b-18’s safe harbor for buybacks that meet certain conditions, and
(3) SEC Rule 10b-5’s prohibition on insider trading.
Disclosure Requirements
In 2003, the Securities and Exchange Commission (SEC) promulgated regulations requiring companies
that conduct stock buybacks to make certain retrospective disclosures. Under these regulations,
companies that repurchase their own stock must disclose in their quarterly public filings: (1) the total
number of shares repurchased during the previous quarter, (2) the average price paid for those shares,
(3) the number of shares repurchased during the previous quarter as part of a publicly announced
repurchase plan, and (4) the maximum number (or approximate dollar value) of shares that may yet be

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purchased under the plan. However, SEC regulations do not mandate prospective disclosures of either the
volume or expiration date of buyback programs, meaning that investors may not learn precise details
about such programs until months after they are initiated.
Market Manipulation
Section 9(a)(2) of the Securities Exchange Act of 1934 (the Exchange Act) prohibits various forms of
market manipulation, making it unlawful to conduct securities transactions with the intent to deceive
investors by controlling or artificially affecting the price of a security. While the boundaries of
manipulative conduct remain difficult to precisely define, stock buybacks might in certain circumstances
qualify as market manipulation to the extent that they are intended to artificially drive up the price of a
company’s stock. Companies seeking to conduct buybacks accordingly operated in “a legally hazy area”
for much of the 20th century.
While the SEC proposed a series of rules throughout the 1970s that would have explicitly limited the
circumstances in which buybacks were permissible, it ultimately settled on a deregulatory posture toward
buybacks in 1982. In that year, the Commission adopted a limited safe harbor from market manipulation
liability for stock buybacks in the form of SEC Rule 10b-18. Under Rule 10b-18, companies are immune
from market manipulation liability when they repurchase shares in accordance with certain “manner,
timing, price, and volume” conditions. Specifically, the Rule 10b-18 safe harbor applies only if companies
conducting buybacks (among other things):
1. use a single broker or dealer per day to bid for or purchase their stock;
2. abide by certain timing restrictions intended to prevent them from establishing either the
opening or closing price of their stock;
3. not offer a price that exceeds the highest independent bid or the last independent
transaction price on the relevant exchange, whichever is higher; and
4. limit their daily repurchases to 25 percent of the average daily trading volume of their
securities during the previous month.
The Rule 10b-18 safe harbor does not apply to repurchases made in technical compliance with these
requirements that are nevertheless “part of a plan or scheme to evade the federal securities laws.”
Although the Rule offers a safe harbor from market manipulation liability for stock buybacks that meet
these and certain other conditions, it does not affirmatively prohibit buybacks that fail to meet these
conditions. According to some commentators, the greater legal certainty provided by Rule 10b-18 has
played an integral role in encouraging buybacks, with one study finding that buyback volume tripled in
the year after the Rule went into effect.
Insider Trading
Section 10(b) of the Exchange Act and SEC Rule 10b-5 prohibit trading securities on the basis of material
non-public information concerning their value—that is, non-public information that a reasonable investor
would consider important. Because the Rule 10b-18 safe harbor discussed above applies only to liability
for market manipulation, it does not insulate companies from insider trading liability for conducting
buybacks on the basis of material non-public information. Moreover, a number of federal courts have held
that corporations have a duty to disclose such information to shareholders with whom they trade. While
corporations that initiate buybacks on the basis of material non-public information accordingly run the
risk of insider trading liability, managers may be able to conduct buybacks on the basis of certain forms of
so-called “soft” information (e.g., internal projections) that may not qualify as legally material (though
certain types of “soft” information may qualify as material depending on the circumstances).

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Reform Proposals
In response to some of the concerns discussed above, a number of lawmakers have proposed overhauling
the regulatory regime surrounding stock buybacks. In the 115th Congress, S. 2605, the Reward Work Act,
would have prohibited open-market stock repurchases—by far the most common form of buyback—
altogether, while also repealing Rule 10b-18. However, the bill would not have prohibited companies
from conducting tender offers for their own stock—that is, offers extended to all of a company’s
shareholders to purchase stock at a specific price, which are subject to more rigorous disclosure
requirements than open-market repurchases.
Other proposals would impose certain conditions on companies that conduct buybacks. An ultimately
unsuccessful amendment to S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection
Act would have given the SEC the authority to require detailed prospective disclosures regarding buyback
plans and their execution, reject buyback plans, and require corporate boards and CEOs to certify that
buybacks are in the long-term “best interest” of their companies. Similarly, in February 2019, two
Senators announced that they planned to introduce legislation that would prohibit companies from
repurchasing their stock unless they meet various preconditions, such as paying workers certain
prescribed wages, providing a minimum amount of paid sick leave, and offering “decent pensions and
more reliable health benefits.” Such measures would echo certain academic proposals that Congress
prohibit buybacks by companies that have unfunded pension liabilities, engage in layoffs, fail to engage
in certain levels of productive investment, and/or have high CEO-to-median-worker pay ratios. Finally,
SEC Commissioner Robert J. Jackson, Jr. has proposed that the Commission amend Rule 10b-18 to deny
its safe harbor to companies that allow their executives to sell their shares shortly after a buyback
program is announced. However, the full Commission has not initiated rulemaking to implement such a
proposal.
Other proposals would alter the tax treatment of stock buybacks. Some legislators have expressed support
for taxing buybacks at the same rate as dividends in order to incentivize companies to invest excess cash
rather than distribute it to shareholders. While lawmakers have yet to introduce legislation fleshing out the
details of this proposal, one commentator has suggested that when a company repurchases its shares, the
income tax code should treat all of its shareholders—including those who do not sell—as if they had
received a dividend and reinvested the proceeds.
With recent surges in stock buybacks showing no signs of abating, the debate over their social value and
the optimal policy response is likely to continue in both Congress and the SEC.


Author Information

Jay B. Sykes

Legislative Attorney

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