I've mentioned SEC Rule 10b-18 a few times, some links after the jump.
A lifetime of looking at this stuff has led me to the conclusion that in the U.S. stock buybacks are nothing more than a tax-avoidance scam with the added benefit of rewarding managers for things they didn't do by, well, managing the company rather than the stock price.
From Matt Taibbi's substack April 10, 2020:
How the coronavirus is creating a political opportunity to overturn one of the worst practices of the kleptocracy era
The Covid-19 crisis has revealed gruesome core dysfunction. Drug companies have to be bribed to make needed medicines, state governments improvise harebrained plans for emergency elections, and industrial capacity has been offshored to the point where making enough masks seems beyond the greatest country in the world.
But the biggest shock involves the economy. How were we this vulnerable to disruption? Why do industries like airlines that just minutes ago were bragging about limitless profitability – American CEO Doug Parker a few years back insisted, “My personal view is that you won’t see losses in the industry at all” – suddenly need billions? Where the hell did the money go?
In Washington, everyone from Donald Trump to Joe Biden to Alexandria Ocasio-Cortez is suddenly pointing the finger at stock buybacks, a term many Americans are hearing for the first time.
This breaks a taboo of nearly forty years, during which politicians in both parties mostly kept silent about a form of legalized embezzlement and stock manipulation, greased by an obscure 1982 rule implemented by Ronald Reagan’s S.E.C., that devoured trillions of national wealth.
The mechanics of buybacks are simple. Companies buy their own stock and retire the shares, increasing the value of shares remaining in circulation. This translates into instant windfalls for shareholders and executives that approve the purchases. That this should be proscribed as market manipulation, and additionally offers a clear path to insider trading – former SEC chief Rob Jackson found corporate insiders were five times as likely to sell stock after a share repurchase was announced – is just one problem.
The worse problem comes when companies not only spend all of their available resources on stock distributions, but borrow to fund even more distributions. This leaves companies with razor-thin margins of error, quickly exposed in a crisis like the current one.
“When companies spend billions on buybacks, they’re not spending it on research and development, on plant expansion, on employee benefits,” says Dennis Kelleher of Better Markets. “Corporations are loaded up with debt they wouldn’t otherwise have. They’re intentionally deciding to live on the very edge of calamity to benefit the richest Americans.”
It’s hard to overstate how much money has vanished. S&P 500 companies overall spent the size of the recent bailout – $2 trillion – on buybacks just in the last three years!
Banks spent $155 billion on buybacks and dividends across a 12-month period in 2019-2020. As former FDIC chief Sheila Bair pointed out last month, “as a rule of thumb $1 of capital supports $16 of lending.” So, $155 billion in buybacks and dividends translates into roughly $2.4 trillion in lending that didn’t happen.
Most all of the sectors receiving aid through the new CARES Act programs moved huge amounts to shareholders in recent years. The big four airlines – Delta, United, American, and Southwest – spent $43.7 billion on buybacks just since 2012. If that sum sounds familiar, it’s because it equals almost exactly the size of the $50 billion bailout airlines are being given as part of the CARES Act relief package.
The two major federal financial rescues, in 2008-2009 and now, have become an important part of a cover story shifting attention from all this looting: the public has been trained to think companies have been crippled by investment losses, when the biggest drain has really come via a relentless program of intentional extractions.
Corporate officers treat their own companies like mob-owned restaurants or strip mines, to be systematically pillaged for value using buybacks as the main extraction tool. During this period corporations laid off masses of workers they could afford to keep, begged for bailouts and federal subsidies they didn’t need, and issued mountains of unnecessary debt, essentially to pay for accelerated shareholder distributions.
All this was done in service of a lunatic religion of “maximizing shareholder value.” “MSV” by now has been proven a moronic canard – even onetime shareholder icon Jack Welch said ten years ago it was “the dumbest idea in the world” – and it’s had the result of promoting a generation of corporate leaders who are skilled at firing people, hustling public subsidies, and borrowing money to fund stock awards for themselves, but apparently know jack about anything else.
During a Covid-19 crisis where we need corporations to innovate and deliver life-saving goods and services, this is suddenly a major problem. “We’re seeing, these people don’t have the slightest idea of how to run their own companies,” says University of Massachusetts economist William Lazonick, whose substantial research on the buyback issue has been a cornerstone of the movement toward reform.
Wall Street analysts spent the last weeks mulling over the grim news that society is wondering if it can afford to keep sending most of its wealth to a handful of tax-avoidant executives and corporate raiders (known euphemistically in the 21stcentury as “activist investors”). The Sanford Bernstein research firm sent a note to clients Monday warning buybacks would be “severely curtailed” in coming years, for the “intriguing” reason that they were becoming “socially unacceptable” in this crisis period.
Goldman, Sachs chimed in with a similar observation. “Buyback activity will slow dramatically, both for political and practical reasons,” the bank told clients.
The political furor on the Hill in the last weeks has mostly been limited to grandstanding demands that recipients of aid in the $2 trillion CARES Act not be spent on stock distributions. “I’ll take it, but most of them don’t know what the hell they’re talking about,” is how one economist described these complains.
If politicians did understand the buyback issue more fully, they either wouldn’t have voted for this unanimously-approved bailout, or would have insisted on permanent bans, given the central role such extraction schemes played in necessitating the current crisis to begin with. The history is ridiculous enough.
***
The newspaper record of November 17, 1982 shows an ordinary day from the go-go Reagan years. Republicans boosted tax cuts and military budget hikes. An NFL player strike ended after 57 days. Soviet and Chinese foreign ministers met, and 80 complete skeletons were found in a dig at Mount Vesuvius in what one scientist called a “masterpiece of pathos.”
There was little news of a rule passed by the Securities and Exchange Commission and implemented with almost no documentary footprint. “It’s not written about in histories of the S.E.C.,” says Lazonick. “It’s barely mentioned even in retrospect.”
Yet rule 10b-18, which created a “safe harbor” for stock repurchases, had a radical impact. For decades before Reagan came into office and stuck E.F. Hutton executive John Shad in charge of the S.E.C. – the first time since inaugural chief Joseph Kennedy’s tenure in the thirties that a Wall Street creature had been made America’s top financial regulator – officials had tried numerous times to define insider purchases of stock as illegal market manipulation.
Again, when companies buy up their own stock, they’re artificially boosting the value of the remaining shares. The rule passed by Shad’s S.E.C. in 1982 not only didn’t define this as illegal, it laid out a series of easily-met conditions under which companies that engaged in such buybacks were free of liability. Specifically, if buybacks constituted less than 25% of average daily trading volume, they fell within the “safe harbor.”
The S.E.C. in adopting the rule emphasized the need for the government to get out of the way of such a good thing:
The Commission has recognized that issuer repurchase programs are seldom undertaken with improper intent… any rule in this area must not be overly intrusive.The rule added that companies may be justified in “stepping out” of safe harbor guidelines, and said that there would be no presumption of misconduct if purchases were not made in compliance with 10b-18. Thirty-three years later, in 2015, S.E.C. Chief Mary Jo White would double down on this extraordinary take on “regulation,” saying that “because Rule 10b-18 is a voluntary safe harbor, issuers cannot violate the rule.”
10b-18 was a victory for a movement popularized in the late sixties by Milton Friedman and furthered in the mid-seventies by academics like Michael Jensen and Dean William Meckling. The aim was to change the core function of the American corporation. If corporate officers previously had to build value for a variety of stakeholders – customers, employees, the firm itself, society – the new idea was to narrow focus to a single variable, i.e. “maximizing shareholder value.”
Like objectivism and other greed-based religions that helped birth the modern version of corporate capitalism, “MSV” was anchored on hyper-rosy assumptions tying efficiency to self-interest. It was said CEOs paid in stock would become owners, which would lead to reductions in spending on private jets and other waste.
Shareholders previously were paid via dividends, or by waiting for share prices to appreciate and selling them. Now there was a shortcut: board members chosen by shareholders could raid their own companies’ assets to buy stock and to goose share prices.
Employees, customers, and society were suddenly in direct competition for resources with executives and shareholders. Should a company invest in a new factory, or should it just deliver instant millions to shareholders and executives paid in options?....
.....MUCH MORE
*See October 2019's:
"Share Buybacks and the Contradictions of 'Shareholder Capitalism'”
In the U.S. stock buybacks are just a straight-up tax dodge with the added attraction of boosting shares-based management compensation. If interested see "The Real Reason Stock Buybacks Are a Problem"
The smart kids, members of Phi Scamma Jamma, are still pitching a differential between tax on earned income and tax on capital gains even though the efficacy of capital gains tax breaks in performing their original purposes, investment and job creation, has been declining since the 1970's and is now just an excuse for a loophole. See "TAXES, CAPITAL AND JOBS" for an exceptionally lucid discussion, again, if interested.
And today's headliner, from American Affairs Journal:...MORE
Or August 2018's "In Which FT Alphaville Pokes At One Of The Most Profound Questions In Finance"
Here is the problem, last seen in 2015's "Mutual Funds In the Venture Capital Business: 'Eye-Popping Valuations'":
Maximizing expected future returns.We'll come back to that asterisk but first, FT Alphaville.
One of our favorite topics, along with agricultural commodities and production, materials science, really, really fast computers, advanced manufacturing technology, energy and Dogbert's schemes for world domination.
One of the most profound facts of investing is that the growth is in the new companies.*
Not small companies, new ones.
So the question is: How to capture that growth?
And while you're at it, maybe mitigate some of the risk inherent in new ventures?...
And just a heads up: our concern here is not buybacks but getting companies public while there is still some growth left in the things. For buybacks, the answer is pretty straightforward, go back to the pre-1982 rules on share repurchases:
...II. Overview of Current Rule 10b-18Here Alphaville looks at both topics, the changing characteristics of the IPO biz and the astonishing metrics of the repurchase racket:
A. Rule 10b-18 as a "Safe Harbor"
In 1982, the Commission adopted Rule 10b-18,4 which provides that an issuer will not be deemed to have violated Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5 under the Exchange Act, solely by reason of the manner, timing, price, or volume of its repurchases, if the issuer repurchases its common stock in the market in accordance with the safe harbor conditions.5 Rule 10b-18's safe harbor conditions are designed to minimize the market impact of the issuer's repurchases, thereby allowing the market to establish a security's price based on independent market forces without undue influence by the issuer....
Or March 2020's "Mark Cuban says bailed out companies should never be allowed to buy back their stocks ever again"
