In May 2023, the SEC adopted new disclosure rules on company stock buybacks (“New Disclosures”) to help investors better evaluate whether the buybacks serve management’s personal interest at the expense of the company and its shareholders. The New Disclosures would require public companies to disclose in their quarterly reports – forms 10Q and, for the final quarter, 10K – daily share buyback activities, the rationales for the buybacks, and any insider trading during the reporting period.
Days after the SEC adopted the New Disclosures, the U.S. Chamber of Commerce filed a lawsuit against the commission in the Fifth Circuit Court of Appeals. Reflecting the concerns of some influential organizations, the lawsuit questioned the necessity of the New Disclosures, given the existing regulatory framework. Current regulations already mandate that companies report monthly aggregate share buyback data in their quarterly filings without requiring them to disclose the underlying motives.
In October 2023, the Fifth Circuit ruled in favor of the chamber, prompting the SEC to suspend the new regulation indefinitely on November 22, 2023, pending a further cost-benefit analysis. Nonetheless, there are calls for the SEC to re-propose the New Disclosures.
In a new article, I argue that, despite widespread skepticism, the New Disclosures can significantly enhance investor protection and market integrity.
Investors who suspect that management has used buybacks to further its own interests at the corporation’s expense may have several claims in court:
- Fiduciary Breach Claim: Under the applicable state’s corporate statute, investors can sue for breach of fiduciary duty due to corporate waste. This claim arises when management diverts capital from growth opportunities to
- Federal Securities Law Violation for Misrepresentation: Investors may argue that management misled the market by hiding its true motives , say, claiming the buybacks were justified because the shares were undervalued.
- Insider Trading Violations: If managers sold their own shares during or shortly after buybacks, they could be liable for insider trading. The rationale is that they traded while knowing the buybacks had inflate the stock price.
- Open-Market Manipulation: Buybacks could constitute market manipulation if their purpose was merely to inflate the stock price.
For fiduciary breach claims under state law, the daily data provided by the New Disclosures would help demonstrate demand futility by showing that directors and management sold stock just after a buyback caused the price of shares to rise, as reported in their Form 4 filings. In the case of securities misrepresentation claims, the New Disclosures would impose on management a duty to disclose the motives behind buybacks, potentially creating a new cause of action for any failure to do so. Currently, management is not required to disclose motives, allowing them to act with relative impunity.
Despite the above benefits, the New Disclosures would still fall short of enabling shareholders and investors to meet the stringent pleading standards associated with fiduciary breach and securities misrepresentation claims.
First, proving a fiduciary breach due to corporate waste requires shareholders to provide specific evidence showing that the buybacks were irrational and did not benefit the company in any way. . Similarly, securities misrepresentation claims are subject to the heightened pleading standard of the Private Securities Litigation Reform Act (PSLRA), which requires plaintiffs to present particular facts demonstrating management’s ulterior motives. These standards are likely insurmountable for shareholders and investors, who lack access to detailed managerial insights, boardroom discussions, specific operational information, and alternative opportunities available to the company.
Second, the New Disclosures would not be adequate for shareholders to access corporate records under Delaware General Corporation Law (DGCL) Section 220. Access requires demonstrating a credible basis, interpreted as presenting facts beyond mere suspicions of mismanagement. The New Disclosures might help investors identify suspicious trades, but they would not extend beyond this preliminary identification.
Third, securities misrepresentation claims based on misleading statements about the company’s stock value face additional challenges. The PSLRA exempts forward-looking statements that are accompanied by cautionary statements. An examination of the press releases regarding stock buybacks reveals a common use of boilerplate language designed to benefit from this exemption.
Despite these limitations, the New Disclosures could significantly assist investors in pleading insider trading and market manipulation claims. Insider trading claims require the plaintiff to establish scienter, meaning they must demonstrate the trader’s knowledge of and intent to act on material nonpublic information. Courts have emphasized the need for plaintiffs to identify specific repurchases that distorted stock prices and enabled insiders to profit from subsequent sales. This requires establishing that substantial buybacks and insider trades occurred close in time. Current monthly aggregate buyback data is insufficient for this purpose, but more granular daily data provided by the New Disclosures would supply the information necessary to meet the requirement. Based on case law, this demonstration would be sufficient for plaintiffs to survive a motion to dismiss or summary judgment.
Additionally, a market manipulation claim requires plaintiffs to show that trading was solely motivated by an intent to distort market prices and that such distortion occurred. Daily buyback data would allow the plaintiff to identify dates of significant abnormal buybacks, analyze their price effects, and assess their proximity to insider trades, executive compensation events, and other corporate transactions influenced by stock price changes. Such information has proven sufficient for the SEC to survive a summary judgment motion in market manipulation lawsuits.
Surviving a motion to dismiss opens the door to discovery, allowing investors and shareholders access to corporate records that might otherwise remain inaccessible. Discovery could further reveal incriminating evidence of suspect motives and misrepresentations, bolstering investors’ misrepresentation claims or fiduciary breach claims.
This post comes to us from Professor Lynn Bai at the University of Cincinnati College of Law. It is based on her recent article, “The Sec’s (Ill-fated) Stock Repurchase Transparency Reform: A Missed Opportunity For Investor Protection,” available here.