Tuesday, June 12, 2018

Insiders participating in buybacks hinder long-term growth, Commissioner Jackson says

By Amy Leisinger, J.D.

In a recent speech, SEC Commissioner Robert Jackson questioned whether executives use corporate stock buybacks as a chance to cash out the shares received as compensation in a manner that long-term growth and development. According to the commissioner, the provision of stock in executive compensation packages is designed to encourage creation of long-term, sustainable value, but this can only happen if corporate managers are required to hold the stock over the long term. Jackson urged the SEC to update its rules to limit executives’ use of buybacks to cash out and to make sure employees, investors, and communities are protected.

Jackson noted that, following passage of the Trump Administration’s tax bill, domestic companies repatriated billions of dollars of overseas money, but many organizations used the influx of cash to execute stock buybacks, as opposed to funding innovation efforts or increasing wages. Typically, when a company announces a stock buyback, it causes the company’s stock price to jump, he said, and there is evidence that many executives use buybacks as a chance to cash out shares received as executive pay, often at investor expense.

Tying executive compensation to the growth of the company only works when executives are required to hold the stock over the long term, Jackson opined. Reviewing 385 buybacks over the last fifteen months, the SEC staff found that at least one executive sold shares in the month following the announcement in half of the buybacks, and twice as many companies have insiders selling stock in the eight days after an announcement as sell on an ordinary day. While this practice is not necessarily illegal, it is troubling, as it indicates that executives tend to focus on short-term trading and financial engineering instead of long-term value creation, according to Jackson.

The Dodd-Frank Act included several provisions designed to give investors more information about executive cash outs, but the SEC has not promulgated required rules, he explained. While the Commission’s regulations provide companies with a safe harbor from fraud liability when pricing and timing of buyback-related repurchases meet certain conditions, several gaps remain, particularly with regard to limits on boards and executives using buybacks and the safe harbor as an opportunity to cash out, Jackson stated.

It is important to ensure that management has skin in the game, according to the commissioner, and the SEC’s rules should be updated to deny the safe harbor to companies that choose to allow executives to cash out during a buyback. More generally, Jackson stated that the Commission should reexamine its rules and seek comment on whether they adequately protect companies, employees, and investors, especially given the record number of recent buybacks. Compensation committees also should be required to carefully review and approve the decision that executives may use a buyback to cash out and disclose to investors why this decision is in the company’s long-term best interest.

“Investors deserve to know when corporate insiders who are claiming to be creating value with a buyback are, in fact, cashing in,” Jackson concluded.