How boards can evaluate stock buybacks during Covid-19 crisis
The Tax Cuts and Jobs Act of 2017 sparked an unprecedented increase in corporate stock buyback programs as companies sought to use their newly realized cash savings from reduced corporate tax rates to increase stockholder value. A little more than two years since the passage of that legislation, companies are facing another unprecedented event with the Covid-19 pandemic, which will have a much different and more significant impact on their businesses and balance sheets.
Companies that now must conserve cash to weather the pandemic, or that are considering whether to seek loans under the Coronavirus Aid, Relief and Economic Security Act (Cares Act), will need to immediately rethink the advisability of their stock buyback programs.
At the other end of the spectrum, companies that find themselves in the enviable position of having more than sufficient cash resources to survive a prolonged decline in the general economy resulting from the pandemic, that won’t need financial assistance under the Cares Act and that are seeing their businesses remain afloat or even thrive, may wonder whether they should continue their existing stock buyback programs or even establish new ones.
Section 4003 of the Cares Act prohibits corporate recipients of loans or loan guarantees authorized under the legislation from purchasing their own or their parent company’s stock listed on a national securities exchange (unless required under a pre-existing contractual obligation) until 12 months after such a loan is no longer outstanding. Accordingly, any company that intends to borrow money under the Cares Act will first need to terminate or suspend, for the requisite period of time, its stock buyback program.
The duration of the restriction means the Cares Act will, in effect, lock the borrower out of buying back its stock for quite some time after the economy recovers and the borrower has returned to a position of healthy liquidity. In evaluating whether to obtain a loan or loan guarantee under the Cares Act, a company’s board of directors should carefully weigh this trade-off, among other factors.
Even if a company doesn’t anticipate needing assistance under the Cares Act, it would still be prudent for its board to carefully evaluate the company’s cash position, cash flow and future liquidity and capital needs in light of the pandemic to determine whether its stock buyback program is still advisable and in the best interests of the company and its stockholders during these uncertain times.
Most, if not all, companies that have stock buyback programs have established those programs under Rule 10b5-1 plans that provide an affirmative defense against insider-trading claims for the prearranged automatic and formulaic purchases made while the purchaser is in possession of material non-public information. In conjunction with terminating or suspending its stock buyback program generally, a company will also likely need to formally terminate its Rule 10b5-1 plan contract with its broker so that further purchases no longer automatically occur.
The SEC does not view the act of terminating a Rule 10b5-1 plan prior to its expiration, in and of itself, as a violation of securities laws even if the company possesses material non-public information at the time of such termination. But the agency has cautioned that a company’s termination of its Rule 10b5-1 plan could affect the availability of the company’s affirmative defense for its repurchases made under such a plan prior to its termination if it calls into question whether the plan was ‘entered into in good faith and not as part of a plan or scheme to evade’ insider-trading rules.
In light of this guidance, a board would be well served by creating a record that it considered all financial and operational circumstances and risks faced by the company given the pandemic to show that the company had no choice but to terminate its Rule 10b5-1 repurchase plan and that this decision does not raise any questions about whether or not the plan was originally entered into in good faith.
For a company availing itself of the Cares Act loan program, the record would be difficult to question. But it would require more thoughtful deliberation for a company that does not need a loan under the law. In addition, the board of such a company would need to get comfortable with the possibility that once the Rule 10b5-1 repurchase plan is terminated, it could be risky to establish a new Rule 10b5-1 repurchase plan shortly thereafter.
Therefore, if a V-shaped recovery materializes, the board would have to carefully consider when it could establish a new Rule 10b5-1 repurchase plan without jeopardizing its affirmative defense under its previous plan.
Those rare companies that are not being negatively impacted by the pandemic and that believe their stock may be undervalued may wish to review whether they should continue to maintain their existing stock buyback programs or even establish new programs.
Apart from analyzing whether the program is permitted under the corporate laws of its jurisdiction of incorporation and the terms of its securities and organizational documents, the company’s board should carefully consider whether buying back the company’s stock is a prudent use of its cash during these highly uncertain times.
Moreover, if stay-at-home orders continue to take a heavy toll on the economy, a well-positioned company may find it would be better to use its cash for acquiring other businesses or assets at attractive valuations. But if a company decides it wants to move forward with establishing a stock buyback program, it cannot make purchases or enter into a Rule 10b5-1 purchase plan while it possesses material non-public information.
Therefore, it may not even be feasible to establish such a stock buyback program unless the company is prepared to preannounce results and provide early disclosure of recent material developments in its business and financial condition.
Parker Schweich is a shareholder in Stradling Yocca Carlson & Rauth’s corporate and securities practice group