SEC nominees must not grant companies 'safe harbor' with buyback rule

SEC nominees must not grant companies 'safe harbor' with buyback rule
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Last week, two nominees went before the Banking Committee to get their chance to become the next commissioners of the Securities and Exchange Commission.  

During the hearing, Sen. Brian SchatzBrian Emanuel SchatzBullock: Running for Senate 'never really got me excited' Cruz asks Trump FAA pick to 'be pissed off' about Boeing crash deaths San Francisco becomes first city to ban facial recognition technology MORE (D-Hawaii) asked the nominees if they would reconsider a specific rule that, in his words, “precipitated a golden age of buybacks:” the stock buyback “safe harbor,” Rule 10b-18. This rule, which the SEC put in place in 1982, protects companies from insider trading when it repurchases its shares, as long as repurchases on any given day is less than 25 percent of the stock’s average daily trading volume over the previous four weeks. Fortunately, both nominees agreed to take a fresh look at this troubling rule if confirmed.

This esoteric-sounding rule enabled public companies to make money off of moving money around — by buying back their own stock, firms can raise the share price of the stock that remains, without having to take a single step to attract more customers or increase productivity.

This may sound minor. But between 2006-2015, the companies in the S&P 500 spent 54 percent of their net income buying back their own stock. Evenly divided among the 24 million employees of these firms, the nearly $4 trillion spent on buybacks could have given each and every worker a $158,650 raise over the decade.

Companies have a certain amount of cash to allocate between buybacks and dividends on the one hand, and other forms of investment on the other, including investing in their workers and R&D. Workers aren’t the only ones hurt: As my colleague J.W. Mason showed in “Disgorge the Cash,” and as William Lazonick showed in “Profits Without Prosperity,” buybacks hurt the long-run productivity of firms themselves by reducing investment in research and development.

Buybacks aren’t just a tool used by struggling companies in a mediocre economy. Walmart just announced it authorized a new $20 billion stock buyback plan for the next two years on October 10 — even as its stock is already up 17 percent in 2017. From 2007-2016, Walmart spent a total of $67.3 billion on share buybacks — 45 percent of its total profits over the decade.

As Catherine Ruetschlin of Demos showed in 2014, Walmart could have raised the wages of its 825,000 frontline employees by $5.13 per hour if it had chosen to invest in its workers, rather than spending $6.6 billion on stock buybacks in 2013.

If Walmart ended this year’s buyback program and invested instead in its workforce, it could meet the call by OUR Walmart, an association of Walmart employees, to pay associates $15 dollars an hour. And because so many Walmart associates shop at Walmart, a raise could boost sales while also reducing turnover and increasing customer happiness.

This is, in essence, companies buying a rising share price. Who does it benefit? Corporate executives have become some of the largest holders of the shares of their own companies, as compensation practices have shifted from salaries to stock options, which means they have personal, as well as professional, incentives to boost share price. In 2012, 83 percent of the compensation of the 500 highest paid executives came from realizing gains from stock.

Allowing for this level of stock buybacks hasn’t always been standard business practice. The safe harbor protects companies from facing any liability for share repurchases even though they don’t have to disclose exactly when they repurchase their stock, and they only have to report on their plans. In the midst of the myriad of other changes ushered in by the Reagan administration, the 1982 safe harbor rule freed companies from charges of market manipulation when buying back shares of your own stock.

The SEC has plenty of options: It can start out by requiring daily transparency, to ensure that companies aren’t violating the threshold. It could lower the percentage that the buyback purchases are judged against, such that buybacks could only constitute 5 percent or 10 percent of the company’s trading volume. It could require that independent directors approve buyback plans. It could certainly institute rules that would reduce the incentives that executives have to buy back stock, such as a 1991 rule that changes when executives can sell their stock.

And of course, it could simply repeal the rule, which would mean that firms can still buy back their own stock, but are open to liability if they’re conducting purchases to manipulate the market. All these would have varying impact to reduce the extent to which companies rely on stock repurchases.

If confirmed, we look forward to both Rob Jackson and Hester Pierce putting forward proposals to end this unproductive enrichment of shareholders. The wages of America’s working families depends on it.

Lenore Palladino is senior economist and policy counsel at the Roosevelt Institute, where she brings expertise to Roosevelt's work on inequality and finance.