On December 15, 2021, the U.S. Securities and Exchange Commission (SEC) proposed amendments to Rule 10b5-1 along with related amendments intended to "modernize" public company disclosure of share repurchase activity. Wilson Sonsini's client alerts discussing these proposals generally are available here and here. If adopted as proposed, these changes will have particular and significant impact on issuer stock buybacks executed through Accelerated Share Repurchase (ASR) programs.
Accelerated Share Repurchase (ASR) Programs
In a typical ASR, an issuer agrees to purchase a fixed dollar amount of its common stock from a financial institution dealer. ASRs are usually documented as share forward transactions under bespoke International Swaps and Derivatives Association (ISDA)-based equity derivative confirmations. The aggregate number of shares repurchased in an ASR is determined by reference to the volume-weighted average price (VWAP) per share over the duration of the ASR (which is typically three- to six-months), less a negotiated discount to VWAP. Dealers are willing to offer this discount in exchange for, among other things, the right to accelerate the maturity of the ASR in the event of a precipitous drop in share price, which results in a profit for the dealer.
When the issuer prepays the total fixed dollar amount of the buyback, the dealer makes a partial up-front delivery of shares, typically negotiated to have a notional value of at least 75 percent of the fixed dollar prepayment based on the closing price per share on the day the ASR is effective. The dealer borrows the up-front shares from the institutional stock loan market. These initial shares may be immediately retired by the issuer upon delivery, providing a focused boost to earnings per share relative to the gradual impact of open market repurchase programs. Most ASRs conclude with an additional delivery of shares by the dealer to the issuer. In rare circumstances, the issuer may owe a payment (which may be in cash or shares) to the dealer at maturity of the ASR if the issuer's stock price has increased significantly during the ASR's term.
ASRs may be an advantageous means of executing buybacks primarily because of the discount to VWAP and the immediate EPS impact. In addition, it has historically been standard to structure ASRs to benefit from the Rule 10b5-1(c)(1) affirmative defense, which mitigates legal risk related to average pricing that includes periods during which the issuer would discontinue open market repurchases because it is or may be in possession of material non-public information.
Impact of Proposed Amendments to Rule 10b5-1
Proposed Cooling-Off Period
As discussed in our general client alert, the SEC has proposed to amend Rule 10b5-1 to require a 30-day "cooling-off" period prior to the commencement of trading under an issuer's 10b5-1 repurchase plan. While there are examples of issuers entering into "forward-starting" ASRs when targeting a commencement date that is set to occur during or immediately after a "closed window" or "blackout" period, these mechanisms are not that common and must be structured with care to avoid accounting foot-faults. It is also unusual under these forward-starting ASRs for the delay between execution and effectiveness to be more than one or two weeks.
While forward-starting ASRs could be adapted to comply with the proposed 30-day cooling-off period, it is likely that a delay of this length will introduce sufficient uncertainty into the dealer's costs and other pricing inputs as to result in a less favorable discount to VWAP for the issuer. In addition, it will be imperative for issuers to find a method to timely comply with the new repurchase disclosure requirements discussed below without conveying pricing terms of the ASR that could allow market participants to "front run" the ASR as a result of a delayed start feature that is necessitated to comply with a cooling-off period.
Restrictions on Overlapping Repurchase Plans
The SEC has also proposed restrictions on overlapping 10b5-1 trading plans and concurrent agency open market repurchases that will significantly limit the utility of ASRs if they continue to be structured to comply with Rule 10b5-1(c)(1)'s affirmative defense. Issuers commonly enter into an ASR as part of a larger buyback effort that includes Rule 10b-18 compliant open market repurchases in an agency arrangement with a broker-dealer affiliate of the issuer's ASR counterparty. In addition, some issuers choose to execute less common dual- (or multi-) dealer, alternating day or single-dealer staggered-maturity ASR structures to mitigate counterparty credit risk or attempt to optimize pricing.
If adopted as proposed, the restrictions on concurrent trading activity will likely put an end to these multi-plan strategies if issuers wish to perfect an affirmative defense to an allegation that repurchase activity was on the basis of material non-public information. When taken together with the almost certain deleterious effect of a required 30-day cooling-off period on pricing and orderly execution of ASRs, it will be worth considering whether the costs of perfecting a Rule 10b5-1(c)(1) affirmative defense outweigh the benefits in the context of a share buyback program that includes ASRs.
Impact of Proposed Disclosure Regime
Among the new disclosure obligations, which we discussed in our general client alert, is the new Form SR that must be furnished one business day after an issuer "executes a share repurchase," which also presents unique challenges for ASRs. The SEC proposing release explains in a footnote that it considers the "date of execution" of a repurchase to occur when the parties become irrevocably bound to the transaction under applicable law and obligated to perform under the agreement, rather than when performance actually occurs. In the text of the proposing release, the SEC suggests that it expects the issuer's one business day Form SR filing deadline to commence on the date of execution, in advance of settlement, based on the SEC's understanding that pricing details are by then already known.
It is unclear how this can be put into practice in the context of an ASR. If Form SR disclosure is due on the business day following execution of the ASR contract, it will occur at a time when salient required data (i.e., the total number of shares repurchased, and the average price paid per share) are not known. As discussed above, the total number of shares repurchased and average price per share are determined by the VWAP averaging period that concludes just prior to final maturity of the ASR, which is typically scheduled to occur three- to six-months following the date of execution.
Unless the SEC provides additional guidance, market participants will be left to determine what, if anything, to disclose on the business day following execution of an ASR, and how and when to amend or supplement any initial disclosure once further or final data is known.
Given the proposing release's focus on daily disclosure during the term of share repurchase programs in other contexts, there is also a risk that some market participants may take the view that some or all of the dealer's hedging activity is required to be disclosed by the issuer on new Form SR. To hedge its obligations under an ASR, the dealer typically executes daily purchases of the issuer's shares within 10b-18 volume limitations during most or all of the ASR's VWAP averaging period as the dealer gradually closes out its short position created by its up-front delivery of shares. The dealer's hedging activity, however, can reasonably be expected to include at least some trading days during which its share purchases are well in excess of 10b-18 volume, particularly if the dealer has exercised or is expecting to exercise its right to accelerate the maturity of the ASR.
Disclosing all or some portion of the dealer's hedging activity on the issuer's Form SR would both be operationally burdensome and involve an ill-advised blurring of the line between the issuer's principal share repurchase transaction with its ASR dealer-counterparty, and that dealer's market hedging activity for its own account. Putting aside these concerns, and understanding that further consideration and dialogue by and among market participants is needed before a consensus around reasonable market practice will emerge, it seems likely that a better approach would be for the issuer either to make two disclosures on Form SR (one incomplete and heavily footnoted Form SR at execution, and another with definitive transaction data following final settlement) or to postpone filing Form SR until maturity of the ASR when transaction data is known.
What to Do Now?
Issuers that have used ASRs as part of their past return of capital to shareholders, as well as issuers considering implementing an ASR for the first time, should be aware of the profound impact of the SEC's amendments if adopted as proposed. It is likely that these proposals will become effective in the near future without significant changes in light of focus from the SEC and federal political leadership on issuer share repurchases. Given this focus, and the ambiguity of the proposals' application to ASRs in critical respects, issuers would do well to tread carefully and work with advisors and counterparties aware of and focused on consistency with market practice as it develops and evolves.
