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SEC Proposes to Modernize Company Repurchases of Common Stock

Client Advisory

March 4, 2010

The U.S. Securities and Exchange Commission recently proposed amendments to Rule 10b-18 under the Securities Exchange Act of 1934 (the “Exchange Act”) that are intended to modernize and clarify the safe harbor provisions in light of market developments since the Rule’s adoption in 1982.[1] 

Rule 10b-18 provides an issuer and certain others a non-exclusive safe harbor from liability under the anti-manipulation provisions of the Exchange Act, including Rule 10b-5, when they repurchase the issuer’s common stock in the market in accordance with the Rule’s manner, timing, price and volume conditions. 

The proposed amendments to Rule 10b-18 include:

  • Creating Additional Restrictions on Opening Purchases: The proposal would restrict issuers from making the opening purchase in the stock’s principal market and the market where the issuer repurchases are effected (in addition to the current restriction on effecting Rule 10b-18 purchases as the first purchase reported in the consolidated system).
  • Permitting VWAP Purchases: The proposal would expand the safe harbor to cover company repurchases using the volume-weighted average price (“VWAP”) methodology, subject to certain conditions intended to reduce the risk of market manipulation.
  • Relaxing the Safe Harbor to Accommodate “Flickering Quotes”: Under the proposal, a company’s non-compliance with the price condition of the Rule solely due to “flickering quotes”[2] would only disqualify the non-compliant purchase (not all of the issuer’s other Rule 10b-18 purchases for that day) from the safe harbor. 
  • Modifying the Merger Exclusion Provision for SPACs: The SEC’s proposed amendments would modify the Rule’s merger exclusion to exclude from the safe harbor all repurchases by special purpose acquisition companies (“SPACs”) until the earlier of (i) the completion of the transaction or (ii) the completion of the vote by both the target shareholders and the SPAC shareholders.

Restrictions on Opening Purchase

Currently, the Rule 10b-18 safe harbor excludes from its scope opening regular way purchases reported in the consolidated system. In the proposing release, the SEC notes that on some occasions the first purchase reported in the consolidated system would not be from the principal trading market for the issuer’s securities, but from a smaller regional exchange. When this occurs, a subsequent larger opening purchase by the issuer on the principal market for the security would currently qualify for the safe harbor. The SEC notes that a larger opening transaction in the principal market may be a more significant indicator of the direction of trading in the security than the smaller regional exchange’s opening purchase reported in the consolidated system that day. 

To address this concern, the proposal would restrict issuers from making the opening purchase in the stock’s principal market and the market where the issuer repurchases are effected (in addition to the current restriction on effecting Rule 10b-18 purchases as the first purchase reported in the consolidated system).

VWAP Purchases

Current Rule 10b-18 limits an issuer to bidding for or buying its security at a purchase price that is no higher than (i) the highest independent bid or (ii) the last independent transaction price, whichever is higher, quoted or reported in the consolidated system at the time the purchase is effected. The proposed amendments would provide an exception to the price condition for purchases made at a VWAP if:

  • the VWAP purchase is for a security that qualifies as an “actively-traded security” (as defined under Regulation M, which provides that an “actively-traded security” have an average daily trading volume (“ADTV”) of $1 million or more and a public float of $150 million or more);
  • the VWAP purchase is entered into or matched before the regular trading session opens;
  • the execution price of the VWAP matched trade must be determined based on a full trading day’s volume;
  • the VWAP purchase does not exceed 10% of the ADTV in the security;
  • the VWAP must not be effected for the purpose of creating actual, or apparent, active trading in or otherwise affecting the price of any security;
  • the VWAP must be calculated in accordance with the Rule[3]; and
  • the VWAP purchase must be reported using a special VWAP trade modifier in order to indicate to the market that such purchases are unrelated to the current or closing price of the security.

Flickering Quotes

Currently, to come within the Rule 10b-18 safe harbor on a particular day, an issuer must satisfy the Rule’s manner, timing, price, and volume conditions. Failure to meet any one of the four conditions of Rule 10b-18 with respect to any of the issuer’s repurchases during the day disqualifies all of the issuer’s Rule 10b-18 purchases from the safe harbor for that day. 

The SEC’s proposing release notes that the increased speed of today’s markets has made it increasingly difficult for an issuer to ensure that every purchase of its common stock during the day will meet the Rule’s current price condition. Presently, even if an issuer inadvertently effects a Rule 10b-18 purchase outside of the Rule’s price condition due to flickering bid quotes in a market, the Rule’s general disqualification provision would cause the issuer to forfeit the safe harbor for all of its Rule 10b-18 compliant purchases that day.

In order to accommodate the increasing occurrence of flickering quotes, the SEC’s proposed amendments would limit the Rule’s disqualification provision in instances where an issuer’s repurchase order is entered in accordance with the Rule’s four conditions but is, immediately thereafter, executed outside of the price condition solely due to flickering quotes. In these instances, only the noncompliant purchase, rather than all of the issuer’s other Rule 10b-18 purchases for that day, would be disqualified from the safe harbor.

Merger Exclusion

The current Rule 10b-18 precludes purchases effected during the period from the time of public announcement of a merger, acquisition, or similar transaction involving a recapitalization, until the earlier of (i) the completion of such transaction or (ii) the completion of the vote by the target shareholders (the “merger exclusion”). In the proposing release, the SEC states that a SPAC’s acquisition of its own shares presents unique conflicts of interest and significant financial incentives for the SPAC management. The SEC notes that presently if the SPAC management believes that SPAC shareholders will vote against an acquisition by the SPAC, they may attempt to rely on Rule 10b-18 to repurchase a substantial percentage of shares of the SPAC common stock in the open market to assure the acquisition will be approved. These repurchases can also raise the SPAC’s share price, causing others to buy shares in the SPAC in the open market when they might not otherwise have done so. 

The proposed amendments would modify the merger exclusion in connection with an acquisition by a SPAC of its own shares by extending the time period during the safe harbor is unavailable until the earlier of: (i) the completion of the transaction or (ii) the completion of the vote by both the target shareholders and the SPAC shareholders.


Questions regarding this advisory should be addressed to Steven J. Glusband (212-238-8605, glusband@clm.com) or G. Christina Gray-Trefry (212-238-8696, gray@clm.com).


Endnotes


[1] Purchases of Certain Equity Securities by the Issuer and Others, Exchange Act Release No. 34-61414 (Jan. 25, 2010), available at http://www.sec.gov/rules/proposed/2010/34-61414.pdf.

[2] Flickering quotes occur when there are rapid and repeated changes in the current national best bid during the period between identification of the current national best bid and the execution or display of the Rule 10b-18 bid or purchase.

[3] The VWAP price must be calculated by: (i) first calculating the values for every regular way trade reported in the consolidated system during the primary trading session; (ii) then compiling an aggregate sum of all values; and (iii) then dividing this aggregate sum by the total number of trade reported shares for that day in the security that represent regular way trades effected in accordance with the Rule’s timing and pricing conditions that are reported in the consolidated system during the primary trading session for the security.



Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
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