Capital Investment Advisors

What You Should Know About The SEC Rule 10b-18 And Stock Buybacks

There are rumblings in Washington about stock buybacks. To be precise, there is new legislation aimed at rolling back a Securities and Exchange Commission (SEC) provision which allows companies to purchase their own shares.

It’s doubtful the bill will become law. Why? Because the reasoning behind the measure is inherently flawed. Still, it’s worth exploring as the issue is generating so much buzz.

Let’s start with a quick explanation of the law, and the problem some legislators have with stock buybacks.

SEC Rule 10b-18 provides a “safe harbor” for companies and their affiliated purchasers when the company or affiliates buy back shares of their common stock. Under the rule, companies engaging in this practice will not be deemed to have violated anti-fraud provisions of the Securities Exchange Act of 1934, so long as the repurchases fall within four conditions of the rule. In everyday speak, the regulation allows companies to buy their own stock back. Period.

A lot has changed since the rule was adopted during the Reagan administration. As Forbes reports, “Since the de facto legalization of open-market share buybacks in 1982, there has been a 40,000% increase in stock buybacks. Since the recent enactment of the Republican tax reform, corporations have announced more than $480 billion in stock buybacks, overwhelmingly benefiting top executives. Publicly-traded U.S. companies are now on pace to buy back $1 trillion worth of their own shares in 2018 alone.

If we listened only to arguments like those from this article from Forbes, or complaints from legislators pushing for repeal of the stock buyback rule, we might believe that stock buybacks only benefit greedy corporations and hurt working Americans.

If you ask me, not so.

Reports that “corporations have announced more than $480 billion in stock buybacks, overwhelmingly benefiting top executives,” in my opinion, is nonsense. And, it’s from data that is politically motivated.

I know this because I looked at the real data – the impartial data. Let’s talk about JUST Capital.

JUST Capital is not politically motivated. They are impartial data seekers. From their website, they state that their mission is to:

“Build a more just marketplace that better reflects the true priorities of the American people. We believe that business, and capitalism, can and must be a positive force for change. We believe that if they have the right information, people will buy from, invest in, work for, and otherwise support companies that align with their values. And we believe that business leaders are searching to win back the trust of the public in ways that go beyond money.”

Kudos to them. Now, let’s dig into the data and see if there is even a kernel of truth to the claim that buybacks and the corporate tax reforms only benefit wealthy executives.

The Russell 1000 companies tracked by JUST are set to receive a tax windfall of nearly $150 billion. JUST asked these corporations how they plan to distribute that money. Who will benefit the most? Will corporations pass savings onto workers? Invest in growth? Give back to their communities? Reward management and shareholders?

Here’s what they found:  About 43% of this extra money directly benefited workers and consumers, while the other 57% went to shareholders – many of whom are everyday Americans, too!

Here is the breakdown of their data:

7% will go back to workers in the form of higher wages or bonuses (it’s a 50/50 split of wages increases and one-time bonuses).

7% will go to customers in the form of lower prices and improved shopping experiences.

8% will go to improve products (i.e., R&D).

3% will go to charity.

18% will go to new job creation.

57% will go back to investors in the form of dividends and, yes, share buybacks.

As you can see, almost 50% of the extra money corporations are slated to receive from tax reform will go to everyday Americans. Companies aren’t just pocketing the “tax windfalls” in the form of corporate buybacks.

On a side note, some fear mongering hucksters are claiming that a ban on buy-backs would crater the market by eliminating $5 trillion in stock purchases. I don’t believe that. If share buybacks did go away, companies would still have to do something with their tax reform cash. So, we could see more capital flow to the following: investments (new plants, facilities, and research); lowered prices to become more competitive; increased worker compensation to keep the best talent; debt reduction; and increased shareholder dividends. After all, from 1936 until 1982, when there was no such thing as stock buybacks, the S&P 500 went up 9.5% per annum.

All of this is to say, don’t fret over the fate of stock buybacks. The market won’t fail over this issue. Corporations aren’t looking to stick it to the little guy. So, keep your chin up, and hold the impartial facts front of mind.

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