Elizabeth Warren and Tammy Baldwin, buyback skeptics.

Photographer: Alex Wong/Getty Images

Senators Think Stock Buybacks Might Be Manipulative

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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A thing that I learned recently and sort of couldn't believe is that some politicians, like Senators Elizabeth Warren and Tammy Baldwin, think that stock buybacks are bad and that the Securities and Exchange Commission should forbid them as market manipulation. I mean the first part of that did not surprise me. Lots of people think that stock buybacks are bad. Larry Fink thinks it! It's a totally respectable position. 

But the second part is super weird. The SEC is not especially in the business of regulating what companies do with their money. If you are a public company and you want to spend your money on paying your employees or developing a new car or building a big headquarters or giving it back to your shareholders, that is up to you, not the SEC. All the SEC asks is that you disclose whatever you're doing. What to do is for you to decide, however corporations decide things. In practice, mostly managers and boards of directors decide, but sometimes shareholders get involved. To the extent the shareholders and managers disagree -- generally because shareholders want their money back and managers prefer to keep it -- the SEC does sometimes get involved: Proxy fights are subject to proxy rules, management discussions with shareholders are covered by fair disclosure rules, and even conversations among shareholders might implicate shareholder disclosure rules.

Assuming a company wants to give money back to shareholders, though, the SEC is generally not in the business of stopping it. A company can give money back to shareholders in the form of a dividend and that is pretty much none of the SEC's business, though of course it will want the company to disclose it properly. On the other hand, if a company decides to give the money back in the form of a stock buyback, the SEC does have some more interest. Buying stock requires trading on the stock market, and the SEC regulates stock-market trading. So, for instance, companies that want to buy back a lot of stock sometimes do public tender offers, and a tender offer is a very regulated SEC thing where you have to file documents and give everyone lots of notice and treat them all fairly and so forth.

But tender offers are relatively uncommon, and the more usual way for companies to buy stock is what is called an "open market repurchase," which is just, you know, you repurchase stock in the open market.  The open market is very much subject to SEC regulation. One way that the SEC regulates open markets is that it forbids insider trading. Since companies are in a sense insiders in themselves, they are subject to the same insider-trading rules as anyone else, and aren't generally allowed to buy back their own stock when they have material undisclosed information.  This seems sort of weird on first principles -- don't companies almost always have more information about themselves than the rest of the market does? -- but it is not much of a practical problem. Companies tend to buy back stock not because they have private information that prices will go up but because they are full of money and enthusiasm.  This means they are mostly terrible at it: They have an unfortunate and consistent tendency to spend more on buybacks when prices are high than when they are low.

Another way that the SEC regulates open markets is that it forbids market manipulation. This is a tough one because no one really knows what market manipulation means. If you buy a lot of stock, that will tend to push up the price of the stock, and so the stock you bought will be worth more. Did you buy the stock to make its price go up (maybe manipulation), or because you wanted to own the stock (not manipulation)? Whatever. This is particularly acute for companies buying their own shares, where the objective of making shareholders happy by giving them cash is intimately bound up with the objective of making them happy by increasing the stock price. (Also: the objective of making executives' stock-based compensation worth more by increasing the stock price.) Because this is vague stuff, the SEC has a simple rule to clarify it. The rule is called Rule 10b-18, and the oversimplified gist of it is that if a company's purchases make up no more than a quarter of its stock's volume, then it won't get in trouble for manipulating its stock.  Why a quarter and not, like, a third or a fifth? I don't know, whatever, it's a nice easy number, not too restrictive but also not too much of the volume. There doesn't seem to be much more to it than that.  

Anyway that is the world we live in, but not the world we always lived in. Rule 10b-18 was only enacted in 1982. Baldwin:

In 1982, when the Securities and Exchange Commission (SEC) issued a rule to provide 'safe harbor' from manipulation liability, buybacks were near zero. Last year, over $500 billion was spent on share repurchases.

Nor is it the world that everyone would prefer to live in. Warren:

“These buybacks were treated as stock manipulation for decades because that is exactly what they are,” she said. “The SEC needs to recognize that.”

So ... why would you dislike buybacks? Lots of reasons, I guess, but most of them have to do with the concern that buybacks might be replacing long-term investment. Warren again:

Stock buybacks create a sugar high for the corporations. It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that.

There are also distributive concerns: Buybacks tend to give money to investors, who probably need it less than workers. Baldwin again:

A growing body of research suggests that the vast amounts U.S. corporations have spent to repurchase their own stock is a chief cause of the stagnation of American wages and investment, and could be a potential source of long-term national decline.

My own view is that, you know, that money goes somewhere; mostly it goes back to investment managers to re-invest.  So the question of whether buybacks are Good or Bad is a hard one, and comes down to whether investment managers are better at allocating capital to projects than corporate managers are. I don't have a good intuition about the answer to that one, though I feel like there is evidence both ways.

But never mind that. The point is, people who think buybacks are Bad For America mostly think so because they think that taking cash out of corporations and giving it to investors reduces the productive value of that cash. This has nothing to do with Rule 10b-18. Changing Rule 10b-18 to make it harder to do open market buybacks quickly would cause companies to do open market buybacks more slowly. Even eliminating Rule 10b-18 entirely and treating open market buybacks as stock manipulation would not prevent companies from returning cash to shareholders. They'd just do more tender offers and more dividends. It's worth noting that, yes, buybacks were much less common before 1982, but dividends were higher -- in part because Rule 10b-18 made it easier to replace dividends with buybacks. Without 10b-18, most of the dynamics driving share repurchases -- companies with huge cash balances and limited investment prospects, activists who distrust managements and want them to disgorge cash -- would still exist. In a world without open market repurchases, Carl Icahn would be agitating for Apple to do more tender offers and special dividends. He is, after all, an owner of Apple. It's his money. He has every right to ask for some of it back.

Now if you really believe that open market repurchases are about manipulating stock prices, then you might want to change Rule 10b-18. There is something to that belief: Many executives' wealth and tenure are linked to their stock prices, and so the executives have incentives to keep the price as high as possible. Perhaps if they couldn't support the stock by having the company buy it, executives would be less enamored of buybacks than they are now. Baldwin points out that "a recent study has found that buybacks are more likely when a CEO's bonus is directly tied to the company's earnings per share," which suggests that there might be some manipulative intent in the buyback boom.  I do not especially believe that this is a major mechanism; it seems to me that you frequently see shareholders demanding more buybacks than managers want, but you almost never see the reverse. Managers like keeping shareholders' money for themselves; that is why they are managers. Stock-based compensation is just a way to encourage them to loosen their grip on that money.

The proposals to prevent buybacks using SEC rules just seem very ... political. There seems to be a problem here, and the problem is that large public U.S. companies are investing less in the real economy than they used to. Perhaps that is because more investment is being done by private companies, and those companies find it less attractive to go public. Then you could solve the problem by making it more attractive to go public; alternatively, you could declare it not a problem, because those private companies are not exactly lacking for capital and opportunities. Or perhaps the cause is that investors are too short-term-oriented or economic conditions are too uncertain or managers are too risk-averse or something else, I don't know. If those are the causes, you'd want to go address them. But those are hard problems for a government to address. They're hard problems for anyone to address -- they're just hard -- but they're particularly hard to address by rules. You can't just command innovation.

On the other hand, it seems unlikely that the problem of U.S. investment is caused by a market-manipulation safe harbor that allows companies to buy up to 25 percent of the average daily trading volume of their stocks in the open market. But that is something that the SEC can change, so people are calling for the SEC to change it. Not because it's the best thing to do, but because it's the thing that is closest to hand.

  1. In part from a June 10 research note from Alec Phillips of Goldman Sachs Global Macro Research, "US Daily: Political Scrutiny of Share Buybacks Is Rising."

  2. And, in fact, if you wanted the SEC to reduce stock buybacks, one thing you might do is ask the SEC to limit activism, which the SEC has a lot of power to do via those shareholder disclosure rules. Activism and buybacks aren't perfectly correlated, but they do seem to have something to do with each other.

  3. Companies that want to buy a medium amount of stock sometimes do so through what is called an "accelerated stock buyback," a delightful derivatives product that I used to sell and that I have occasionally mentioned here. I don't discuss ASBs in the text because they are complicated and because they don't change much about the discussion: From a rules perspective, ASBs tend to follow Rule 10b-18 (or 10b-18 by analogy) and so would probably be affected by changes to 10b-18 in much the same way that open market buybacks would be. 

  4. Though they can enter into 10b5-1 plans, which let them buy back stock while in possession of material nonpublic information, as long as they don't have MNPI when they enter into the plans. Those plans are themselves controversial.

  5. There are arguments the other way on this, though I do not believe them.

  6. Again, obviously this oversimplifies, and you can go read the rule. That quarter of the volume thing (10b-18(b)(4)) is based on trailing-four-weeks average volume (10b-18(a)(1)), and has exceptions for block trades. Also companies can only use one broker at a time (10b-18(b)(1)), can't buy too close to the open or close of trading (10b-18(b)(2)), can't pay more than the best quoted bid (10b-18(b)(3)), etc. 

  7. In 2003, the SEC amended Rule 10b-18 and got comment letters that "suggested raising the volume limits, especially for small capitalization companies with limited liquidity, from 25% to 35% (or even 100%) of a security's" average daily trading volume. On the other hand, in 2010, the SEC solicited more comments, including on the questions "Should we retain the current 25% volume limitation? Is the 25% a reasonable limitation that furthers the objectives of the Rule or should the volume limitation be reduced?" It's still 25 percent though.

  8. Here is an article by a venture capitalist saying that "these buybacks drain trillions of dollars of windfall profits out of the real economy," which is just not at all how my model works. Like do investors just get their buyback checks and burn them?

  9. Sort of, though that's more a matter of accounting manipulation (earnings per share) than market manipulation (share price).

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net