Table of Contents
Once an illegal practice, stock buybacks are when a company repurchases its own shares. Buyback programs often lead to company profits getting invested into the stock market, sitting there appreciating in value without incurring taxes until they are withdrawn.
This is money that could go to expanding the business, creating jobs, increasing worker salaries. Capital that could, and maybe should, be going to paying off trillions in national debt and improving social services, for example.
Furthermore, the working class’ retirement is 401(k) and IRAs so that means it is in the stock market. If share buybacks redirect much of the GDP growth (company’s profits) far more to company executives instead of going to working-class retirement funds, then American workers might never get an actual retirement.
Keep in mind: the wealthiest 1% own 56% of the U.S. stock market. Since they can keep it there as long as they please, they can theoretically never pay taxes on all of the stock they keep holding. Share buybacks allow the wealthiest to essentially store their profits without having to pay taxes on profits.
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A Potential Rigged Area of the Economy
For the last 200+ years, the U.S. has enjoyed very strong and consistent GDP (Gross Domestic Product) growth (look at the blue line in the graph below). The question is: why have the real median weekly earnings of full-time workers stagnated (red line)? Is the American public at large receiving its fair share of the GDP it’s responsible for, or are we getting ripped off, for one, by crony capitalists buying back company shares?
The Zero Theft Movement, in this first part of our exploration on stock buybacks, will cover:
- What is a stock buyback?
- German buyback regulations vs. U.S. regulations
- The Securities Exchange Act of 1934 and Rule 10b-18
What is a Stock Buyback?
A stock buyback (a.k.a a share repurchase) refers to when a corporation buys back its shares from the marketplace. By simultaneously absorbing its own stock and reducing the number of shares on the market, the business increases its relative ownership stake.
Companies can execute a buyback in two ways: a tender offer or re-purchasing through the open market.
The company shareholders get a tender offer, which requests they submit, or tender, some or all of their shares within a designated period. The tender offer informs shareholders of the number of shares the company intends to buy back and an estimated price range for the shares. Shareholders who accept the offer state how many shares they wish to tender and the price they deem acceptable. After receiving responses from its shareholders, the company determines the tender offers that allow it to buy its shares at the lowest cost while honoring the shareholders proposed price.
The company simply buys back its shares on the open market at its listed price. Stock buybacks often cause the shares to shoot up in price because the market views these reinvestments as a sign of a healthy/profitable business.
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German Buyback Regulations
On May 1, 1988, the Law on Control and Transparency (KonTraG) became effective. The legislation allows companies to buy back up to 10% of their shares, only after they follow a standardized procedure.
- The buyback must receive approval at the annual general meeting of shareholders (AGM);
- Shareholders must decide on the maximum amount of shares the company can repurchase. As a rule, buybacks must be made using distributable profits;
- The AGM must a buyback period, which cannot exceed 18 months;
- An exact buyback method must be identified and established unless the repurchase is going to be executed through the free market;
- Germany’s financial services authority (BaFin) must receive immediate notification that the AGM has authorized the buyback;
- The company must make a public announcement but does not have to disclose the amount.
- If the company elects to go through with the stock buyback, transactions must be conducted in a manner where all the firm’s shareholders receive equal treatment. Furthermore, the buyback cannot be used for the purpose of trading.
- At the next AGM, the company must follow up with an explanation of why it repurchased its shares, as well as how many shares and at what price it conducted the buyback.
INVESTIGATIONS INTO THE FINANCE SECTOR
U.S. Corporate Buybacks
Economist William Lazonick, in a 2014 article for the Harvard Business Review, writes:
“The SEC [Securities and Exchange Commission] requires companies to report total quarterly repurchases but not daily ones, meaning that it cannot determine whether a company has breached the 25% limit without a special investigation.”
A year later, Lazonick published further research on stock buybacks. He focuses his attention on open-market repurchases and SEC Rule 10b-18, in particular.
DID YOU KNOW?
Rule 10b-18 was created to reduce liability for companies (or their affiliate purchases) when they buy back their common stocks. If companies/affiliates abide by the following four conditions when repurchasing shares, the SEC cannot deem their transactions violations of anti-fraud provisions stated in the Securities Exchange Act of 1934.
- All shares must be purchased from a single broker or deal during a single day.
- Companies with average daily trading volumes (ADTV) under $1 million/day or that have public float values under $150 million cannot trade during the final 30 minutes of the trading window. Companies with higher average trading volume or public float value can trade until the last 10 minutes.
- The issuer must buy back its shares at a cost that does not exceed the highest independent bid or the most recent quoted price.
- The issuer cannot buy back over 25% of the average daily volume.
Lazonick, skeptical of the effectiveness of Rule 10b-18, writes: “Under Rule 10b-18, companies need not disclose the actual amount of buybacks that they do on any given day, either at the time when they are done or after the fact. If the SEC is going to continue to permit open-market repurchases by companies, it should at least require each company to reveal immediately, on a daily basis, how much it has done on any given day so that the agency and the public can assess whether stock-price manipulation is going on. It would then also be transparent if executives and other insiders have timed the sales of their own personal holdings of the companies’ shares (including those acquired from exercising stock options or the vesting of stock awards) to take advantage of price boosts from buyback activity…”
Germany vs. The U.S.
Under KonTraG, Germany appears to place tight restrictions on all share buyback programs. Not only do corporations operating in Germany have a 10% limit, but they also have to adhere to strict reporting requirements.
Companies operating in the U.S., under Rule 10b-18, do not have the same degree of regulatory restrictions as companies operating in Germany. It’s almost as if there’s essentially no real restrictions, really.
The highly esteemed New York Times published an opinion piece on stock buybacks, claiming: “In 2003, the SEC revealed that it was aware of the use of buybacks to manipulate the stock market. The agency acknowledged, in amending Rule 10b-18 to include block trades, that ‘during the late 1990s, it was reported that many companies were spending more than half their net income on massive buyback programs that were intended to boost share prices—often supporting their share price at levels far above where they would otherwise trade.’”
Should we adopt and adapt Germany’s share buyback laws? Not necessarily in full or provision for provision, but some parts at least?
The Securities Exchange Act
Rather than creating regulations limiting share buybacks, the Securities Exchange Act seems to have assisted widespread repurchases.
The aforementioned Loznick, along with Mustafa Erdem Sakinc and Matt Hopkins, penned an article called ‘Why Stock Buybacks Are Dangerous for the Economy.’ The three economists argue, “Stock buybacks done as open-market repurchases emerged as a major use of corporate funds in the mid-1980s after the Securities and Exchange Commission adopted Rule 10b-18, which gives corporate executives a safe harbor against stock-price manipulation charges that otherwise might have applied.”
According to a 2017 Forbes article, “For most of the 20th century, stock buybacks were deemed illegal because they were thought to be a form of stock market manipulation. But since 1982, when they were essentially legalized by the SEC, buybacks have become perhaps the most popular financial engineering tool in the C-Suite tool shed. And it’s obvious why Wall Street loves them: Buying back company stock can inflate a company’s share price and boost its earnings per share — metrics that often guide lucrative executive bonuses.”
By passing the Securities Exchange Act, and Rule 10b-18 in particular, did Congress contribute to making stock buybacks a powerful tool for the wealthy few who own the majority of the U.S. stock market?
Ready for Part II?
In part II, we investigate whether stock buybacks are depleting funds that should arguably be going to the government and us, the American people.
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