March 24, 2003
By e-mail: firstname.lastname@example.org
Securities and Exchange Commission
Re: File No. S7-050-02
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association (the "Committee")* in response to the Securities and Exchange Commission's request for comments on its December 10, 2002 release entitled "Rule 10b-18 and Purchases of Certain Equity Securities by the Issuer and Others" (the "Proposing Release").
The comments expressed in this letter represent the views of the Committee only and have not been approved by the American Bar Association's House of Delegates or Board of Governors and therefore do not represent the official position of the ABA. In addition, this letter does not represent the official position of the ABA Section of Business Law, nor does it necessarily reflect the views of all members of the Committee.
At the outset, we would like to commend the Commission for its efforts to update Rule 10b-18 under the Securities Exchange Act of 1934 ("Exchange Act") to better fit how securities markets currently operate and express our appreciation for the opportunity to comment on the Commission's proposals. Stock repurchase programs are very important to public companies and the securities markets generally. Repurchases can minimize dilution to public stockholders as a result of equity-based employee benefit plans, provide a more tax-advantageous way under current tax law to return capital to stockholders than paying a dividend, and provide liquidity in extreme market declines, such as the stock market crash of October 1987 and the reopening of the securities markets after September 11, 2001. Most companies conduct their repurchases to conform to the conditions of the safe harbor to avoid claims of market manipulation based on the manner, timing, price and volume of their repurchases.
Due to the importance of repurchase programs, it is essential that the terms of the safe harbor, which facilitate repurchase activity, are clear and can be readily applied in our changing securities markets. We believe that the dynamic nature of the securities markets -- as evidenced by the proliferation of new ways of trading securities, such as through electronic communications networks ("ECNs"), the increasing globalization of the securities markets, and increased opportunities for after hours trading -- have posed, and will continue to pose, special challenges for keeping Rule 10b-18 well tuned to its purpose. Uncertainty as to the application of the safe harbor may result in fewer companies repurchasing in accordance with the rule's conditions, which we believe would be detrimental to those companies as well as the markets generally. Hence, we believe that periodic rulemaking amendments to Rule 10b-18 are an important undertaking of the Commission.
To keep Rule 10b-18 current between periodic rulemaking initiatives, however, we respectfully urge that the staff of the Division of Market Regulation adopt a more active role in providing interpretative advice with respect to Rule 10b-18. Since the original adoption of Rule 10b-18 in 1982, changes in the way securities are traded, as well as regulatory changes affecting the securities markets, have caused an increasing number of interpretive issues with respect to the application of the safe harbor. For the past several years, it appears that the Division's staff has adopted a policy, formally or informally, of not responding to requests for interpretive guidance with respect to Rule 10b-18. Apparently, the staff reasoning for this position is that Rule 10b-18 is a safe harbor provision and, as such, companies and brokers must use their own judgment in applying its terms and are not entitled to staff interpretative guidance. However, we have seen other cases where staff interpretive guidance on a safe harbor provision is critical to the efficient and effective operation of that provision. Given the rapidly changing nature of the securities markets and the importance of Rule 10b-18, we respectfully submit that this regulatory position is not in the best interests of the securities markets. Providing interpretative advice is essential to keeping the rule relevant and faithful to its original purpose in our dynamic and fluid securities markets and may obviate further need for major rule amendments.
We comment below on those aspects of the proposals that raise the most significant issues.
Amendments Concerning the Scope of the Safe Harbor
The Commission proposes to revise the definition of "Rule 10b-18 purchase" so as to include "any bid or limit order that would effect such purchase." We respectfully request that the Commission confirm that collapsing the definition of "Rule 10b-18 bid" into the definition of "Rule 10b-18 purchase" in this manner does not effect any substantive change to the Rule.
We also support the proposal to codify the staff's position that the Rule 10b-18 safe harbor extends to repurchases of all common equity securities. Since the adoption of Rule 10b-18 in 1982, a number of new types of securities issuers have emerged or become more prevalent, as well as methods for issuing securities that are the equivalent of shares of common stock. For example, the increased frequency of Real Estate Investment Trusts as publicly held entities has made shares of beneficial interests more common in the public markets. Similarly, the increasing number of foreign issuers has made publicly traded American Depositary Receipts ("ADRs"),1 a regular feature in the securities markets. Beneficial interests and ADRs are indicative of the new types of issuers and forms of securities necessary to accommodate the evolving nature of the securities markets. The substance of both beneficial interests and ADRs are the functional equivalent of common stock for the purposes of Rule 10b-18 and should be entitled to the safe harbor.
The Committee believes that the proposed change in the merger exclusion would drastically expand the scope of the exclusion and keep issuers out of the market far longer than necessary. In its current form, Rule 10b-18 excludes from the definition of a "Rule 10b-18 purchase" a purchase "pursuant to a merger, acquisition, or similar transaction involving a recapitalization." The effect of this exclusion is to preclude an issuer from relying on the safe harbor when making purchases of the kind described in the exclusion. According to the Proposing Release, this exclusion would be modified to "make clear" that it extends to purchases "[e]ffected during the period from the time of public announcement of the merger, acquisition, or similar transaction involving a recapitalization, until the completion of such transaction." This change, however, is far more than a mere "clarification." It would drastically expand the scope of the exclusion, making the safe harbor unavailable for what could be very long periods when the risk of manipulation is low and when issuers have traditionally conducted stock purchase programs in the ordinary course.
As noted above, the merger exclusion currently applies only to purchases made "pursuant to" a merger or other covered transaction. We have always understood the quoted language to refer to purchases made in, or as a part of, the covered transaction, so that purchases outside the covered transaction could be made in reliance on Rule 10b-18. This has long enabled issuers to continue conducting Rule 10b-18 purchase programs in the ordinary course while a covered transaction is pending (subject to Regulation M as noted below). Indeed, issuers may actually use Rule 10b-18 to repurchase common stock that will be used as part of the merger consideration.
If the proposed change is adopted, however, the merger exclusion would extend far beyond purchases made in the covered transaction and would apply to all issuer purchases made during the pendency of the transaction, however long that may be. This is a very significant extension of the merger exclusion and, because issuers are unlikely to continue their purchase programs when the safe harbor is unavailable, is likely to result in very significant disruption of those programs.
Moreover, the proposed merger exclusion would cover a period far longer than that covered by the companion exclusion for purchases effected during a Regulation M restricted period (see paragraph (a)(13)(i) of the proposed rule). In the context of a covered transaction involving a Regulation M distribution (e.g., a stock-for-stock merger), the latter exclusion would apply from the time when the proxy or other solicitation materials are disseminated to the time when the shareholder vote is completed. It may resume during any subsequent valuation period.2 For purposes of Regulation M, the Commission has concluded that, in this context, the risk of manipulation by an issuer is greatest during the proxy or other solicitation period (when shareholders make their investment decisions regarding the transaction) and any valuation period (when the value of the transaction is fixed by reference to market prices), and that any risk of manipulation that may exist at other times, whether earlier or later, during the pendency of the transaction is simply not sufficient to justify keeping the issuer out of the market. This balanced approach is especially appropriate - indeed, it is critical to issuers - in light of the fact that the total period during which a merger or other covered transaction can be pending, from announcement all the way to closing, can be very long. Depending on the conditions to completing the transaction - particularly the need to obtain regulatory approvals - this period can often run for six months to a year or even longer.
Consequently, insofar as Regulation M is concerned, the Commission has wisely recognized that it would be unnecessarily disruptive to impose a restricted period during the entire time when a covered transaction involving a distribution is pending. Given the similarity of the policy goals underlying Regulation M and Rule 10b-18 - i.e., to reduce the potential for manipulation of the trading market for a security by the issuer and others acting with it - we do not understand why the scope of these rules should differ in the context of a covered transaction. If it is not necessary to extend the restricted period beyond the solicitation (and any valuation) period relating to a covered transaction under Regulation M, why should it be necessary to extend the merger exclusion beyond this period in a covered transaction under Rule 10b-18? Moreover, Rule 10b-18 permits an issuer to rely on the safe harbor only if it complies with price, time, volume and manner restrictions. There are no such restrictions on transactions permitted under Regulation M. We think that any risk of manipulation during periods when no solicitation or valuation occurs would be more than adequately addressed by these substantive limits on bids and purchases.
The proposed change also raises two interpretive problems. First, the amended merger exclusion would be triggered by any "acquisition," regardless of its size and whether or not it is likely to have any effect on the market price of the issuer's stock. The open-ended nature of this term has not been an issue in the past because the exclusion has extended only to purchases made "pursuant to" an acquisition. If the exclusion is extended to cover any purchase made after an acquisition is announced and before it is completed, however, the fact that the term "acquisition" potentially includes any transaction - however big or small and regardless of its structure - in which the issuer may acquire a business unit of any size or kind would have significant consequences for issuer repurchase programs.
Second, the amended merger exclusion would be triggered by an "announcement" of a merger or other covered transaction. The concept of announcement is imprecise and would add uncertainty when used for this purpose. For example, how detailed and specific must it be; is a statement of intention to pursue a possible transaction sufficient? The Commission and its staff have encountered this interpretive thicket in other contexts (e.g., application of Section 5 in transactions involving mergers and acquisitions) and would need to work through it here as well.
For all the reasons set out above, we urge the Commission not to extend the merger exclusion beyond purchases made "pursuant to" a covered transaction. The exclusion has long been written and applied this way and has worked well. The Commission has not shown any evidence to suggest that issuers have abused the Rule 10b-18 safe harbor when covered transactions are pending. In the absence of such evidence, a change in the merger exclusion as drastic as what is now proposed would not be justified.
If the Commission nevertheless decides to extend the merger exclusion, however, we strongly urge the Commission not to extend it more broadly than the current exclusion relating to the Regulation M restricted period, as the latter would apply in similar circumstances. In other words, if extended, the merger exclusion should apply only to purchases made during the period beginning when proxy or other solicitation materials relating to the merger, acquisition or similar transaction involving a recapitalization are disseminated to security holders and ending when security holders are no longer entitled to vote or otherwise make an investment decision regarding the transaction (or during any subsequent valuation period, as understood in the context of the Regulation M restricted period). If security holders are not entitled to vote or make any investment decision and there is no valuation period regarding the covered transaction, the merger exclusion should not apply at all. This latter point is particularly important in light of the two interpretive problems noted above. Given the broad sweep of the term "acquisition" and the uncertainty about what constitutes an "announcement," it is important that the exclusion, if extended, be triggered only by a solicitation or valuation period.
The Proposing Release asks whether the Rule 10b-18 safe harbor should apply to issuer purchases effected in markets outside the United States. In many cases this is an academic question because these transactions generally are beyond the jurisdictional reach of the federal securities laws. The Commission has noted, however, that fraudulent or manipulative activities in a foreign market can implicate the federal securities laws if the activities have a significant effect on U.S. markets.3 To this extent, the safe harbor can provide meaningful protection and guidance for an issuer whose stock is traded in both U.S. and non-U.S. markets and that proposes to conduct a purchase program outside the United States. Put another way, if an issuer's purchases in these circumstances may be subject to the anti-fraud or anti-manipulation provisions of the federal securities laws, then the issuer ought to have access to the safe harbor provided by Rule 10b-18.
We urge the Commission to amend Rule 10b-18 to expressly provide that the safe harbor applies to bids and purchases in non-U.S. markets, with the price, volume, timing and manner conditions modified as set forth below so as to apply on a market-by-market basis in order to address certain practical problems associated with shares traded in multiple markets around the world. For this purpose, we see no reason to distinguish between U.S. and non-U.S. issuers or between issuers whose principal market is in the U.S. and those whose principal market is not. If an issuer's stock is traded in both a U.S. market and a non-U.S. market, the safe harbor should be available for bids and purchases effected in either market, regardless of which one is the principal market for the issuer's stock and regardless of whether the issuer is a domestic or foreign company.
The following suggested modifications of the price, volume, timing and single-broker conditions are intended to apply to any Rule 10b-18 purchase (including any bid) effected in a market located outside the United States, whether the issuer is a U.S. or non-U.S. company and whether the principal market is located in the United States or elsewhere. Bids and purchases effected in a market located in the United States would remain subject to Rule 10b-18 as it would otherwise apply; the modifications described below would not apply to a Rule 10b-18 purchase in any U.S. market.
Price. In the Proposing Release, the price condition refers to the highest independent bid or the last independent transaction price, whichever is higher (the "maximum permitted price"), in the consolidated system or as disseminated on a national securities exchange or inter-dealer-quotation system that displays at least two priced quotations for the security. These pricing sources, of course, reflect trading only in U.S. markets. For transactions in a non-U.S. market, the maximum permitted price should be determined by reference to prices in the market in which the transaction is effected, for two reasons. First, prices in the non-U.S. market may be different from those in the U.S. market, due to differences in liquidity, arbitrage, currency exchange rates or other factors, and determining the maximum permitted price by reference to the U.S. market may result in transactions in the non-U.S. market at prices that are above or below prevailing prices in that market. In order to minimize the impact of Rule 10b-18 purchases effected in a non-U.S. market on prices in that market, the maximum permitted price for those transactions should be determined by reference to prices in that market. Second, due to time-zone differences, markets outside the United States may be open for trading at a time when markets in the United States are closed. Consequently, determining the maximum permitted price by reference to prices in any market other than the one in which the transaction is to be effected may result in a maximum based on stale prices. Again, this may lead to transaction prices that are above or below prevailing prices in the market where the transaction occurs.
This rule should apply on a market-by-market basis outside the United States. If the issuer's stock is traded in more than one market outside the United States, the maximum permitted price for any Rule 10b-18 purchase effected in a non-U.S. market should be determined by reference to prices in that particular market.
The safe harbor should be available for transactions in any non-U.S. market if the market is a securities exchange or an inter-dealer quotation system that displays or disseminates current bid and last sale information for the relevant security, provided that, in the case of an inter-dealer quotation system, at least two priced quotations are displayed for the security. If a non-U.S. market does not meet this requirement, then transactions in that market would have to be effected at a price no higher than the highest independent bid obtained from three dealers in that market.
This market-by-market approach is preferable to one that refers to prices in the principal market. The latter approach would be difficult to apply in light of time zone differences and currency exchange rate fluctuations. It would also be more complicated and could lead to transaction prices that move prevailing prices in the non-principal market. While there are sound policy reasons for referring to prices in the principal market in the context of multimarket stabilization, as Rule 104 of Regulation M provides, we see no reason why the Rule 10b-18 safe harbor cannot be applied solely in relation to the particular non-U.S. market in which the transaction is effected, whether or not it is the principal market. We think the purpose of the Rule 10b-18 price condition should be primarily to minimize the impact of issuer purchases on prices in the market where the transactions are effected, rather than to "harmonize" or promote consistency among prices in multiple markets, which is an important objective in the stabilization context.
Volume. For Rule 10b-18 purchases effected in a non-U.S. market, the volume condition should be applied by reference to the average daily trading volume ("ADTV") in that particular market. While good arguments could be made for applying the condition on the basis of ADTV in all markets worldwide, we think a market-by-market approach is preferable because it is simpler to apply and ensures that issuer purchases in a non-U.S. market will be appropriately limited in relation to trading activity in that market. For an issuer whose principal market is in the United States but whose stock is also traded outside the United States, Rule 10b-18 purchases effected in a secondary market outside the United States in amounts based on volumes in the principal market could have a disproportionate effect on trading activity in the secondary market.
Timing. The timing condition should also be applied outside the United States on a market-by-market basis. For Rule 10b-18 purchases effected in a non-U.S. market, those purchases should not be the first purchase reported in that particular market and should not be effected during the applicable 10- or 30-minute period prior to the close of that particular market or in the principal market. In determining whether the pre-close period in the non-U.S. market should be 10 or 30 minutes, the issuer should refer to the ADTV for that particular market. Reference to ADTV worldwide could result in a volume limitation that is disproportionately large in relation to the trading volume in the particular market, if it is not the principal market. However, we think the public float test should be applied on a worldwide basis because it would be difficult to determine public float with regard to a particular market and, in any event, the ADTV test, which would not be applied on a worldwide basis, is the more significant test in terms of assessing market impact of issuer purchases.
The prohibition on effecting transactions "after the termination of the period in which last sale prices are reported in the consolidated system" (see paragraphs (b)(2)(ii)(C) and (b)(2)(iii)(C) of the proposed rule) may preclude transactions in a foreign market that is open for trading when the U.S. markets are closed. Therefore, this clause of the timing condition should not apply to any Rule 10b-18 purchase effected outside the United States.
One Broker. Because broker-dealer regulatory requirements vary from country to country, a single broker-dealer generally will not be able to effect transactions in markets in more than one country. Consequently, the single-broker condition should be modified so as to apply separately with regard to the United States and each foreign jurisdiction that regulates the conduct of broker-dealers. In other words, the issuer would be required to use a single broker-dealer for all transactions in the United States on a single day and, with regard to each such foreign jurisdiction, a single broker-dealer for all transactions in that jurisdiction on a single day. The broker-dealer used in any particular jurisdiction need not be the same as one used in another jurisdiction. The exception for ECNs described below should also be available with regard to the United States and each such foreign jurisdiction.
Purchases By or For Issuers and Affiliated Purchasers
The Committee believes that the current definition of "affiliated purchaser" is appropriate and is not in need of revision at this time. In considering whether the definition should be amended to either include (or exclude) other persons, we focus particularly upon the fact that Rule 10b-18 is a safe harbor rule. In choosing to craft Rule 10b-18 as a safe harbor rather than a prophylactic rule, the Commission staff noted that issuer repurchase programs "are seldom undertaken with improper intent, may frequently be of substantial economic benefit to investors, and undue restriction of these programs is not in the interest of investors, issuers or the marketplace."4 One of the purposes of the rule is to provide issuers with "clarity and certainty" and to "avoid what might otherwise be substantial and unpredictable risks of liability under the general anti-manipulative provisions of federal securities laws" in connection with their repurchase programs.5 We believe that preserving the rule's simplicity is important to encouraging compliance with the rule's safe harbor conditions. In our view, the current definition provides issuers with the clarity and certainty they need in determining which of their affiliates' repurchases will need to be coordinated with those of the issuer (e.g., with regard to the one broker-dealer requirement) and effected in accordance with the rule's conditions in order to preserve the availability of the safe harbor for both the issuer and such affiliates. It also provides the affiliates comfort in knowing that stock repurchases effected in accordance with the rule's conditions will receive the benefit of the safe harbor from manipulation liability. In short, the current definition of "affiliated purchaser" has proven a workable one, and we are of the view that an expanded, more complex definition, such as that contained in Rule 100 of Regulation M, would unnecessarily complicate the rule.
Amendments to the Purchasing Conditions
Manner of Purchases
The Commission also requests comment on whether the single broker condition of the safe harbor should be amended to accommodate issuer repurchases effected on or through alternative trading systems ("ATSs"), including ECNs. ATSs present an interesting issue, because at times their role in the market place is that of an execution venue, very much akin to an exchange, and at other times their role is really that of a broker. The Commission recognized this dual-hatted role in Regulation ATS by allowing most ATSs to choose to be regulated either as exchanges or broker-dealers.6
We believe that Regulation ATS provides the appropriate framework for determining how issuer purchases effected on or through ECNs and other ATSs should be treated for purposes of Rule 10b-18. In particular, if a broker effecting an issuer's repurchase program purchases the issuer's securities on or through an ATS, such transaction should be deemed to satisfy the one broker condition of the Rule's safe harbor. In this circumstance, the ATS would be acting in its capacity as an exchange, albeit an exempted exchange, or other execution venue, and the broker effecting the purchase on behalf of the issuer would be the single broker for purposes of the manner of purchase condition of the Rule.
Price of Purchases
The Commission requests comment on whether the "last independent transaction price" (referred to herein as the "last sale price") alternative should be eliminated. Absent any empirical evidence to support elimination of the last sale price alternative, we believe that both the "bid test" and the "last independent transaction price" should be retained as references for pricing restriction. Restricting the price reference to the bid test would restrict a broker-dealer's ability to take offers based on last sale price.
In addition, the Committee disagrees with the statements in the Proposing Release that purchases at the last sale price allow the issuer, or its agent, to influence the market. In our view, purchases effected at last sale prices follow the market, rather than lead it, which accordingly minimizes the potential for any manipulative impact from purchases at such price.
The proposal to limit issuer repurchases to a static bid price would unfairly restrict an issuer's ability to access offered liquidity during a fast moving market where automatic executions occur rapidly. Such a restriction could also place a broker-dealer effecting an issuer's repurchase program with the untenable choice of backing away from its quote or performing on a stale bid.
The Commission also requests comment on whether the Rule's price condition should apply if the issuer (and its affiliated purchasers) cannot control, directly or indirectly, the price at which a Rule 10b-18 purchase will be effected. In particular, the Commission seeks comment on automated trading systems that utilize "passive" (independently-derived) pricing, such as the volume weighted average price ("VWAP") or the mid-point of the national best bid or offer ("NBBO").
The Committee believes that automated trading systems utilizing VWAP or mid-point NBBO passive pricing algorithms should be exempt from the pricing condition of the Rule. By utilizing such passive pricing mechanisms, the issuer (and its affiliated purchasers) relinquish control over the timing and pricing of the executions, thereby limiting (if not eliminating) the potential for purchases effected through such algorithms to be used to manipulate the price of the issuer's securities. The whole purpose of these algorithms is to achieve objective pricing based on benchmarks that are derived from independent market forces and are identifiable to all market participants.
We note that the Division of Market Regulation, acting pursuant to delegated authority, has previously recognized the limited potential to influence the price of transactions effected pursuant to passive pricing algorithms by exempting such transactions from Rule 10a-1 under the Exchange Act.
The Commission also asks whether Rule 10b-18's price condition should be based on prices quoted or reported for the security in the "consolidated system," or solely on prices reported (or quoted) in the "principal market" for the security. We believe that the reference price for the Rule 10b-18 price condition should be the price reported or quoted for the security in the principal market. This standard provides greater certainty for issuers and their broker-dealers in effecting repurchases and eases the administrative burden of repurchase programs. Precedent for this approach can be found in the manner in which the "tick" test of Exchange Act Rule 10a-1 is applied, pursuant to which, for example, a floor broker is not permitted to look to an "away" market to find an uptick.
Riskless Principal Transactions
The Commission requests comment regarding the application of Rule 10b-18 to riskless principal transactions. We believe that transactions that qualify for the riskless principal trade reporting under the NASD trade-reporting rules should be entitled to the safe harbor if the open market leg of the transaction meets the conditions of Rule 10b-18. In order to qualify for this reporting, the two legs of the transaction (the first leg of the transaction when the broker-dealer purchases shares in the open market and the second leg when the broker-dealer effectuates an offsetting transaction to the buyer) must be executed at the "same price" (exclusive of a markup or markdown, commission equivalent, or other fee). If a riskless principal transaction meets this requirement and the open market leg of the transaction meets the conditions of Rule 10b-18, then both legs of the transaction would be entitled to the protections of the safe harbor. We believe that this treatment of riskless principal transactions, which focuses on the market side of such transactions, is appropriate given that the purpose of Rule 10b-18 is to prevent market manipulation.
Volume of Purchases
The Committee recognizes that market conditions are significantly different than those present at the time of the rule's adoption. We do not believe, however, the Commission's concerns regarding the use of block purchases in today's marketplace warrant elimination of the exclusion of block purchases from the volume limitation. At most, the changes in market conditions suggest that the definition of a "block" in Rule 10b-18 should be recalibrated to account for those conditions.
The safe harbor's purpose is to allow investors to rely on a market that is set by independent market forces, not manipulative influences. The block exclusion was permitted in the original rule because the Commission believed that "the market impact of a block purchase is likely to be less than that of a series of purchases of smaller amounts that in the aggregate are equal in size to the block but are accomplished over a period of time."7 Thus, it appears that the Commission concluded that, at the time, block purchases were not likely to misled investors about the integrity of the market as an independent pricing mechanism.
In support of eliminating the block purchase exception, the Proposing Release cites to decade old studies that conclude block purchases can affect a stock's price. While the Committee does not disagree with the studies' conclusions, there has been no showing that block purchases, by themselves, are successfully used to provide the type of artificial floor for a stock's price that multiple retail purchases might provide. Accordingly, even in today's market, block purchases are not likely to misled investors.
As further justification for now eliminating the block exclusion, the Commission notes that the exception essentially allows issuers to avoid the volume limitation. The Commission also points to the significant increase in the frequency of block purchases and the relatively low size of a "block" under Rule 10b-18 as reasons for eliminating the exclusion. The Committee suggests, however, that all of these factors have given issuers ample opportunity to use the block exception as manipulative device. Yet, the Proposing Release does not present evidence of any significant manipulative behavior over the last twenty years.
Absent evidence of manipulative behavior, the changes in market conditions merely suggest that the definition of "block" in Rule 10b-18 should be reviewed to ensure that it is appropriate in light of those conditions. The Committee notes, however, that both the average size of a trade and the average size of a block purchase on the New York Stock Exchange ("NYSE") have remained relatively unchanged over the last 20 years. In 1980, when the current definition of "block" was proposed (e.g., 5,000 or more shares), the average size of a trade was 872 shares and the average size of a block purchase was 24,784 shares.8 In 2002, the average size of a trade was 666 shares and the average size of a block purchase was 25,702 shares.9 Thus, it appears that the fact that Rule 10b-18's definition is substantially lower than the one used by the exchanges or Nasdaq (e.g., 10,000 shares) is somewhat irrelevant for purposes of determining the appropriate definition for Rule 10b-18. If the Commission is going to amend the definition in Rule 10b-18, however, it should conform to the definition that the NYSE and Nasdaq use -- if for no other reason than uniformity among regulators.
The exclusion for block purchases, however, should remain in the rule. However, the SEC might wish to consider preserving its proposed treatmment as an alternative to reliance on the block exception. Under this approach, if the issuer chooses to rely on the block exception, the issuer would not be allowed to include any block purchases in the trading volume for that day, which may result in a lower volume limit for future periods of purchasing activity. As an alternative, the issuer could treat a block purchase as any other purchase, thereby allowing the block purchase to be counted in the determining the ADTV on which the volume limit is based.
With respect to after-hours trading, the Committee believes that the Commission should confirm the staff's current position on the application of Rule 10b-18 and relax the single-broker condition, but should not adopt the Guzman proposal. The Proposing Release states in effect that the Division of Market Regulation has interpreted Rule 10b-18 to apply to transactions effected in an after-hours trading session differently than it applies to transactions effected in a primary trading session, in two important ways. First, the prohibition on effecting transactions during a specified period prior to the close of the session applies only with regard to the close of the primary session; in the after-hours session, transactions may be effected throughout the session, until its close. Second, transactions may be effected in an after-hours session at the closing price for the primary session, subject to any later bids or sales reported in other markets.
The Committee thinks this interpretive position makes good sense and should be confirmed by the Commission in the adopting release. We also believe the Commission should modify the interpretation in the following four ways. First, the prohibition on a Rule 10b-18 purchase being the opening trade in the consolidated system should apply only with regard to the opening of a primary trading session and not the opening of an after-hours session. Since trading in the after-hours session is likely to be driven by trading at the close of the primary session, there is no need to apply the timing condition to the opening transaction in the after-hours session. Second, the proposed timing prohibition on effecting a purchase after the close of the consolidated system should be waived with regard to after-hours purchases. Third, the after-hours interpretation (as modified in this paragraph) should apply with regard to trading in an after-hours session on any national securities exchange, interdealer quotation system or ATS on which after-hours trading is now or hereafter permitted. Fourth, the interpretation should be updated to reflect changes to Rule 10b-18 adopted in the current rulemaking. In other words, to the extent that a provision of Rule 10b-18 would apply to a transaction in an after-hours session pursuant to the interpretation, that provision would apply as amended in the current rulemaking. Finally, the single-broker condition should apply separately in the context of an after-hours session, so that an issuer will comply as long as it uses only one broker-dealer in the after-hours session, whether or not that broker-dealer is the same broker-dealer used in the primary session. It may be impractical for an issuer to use the same broker-dealer in both a primary session and an after-hours session, especially if the latter occurs in an electronic or other "alternative" market.
If the Commission takes the steps described above, we see no need to adopt the Guzman proposal regarding after-hours trading (other than to relax the one-broker condition as noted above). We think the Guzman proposal, at least as it is described in the Proposing Release, may be overly restrictive if it would require that bids and purchases in an after-hours session be effected at a price lower than the last reported price in the primary session in the primary market.
Rule 10b-18 Alternative Conditions
The Commission requests comment on whether sufficient liquidity could be facilitated by increasing the volume limitation to something less than 100%, following a market-wide trading suspension. The Committee believes that the variety of facts and circumstances that could precipitate a market-wide trading suspension render it somewhat difficult to conclude that any particular volume level increase would be sufficient to address all situations. In light of the staff's recent exercise of its exemptive authority to liberalize the rule's volume conditions following the terrorist attacks of September 11, 2001, the Committee would generally defer to the staff's observations as to whether the increase of the volume limitation to 100% was successful in providing sufficient liquidity during those weeks. In the absence of any indications of abuse, however, the Committee would generally support an increase of the volume limitation to 100% following a market-wide trading suspension. Increasing the volume limitation to 100% would also appear to be generally consistent with the staff's observations as to the positive market effect of increased issuer repurchases during the week following the 1987 market break.10 In evaluating any data the staff has collected with regard to increasing the volume limitation following a market-wide trading suspension, the Committee encourages the staff to bear in mind the extent to which those statistics would be affected by the staff's current proposal to either eliminate the "block" exception or amend the block definition (i.e., whether a greater increase in the volume limitation may be necessary and appropriate in order to compensate for an elimination of the block exception or an amendment to the block definition).
The Commission also requests comment on whether the "alternative conditions" should be further modified during periods of severe market decline. Again, the Committee would generally defer to the staff's observations in connection with the liberalization of the safe harbor conditions following September 11, 2001. Given the rule's fundamental purpose as a safe harbor from manipulation liability, however, the Committee would not recommend providing any uniform modification or exception to the rule's pricing limitations, even during the period following a "market-wide trading suspension." We note that the Commission staff did not determine to provide any relief from the rule's pricing conditions even during the weeks following September 11th. To the extent the staff may in the future determine that particular market circumstances warrant a liberalization of the rule's pricing conditions, we believe that it would be more appropriate for the staff to provide such relief on a case-by-case basis, pursuant to its exemptive authority under Sections 12(k)(2) and 36 of the Exchange Act.
The Committee recommends retaining the current definition of "market-wide trading suspension," which was first adopted in September 1999. While the definition generally keys off of a market-wide trading halt imposed pursuant to the rules of a national securities exchange or registered national securities association, it preserves flexibility to the extent that it also includes any market-wide trading suspension ordered by the Commission pursuant to its emergency exemptive authority under Section 12(k). Given the self-operative nature of the rule's alternative conditions following a "market-wide trading suspension," we believe that the rule's narrow definition of this term is appropriate. Rather than using an expanded definition as a vehicle for uniformly extending the rule's alternative safe harbor conditions to other market situations, we would recommend that the Commission provide for such circumstances on a case-by-case basis, in the form of an order issued pursuant to its exemptive authority under Sections 12(k)(2) and 36 of the Exchange Act.
The Committee supports the Commission's goal of furnishing important information to investors, but believes that the proposed disclosure is not necessary to fulfill this objective because existing disclosure standards applicable to issuer repurchase activity result in the provision of adequate information to the investing public. For over three decades, the Commission has periodically considered whether, and how, to regulate an issuer's market repurchases of its equity securities. In this regard, the Commission has always declined to adopt a specific disclosure requirement (other than those that apply in situations where the magnitude and method of the issuer's repurchase activity triggers the tender offer and other specifically tailored line-item requirements). Instead, the Commission has determined that investor protection is best served by leaving the materiality judgments to the issuer under applicable antifraud rules such as Exchange Act Rules 10b-5 and 12b-20. We see no reason for the Commission to revise its longstanding conclusion that the relevant provisions of the federal securities laws and existing policies and procedures of the various self-regulatory organizations are sufficient to provide investors and the market with adequate information about issuer repurchases.
We respectfully submit that the Commission, in attempting to address certain perceived abuses of Rule 10b-18 purchase programs, has gone too far in proposing to compel disclosure of all issuer repurchases, whether or not effected in reliance upon the safe harbor. The Commission is attempting to use alleged abuses in an ostensibly voluntary safe harbor rule to establish a broad new mandatory disclosure requirement applicable to all issuer repurchasing activity regardless of whether conducted within the ambit of Rule 10b-18 and in the absence of empirical evidence of actual abuse outside the mergers and acquisitions area. To buttress its contention that issuers may announce repurchase programs to cause an increase in their stock prices without any serious intention of actually effecting repurchases, the Commission cites four out-of-date studies, two of which date back to 1980 and the most recent of which was published twelve years ago. We respectfully submit that since those studies were published there has been an increase in the quality of disclosure and heightened sensitivity to providing proper disclosure and avoiding liability under the antifraud rules, which suggest the need for more current information before a well-grounded conclusion can be reached.
If, however, the Commission determines to impose disclosure requirements, it should not require issuers to bifurcate their disclosures based on whether purchases were pursuant to, or outside of, the safe harbor, as such disclosure would raise a negative inference that purchases outside of the safe harbor were somehow inappropriate. The Committee believes that such a disclosure requirement would be inconsistent with the Commission's prior statements that Rule 10b-18 is only a safe harbor and "is not mandatory nor the exclusive means of effecting issuer purchases without manipulating the market."11
There are a number of other revisions to the proposed amendments that we urge the Commission to consider. First, we believe that the disclosure of potential future purchases also is best served by leaving the materiality judgments to the issuer under applicable antifraud rules such as Exchange Act Rules 10b-5 and 12b-20. As the Commission itself acknowledges, a public announcement by an issuer of a repurchase program is often followed by a rise in the issuer's stock price. Thus, requiring issuers to announce potential future purchases - rather than allowing issuers to disclose this information when they believe it is necessary to do so to satisfy their antifraud disclosure duties -- could encourage issuers to "prime" the market, which is one of the putative abuses the Commission has identified in the Proposing Release. Conversely, such disclosure may tend to tie issuers' hands and make it difficult for them to revise their purchase plans, once disclosed, lest they be accused of having "hyped" the market. Finally, such disclosure could lead to market overhang damage for some issuers. The Commission has in the past been cognizant of market overhang concerns; for example, such concerns prompted the Commission to permit unallocated shelf offerings by issuers primarily eligible to use Form S-3. For these reasons, we believe that the proposed mandatory disclosure of potential future purchases may well be more harmful than beneficial for both investors and issuers.
Additionally, most companies that approve a buyback program obtain board authorization to implement the program subject to market conditions over a specified period, usually lasting about 18 months. Although a board may approve a range of stock prices at which the company may repurchase its own common stock, often the board simply authorizes the maximum dollar amount of shares that may be repurchased with a goal as to the maximum number of shares. We recognize that the Commission has proposed to give issuers the alternative of disclosing the maximum dollar amount; however, we believe that the same damage could be done because the markets can make calculations based on current stock prices. Either alternative form of disclosure, in our view, would be of limited value to investors while locking the company into potential repurchase activity that may not be in shareholders' best interests to effect depending on market conditions or corporate developments that are not ripe for disclosure. Disclosure regarding possible issuer intentions to "draw-down" under a buyback program where antifraud considerations otherwise do not dictate that disclosure could harm issuers and their shareholders by circumscribing a company's decisional flexibility in the event of adverse market conditions. Moreover, insider trading liability concerns may preclude repurchases over prolonged periods in which an issuer might be engaged in preliminary merger negotiations that it otherwise would have no duty to disclose under applicable line-item or antifraud requirements.
The Commission proposes that issuers provide quarterly disclosure with a monthly breakout. We respectfully submit that the Commission has not identified any empirical support for imposing a monthly-breakout disclosure standard. To our knowledge, such a standard is unprecedented in the sense that there would appear to be no other periodic reporting obligation to disclose information on a monthly basis (for purposes of our analysis we, like the Commission, do not treat Form 8-K's event-driven disclosure requirements as periodic in character). Moreover, we do not believe that the Commission has adequately taken into account the cost of data collection and reconstitution. Should the Commission nevertheless determine to proceed with a quarterly reporting obligation, rather than leave it to the antifraud provisions of the federal securities laws, we urge the Commission to permit aggregated reporting of repurchase activity on a quarterly, not a monthly basis. More frequent disclosure or trade-by-trade disclosure, about which the Commission also seeks comment, would be extremely cumbersome for issuers with little value added from investors' perspective. (As noted above, we respectfully submit that any prescriptive line-item requirement to provide detailed disclosure of repurchase activity is unduly burdensome and, at a minimum, should be confined to activity eligible under Rule 10b-18.
With respect to announcement of new buyback programs, we believe that the duty to disclose should be left to issuers applying general antifraud principles rather than shifted to a mandatory line-item requirement in periodic reports. Should the Commission nevertheless determine to compel disclosure by all domestic registrants of institution of a new buyback program, we suggest such disclosure be triggered off of first public announcement by the company. This alternative would allow issuers to retain the flexibility to make case-by-case determinations of whether such disclosure is material to their investors. The same rationale holds true with respect to requiring separate columnar disclosure of all repurchase plans or programs that have been approved by the issuer's board of directors - these judgments should be subject to applicable antifraud provisions and, where triggered, the MD&A disclosure standards set forth in Item 303 of Regulation S-K.
In sum, the Committee urges the Commission to continue to leave to issuers the ability to make case-by-case disclosure decisions under applicable antifraud provisions with respect both to the initial adoption of a repurchase plan (or plans) and the ensuing repurchase activity thereunder. The mere fact that many issuers announce their repurchase programs and periodically report on repurchase activity does not mean that all such programs are per se material to the investors of all issuers. Instead, the foregoing disclosures, we believe, reflect each issuer's judgment regarding the materiality of repurchase information and their duties to disclose it pursuant to the antifraud roles and/or elements of the MD&A line-item requirements in Item 303 of Regulation S-K that might be triggered under a particular issuer's circumstances.
For the reasons outlined above, we do not support requiring issuers to make disclosure about their possible future purchases under repurchase plans. In the event the SEC decides that disclosure of some kind about announced plans is necessary, however, we suggest that issuers be permitted to "furnish" their press releases announcing their plans to the SEC on Form 8-K. Such a requirement would be similar to the recently adopted requirement regarding the furnishing of quarterly earnings releases. In this way, issuers can make the materiality judgment whether disclosure is necessary. It is common practice for issuers to issue press releases disclosing the adoption of repurchase plans for any significant number of shares.12 Even more than an earnings release, which may contain an earnings estimate or similar information, a press release announcing a buyback plan is essentially forward-looking and contains "soft" information about possible future events that may not occur as intended. If issuers have no choice but to submit this type of information to the SEC, they ought not be required to assume liability under Section 18 of the Exchange Act for it. Like portions of an earnings release, this kind of information is by nature incomplete and indefinite and is not intended to serve the same purposes that a formal SEC filing is. In any event, though, issuers should not be required to issue press releases about their buyback plans; only if they choose to do so should such a furnishing requirement apply. This, too, is consistent with the recently adopted rule regarding the furnishing of quarterly earnings releases.
The Committee also views public disclosure of the identity of the broker-dealer used to effect purchases to be particularly troublesome. We understand the purpose of, and support the manner of purchase condition requiring issuers to use a single broker or dealer per day to bid for or purchase its common stock in reliance upon Rule 10b-18. However, the Commission cites no evidence to indicate that issuers conducting stock repurchases within the ambit of Rule 10b-18 run afoul of this condition. Nor do we believe that the identity of the broker-dealer under these circumstances is material to investors. Indeed, its primary purpose would appear to be to facilitate Commission policing of the safe harbor, which we believe could be accomplished in a less onerous manner.
To require disclosure of the identity of the broker-dealer executing 10b-18 repurchases on the issuer's behalf could lead to unintended harm by providing an inducement to the investing public to contact this broker-dealer with offers to sell. Thus, the proposed disclosure could in effect be deemed a solicitation (whereas unsolicited purchases are not subject to Rule 10b-18) that, depending on the magnitude of the market response, could subject the issuer to the risk of tender-offer regulation under Rule 13e-4 and dampen market prices of the issuer's securities to the detriment of the issuer. Additionally, disclosure of the identity of the executing broker-dealer could have another unintended consequence - forcing an increase in fees in an already competitive market for brokerage services. If the Commission nevertheless decides to proceed, we urge consideration of a less restrictive requirement to make regular confidential submissions of this information directly and solely to the Commission and the self-regulatory organizations.
The Commission seeks comment as to whether the disclosure requirement should be limited to common stock of a class registered under Section 12, excluding convertible securities and options. We believe that only repurchases of Section 12 registered securities in the form of common or nonconvertible preferred stock should be reported, not repurchases of securities that are convertible into common stock. This treatment would be consistent with another set of anti-manipulation rules, codified in Regulation M, which restricts repurchases of only those securities being distributed ("subject securities") and any "reference securities" of the subject securities. The Commission has already made a judgment that repurchases of non-reference securities do not affect the price of the covered common stock and thus are not readily susceptible to manipulation. This reasoning is equally apposite as applied to Rule 10b-18. Repurchases of non-reference securities do not affect the price of the common stock and should not require reporting. Additionally, as discussed above, we believe that disclosure should apply only to transactions covered by 10b-18 (whether or not the safe harbor is used), which is limited to open market purchases, and does not extend to privately negotiated transactions and other repurchase activity that currently is not eligible for safe-harbor treatment under this Rule.
If the Commission adopts disclosure requirements for repurchases, we request that the Commission clarify that transactions pursuant to equity-based compensatory plans are not subject to such new requirement. Many common transactions involving equity-based compensatory plans could be viewed under the proposal as "repurchases." For example, plan participants often can pay the exercise price of a stock option, and any resulting tax withholding obligation, by using equity instead of cash (either by a "net" option exercise, in which the issuer reduces the number of shares deliverable upon exercise in an amount equal to the exercise price, or in a "stock-for-stock" exercise, in which an optionee pays the exercise price by delivering to the issuer shares already owned by the optionee). Also option exchange programs might be regarded as "repurchases" subject to the proposed disclosure requirement. These transactions, however, are for compensatory reasons and their timing is not within the control of the issuer. For these reasons, we believe that they are fundamentally different from open market repurchases or other repurchases, and should not be subject to any disclosure requirement contained in the proposal.
The Commission seeks comment regarding disclosure of transactions involving derivatives (e.g., short put-options, forward contracts, or synthetic forward contracts) written on the issuer's own stock. We believe that any concerns the Commission has regarding issuer hedging are more appropriately addressed directly under the Securities Act of 1933 and not pursuant to an expansion of an ostensibly voluntary, non-exclusive safe harbor through the mechanism of disclosure -- without even sufficient evidence of abuse -- to encompass all repurchase activity whether or not conducted under the auspices of Rule 10b-18. Notwithstanding the above, should the Commission determine to impose disclosure requirements under the Exchange Act, it should not require disclosure of the identify of the broker-dealer, as that would increase the potential for front running opportunities because the market would be notified that the broker would be trading in the stock and could take advantage of this information, to the detriment of the issuer and the broker. Similarly, disclosure regarding affiliated purchaser transactions, which is another area about which the Commission seeks comment, to the extent it involves executives, is more properly addressed under the Section 16(a) disclosure requirements.
The Committee appreciates the opportunity to comment on the proposal and respectfully requests that the Commission consider the recommendations set forth above. We are prepared to meet and discuss these matters with the Commission and the staff and to respond to any questions.
cc: William H. Donaldson, Chairman