Do the insider trading rules apply to share buybacks by companies?

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Auditor Mark Drozda, of La Jolla, Calif., Asked:

How do the insider trading rules apply to share buybacks by companies? For example, what’s stopping Warren Buffet and Charlie Munger from waiting for Berkshire Hathaway to release news that they know will drive the share price down to buy back shares?

Share buybacks have gained momentum again this year after the economy fell due to the COVID-19 crisis.

In the second quarter, S&P 500 companies spent nearly $ 199 billion on share buybacks, compared to $ 88.7 billion during the same period last year. Buyouts have come under more scrutiny in recent years, with critics claiming they manipulate stock prices and benefit senior executives when the profits could go into, say, workers’ wages.

When it comes to buyout regulations, insider trading laws apply to individual officers and directors, but leave companies unhindered, says David Yermack, professor of finance and business transformation at the Stern School. of Business from New York University.

“The general rule is: Disclose or abstain. Which means if you know of material inside information, that information should be made public before trading, or you should just refrain from trading, ”Yermack said.

He explained that the regulation falls on Rule 10b-5 – a general anti-fraud measure that the Securities and Exchange Commission instituted in 1934.

This rule prohibits people from using any means to defraud, make a false statement or omit information about a “material fact” or engage in a deceptive practice in connection with the purchase or sale of a security.

But Yermack said there are a lot of gray areas when it comes to defining “material” information – in general, information that could affect the value of a business – and what it means to disclose it.

“You have more and more difficulty with the area of ​​what’s important and what’s not because I would say managers almost always have important information. They always know more than the public, and some of what they know is definitely important, ”Yermack said. “What the law is really obsessed with are cases involving mergers and acquisitions and other high-profile announcements like quarterly earnings, bankruptcies – things where it would be indisputable that it really matters.”

Justin Klein, director of the Weinberg Center for Corporate Governance at the University of Delaware, said it would be “problematic” for a company to intend to sit on information while waiting for a more share buyback opportunity. profitable. However, he said, there is no specific law that defines insider trading in this area.

In 1982, the SEC instituted Rule 10b-18, also known as the Safe Harbor Rule, which aims to reduce a company’s liability for manipulation during the repurchase of shares. Essentially, this has made it much easier for companies to buy their own shares as long as they several conditions.

Companies should buy stocks through a single broker or broker on a day and hour of their purchases so that companies cannot trade in the last 10 to 30 minutes of the day (depending on the size of the business). business). They also cannot buy shares at prices lower than or equal to the highest independent offer, nor can they buy back more than 25% of the average daily trading volume of a share.

“A company can’t really commit insider trading,” Yermack said. “But theoretically, a company could be breaking market manipulation laws if they had a very shady buyout program in which they didn’t make public announcements and go beyond the rules, but I don’t think that’s happening.”

Since this 1980s rule came into effect, buybacks have skyrocketed. In 2018, they reached a record $ 806 billion. In 2015, Mary Jo White, then president of the SEC, acknowledged that the commission did not monitor redemptions.

We have seen other issues around buyouts, with company insiders taking advantage of announcements of sale stocks after news that pushed the price up.

In 2017, video game maker Activision announced a billion dollar program to repurchase its shares, the Washington Post reported. The price rose as investors massively bought its shares. In response, Activision’s top executives ended up sell stocks valued at over $ 430 million. All perfectly legal.

“The ability for company insiders to personally benefit from knowledge of buyout activity is an obvious problem. And that’s an obvious shortcoming, ”said Lenore Palladino, assistant professor of economics and public policy at the University of Massachusetts at Amherst.

Palladino said company insiders should be prohibited from trading their own shares during buyback periods. If they are not restricted, they should disclose these transactions in real time.

She also argued that the SEC should, at the very least, collect data on daily buyout activity. Currently, companies are required to report monthly share buybacks on their Form 10-Q – a quarterly report.


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