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Published on the Harvard Law School Forum on Corporate Governance in May 2020.
In light of the ongoing coronavirus pandemic (COVID-19), corporations face an increasingly difficult task: navigating the volatility of the financial markets and performance of the company’s financial metrics (e.g., share price and earnings per share) while balancing initiatives that champion goodwill and sustainability on their behalf and on behalf of their key stakeholders. Stock buyback programs are a common tool used by corporations to manage volatility and enhance stockholder value. In 2018 and 2019, corporations repurchased nearly $1.5 trillion of their own shares through stock buyback programs.1 These repurchases generally served to stabilize, even encourage, share prices and increased earnings per share. However, recent events have led to increased public scrutiny, both financially and politically, of the adoption and continuation of these programs, including from the highest levels of government. Accordingly, implementation and usage is down drastically—more than 35 percent in dollar volumes year-to-date.2
If your corporation is considering the adoption or continuation of a stock buyback program, you should consider the following:
Your Company’s Liquidity. Times are uncertain. You should carefully assess your company’s liquidity and capital needs prior to any sort of discretionary spending, particularly stock buyback programs. Many companies are prioritizing cash retention amidst the current economic uncertainty, which has dried up revenue streams and caused widespread operational shutdowns. The effects of COVID-19 are likely to be prolonged and you must consider all potential effects on the short-term and long-term capital needs of your company.
Public Perception of Your Company. Companies are facing intense scrutiny in the public and political arena regarding stock buyback programs (including their past implementation and usage). Many critics have even called for the suspension of these programs altogether. You should consider the scrutiny that may follow and be prepared to defend your prior, current and future actions with a sound rationale for the implementation or continued usage of the plan (particularly as it relates to the ongoing effects of COVID-19 on your stakeholders, notably your employees).
Regulatory Prohibitions Applicable to Your Company. Certain loan programs under the CARES Act prohibit stock buybacks, among certain other corporate actions, for the duration of any loan issued under such programs, and for the 12 months thereafter. This restriction only applies to companies that receive loans or guarantees under these programs. The limitation does not apply where the company had a contractual obligation to repurchase shares in effect on March 27, 2020 (the CARES Act enactment date), but the typical stock buyback program does not involve a “contractual obligation”. The Congressional Oversight Commission is tasked with regulating the actions of borrowers and intends to scrutinize their actions closely, including inquiries into whether repurchases occurred. Even though the Paycheck Protection Program established under the CARES Act does not prohibit borrowers from engaging in repurchases, such action by a loan or guarantee recipient is certain to attract unwanted attention. Critics could well ask why a company has taken advantage of a federal program intended to help small- to medium-sized businesses retain and pay their employees if the company has enough money to buy back equity from stockholders.
Accordingly, has your company accepted funds under the CARES Act? Is it possible that you will need to do so in the future? If “yes” to either, stock buyback programs are ill-advised at this time.
Knowledge of Material Non-Public Information. The current climate is not “business as usual” and, therefore, you must carefully consider your decision in light of SEC Rule 10b-5. Repurchasing stock at the currently depressed prices of most companies could give rise to a claim that the company was purchasing on the basis of “material non-public information.” At this point, many public companies have not provided extensive disclosure of the impact of COVID-19 on their operations. This relates not only to your company’s performance relative to prior guidance or consensus estimates in Q1 2020, but how the company is likely to perform in the next several quarters. Significant uncertainties exist as to how the crisis will continue to impact a company’s financial condition and results of operations, and the situation is changing rapidly. A company’s management team is likely to be in a better position than the investing public to understand and process the myriad of evolving information. This imbalance of access to information could be material.
Even if your company enters into a “pre-arranged trading plan” pursuant to SEC Rule 10b5-1, which permits a broker to execute a plan with an established formula or algorithm without involvement of your company’s personnel, you will be unable to rely on such a plan if the company were in possession of material non-public information at the time of adoption.
These same considerations militate in favor of substantial caution in any consideration of allowing purchases or sales of company stock by insiders.
Stance of the Proxy Advisory Firms.
In the case of ISS: It will generally support stock buyback programs, sans any regulatory prohibitions or concerns of the company, so long as customary terms are used and limitations followed. However, repurchases will be considered for purposes of its recommendations in 2021 (i.e., were the repurchases responsible?).
Demands of Your Stockholders and Stakeholders. As with the public and political scrutiny, you must be prepared to justify such actions to your stockholders and your stakeholders. There is a growing consensus that repurchase activity for the foreseeable future will decrease because it will be demanded by your stockholders and your stakeholders. In the instance of stockholders, you need to be able to answer how you are creating value otherwise and whether there are other opportunities to generate growth. In the instance of stakeholders, you should be prepared to explain if your actions benefit all employees and benefit your community at large.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.