Corporate Governance

Shearman & Sterling LLP 33 | SEC Proposes Significant Changes to Share Repurchase Disclosure and Rule 10b5-1 Requirements and Disclosure In December 2021, the SEC proposed two sets of rule changes that have the potential to significantly impact the way a company and its directors and executive officers may buy and sell the company's stock. The first of these proposals (the "Share Repurchase Release") 1 would require new and potentially burdensome disclosures relating to issuer share repurchase programs, and the second proposal (the "Rule 10b5-1 Release") 2 would impose new substantive requirements and disclosures relating to trading plans designed to benefit from the affirmative defense to insider trading liability set forth in Rule 10b5-1 under the Securities Exchange Act of 1934 ("the Exchange Act"). Many companies use Rule 10b5-1 trading programs in conjunction with stock buybacks to allow continuous repurchases through what otherwise would be a lengthy blackout period at the end of each quarter. Officers and directors often use Rule 10b5-1 plans to effect sales of company securities they own over time in a manner that is designed to avoid misuse of material non-public information ("MNPI") and protect them from potential insider trading liability. What is surprising about these releases is the frank assertion by the SEC that the proposals are motivated in substantial part by mistrust of the objectives of the companies and individuals that have routinely used these trading techniques, without pointing to specific or widespread abuses. In the Share Repurchase Release, the SEC concedes that there are a number of reasons that issuers conduct share repurchases and that share repurchase can have a positive or negative impact on the market for an issuer's securities. But the release goes on to state that the growth of issuer share repurchase plans and concerns expressed by commentators warrant amendments to the disclosure regime. These concerns include that share repurchases can be used as a form of earnings management to meet consensus estimates, that executives might be motivated to undertake repurchases to maximize share price or earnings-per-share — linked compensation programs or to inflate executive compensation in ways that are not transparent to the market and that share repurchases can be used as a tool to raise the stock price to extract value from the issuer SEC Proposes Significant Changes to Share Repurchase Disclosure and Rule 10b5-1 Requirements and Disclosure Richard B. Alsop, Lona Nallengara and Erica Kent* Insights 1 See U.S. Securities and Exchange Commission, Share Repurchase Disclosure Modernization, 17 CFR Parts 229, 232, 240, 249, and 274, https://www.sec.gov/rules/proposed/2021/34-93783.pdf (December 15, 2021). 2 See U.S. Securities and Exchange Commission, "Rule 10b5-1 and Insider Trading," 17 CFR Parts 229, 232, 240 and 249, https://www.sec.gov/rules/ proposed/2022/33-11013.pdf (January 13, 2022). 20 YEARS rather than using funds to invest in the issuer and its employees. The release focuses less on the use by many companies of share repurchases for ordinary capital management purposes and in a manner that is consistent with maximizing shareholder value. In the Rule 10b5-1 Release, the SEC highlights concerns from courts, commentators and Congress that the current rule has allowed for opportunistic trading of securities on the basis of MNPI in reliance on its protections. The release notes the SEC's concerns about insiders using multiple overlapping plans to selectively cancel trades on the basis of MNPI or commencing trades soon after adopting a new plan or modifying an existing one, and timing gifts of securities while aware of MNPI. The release also suggests that the SEC is aware of some issues with granting options or other equity awards in coordination with the release of MNPI. It also indicates that similar concerns have been raised in connection with issuer repurchases, thus tying the two releases together. While there may be legitimate instances of the kinds of abuses the SEC refers to, the proposed amendments seem quite draconian, almost as if they are designed to discourage share repurchases and Rule 10b5-1 plans entirely rather than to prevent abuse, and excessive relative to what may typically be proposed if there was a belief that most market participants are acting in good faith. It remains to be seen whether the comments, certain of which are discussed below, will cause the SEC to reconsider some of the more burdensome parts of the rules, but companies need to be thinking about how their practices and those of their insiders will change if the proposals are adopted as currently proposed. *Special thanks to Meaghan Jerrett for her contribution to this article.

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