SEC Issues Final Rules Amending the Rule 10b-18 "Safe Harbor" and Requiring Disclosure of Issuer Repurchases

In adopting the Rule 10b-18 safe harbor in 1982, the SEC sought to address the following problem: while there are many legitimate business reasons for issuers to repurchase their own equity securities in open market transactions (e.g., to make shares available for dividend reinvestment, stock option and employee stock ownership plans, or to reduce the outstanding capital following the cash sale of operating divisions or subsidiaries), because such purchases can affect the market price of an issuer’s stock, issuers are potentially exposed to claims that the repurchases were made in a manipulative manner even when there was no intent to move market prices.

Rule 10b-18 provides issuers with a safe harbor from liability for manipulation under Sections 9(a)(2) and 10(b) of the Exchange Act, and Rule 10b-5 under the Exchange Act, when open market repurchases are made in accordance with the Rule’s manner, timing, price, and volume conditions. It should be noted, however, that Rule 10b-18 does not protect an issuer in all instances where there is technical compliance with the Rule’s conditions. For example, purchases that are found to have been made as part of a plan or scheme to evade federal securities laws will not be given safe harbor status and may be grounds for issuer liability for price manipulation.

The Rule 10b-18 safe harbor applies to bids for, and purchases of, an issuer’s common stock by or on behalf of an issuer. The safe harbor does not cover any other type of security (e.g., preferred stock, warrants, rights, convertible debt securities, options, or security futures products). In addition, through the Rule’s definition of a "Rule 10b-18 purchase," during certain corporate events where an issuer has a heightened incentive to manipulate the market price for its securities, the safe harbor may not be relied upon. Examples of such events are mergers and acquisitions, tender offers and distributions of the issuer’s securities.

The Rule 10b-18 safe harbor covers purchases executed during a single day of trading. To qualify for the safe harbor on a given day, an issuer must comply with each of the following conditions:

• Manner of Purchase. In order to avoid the appearance of widespread trading in an issuer’s common stock, the issuer is required to use a single broker or dealer to bid for or purchase its stock. This condition only applies to purchases that are "solicited" by or for an issuer. As such, an issuer may purchase shares from multiple brokers or dealers as long as the transactions were not solicited. Because the SEC has not defined the term "solicited" in the Rule, an issuer must evaluate the facts and circumstances of each transaction.

• Timing. Issuers may not bid for or purchase their common stock as the opening transaction and must cease making bids or purchases during the last thirty minutes of scheduled trading. If there is no independent opening transaction on a given day, the issuer is precluded from making purchases for that day. This condition was adopted because market activity at these times can significantly affect the direction of trading, strength of demand and current market value of the security.

• Price. To prevent an issuer from leading the market through its repurchases and influencing the market price for its securities (as opposed to the price being determined by independent market forces), the price limitation specifies the highest price an issuer may bid or pay for its stock. That price may vary, however, depending on whether the stock is a reported, exchange-traded, Nasdaq, or other security, and whether the bid or purchase is effected on an exchange. Generally, the issuer must make bids for, or purchases of, its stock at a price that is no higher than the highest independent published bid or last independent transaction price.

• Volume. In order to prevent an issuer from dominating the market for its common stock through substantial purchasing activity (which activity can have the effect of misleading investors about the integrity of the securities market as an independent pricing mechanism), an issuer is limited to aggregate purchases on a given trading day of no more than 25% of the average daily trading volume (ADTV) in its shares. The volume limitation does not include an issuer’s "block purchases" as defined in the Rule (generally, large purchases), and such purchases are not used in determining the ADTV. ADTV is calculated based on the ADTV for the security for the four calendar weeks preceding the week in which the Rule 10b-18 bid or purchase is to be made.

Preliminary Notes. For explanatory purposes, the SEC adopted two preliminary notes to Rule 10b-18. The first note explains that, although compliance with the Rule is voluntary, in order to come within the safe harbor, repurchases made by or for an issuer must (on a daily basis) satisfy each of the Rule’s conditions. This note also states that the safe harbor is not available for purchases that are in technical compliance with the Rule, but are a part of a plan or scheme to evade federal securities laws.

The second note states that regardless of whether issuer repurchases are effected in accordance with Rule 10b-18, issuers filing Exchange Act reports must report their repurchasing activity as required by new Item 703 of Regulation S-K and S-B and Item 15(e) of Form 20-F (as is more fully discussed below under the caption "New Disclosure Requirements Regarding Issuer Repurchases").

Definition of Eligible Securities. Amended Rule 10b-18 merges the definition of "Rule 10b-18 bid" into the definition of "Rule 10b-18 purchase." The merged definition clarifies that the safe harbor is available for repurchases of all common equity securities (i.e., an issuer’s common stock or an equivalent interest, including a unit of beneficial interest in a trust or limited partnership or a depository share). The safe harbor still, however, does not apply to any other type of security (such as preferred stock or convertible debt securities), even if the security is related to the issuer’s common equity interests (such as warrants, options and rights).

Merger Exclusion. In response to comments on the SEC’s proposed amendments to Rule 10b-18, the SEC determined that it was not necessary to exclude from the safe harbor all issuer repurchase activity following the announcement of a merger, acquisition, or similar transaction involving a recapitalization, as it had originally proposed to do in its proposing release. Under the original proposal, the amended definition of "Rule 10b-18 purchase" would have excluded the foregoing activity during the period from the time of the public announcement of the transaction until its completion. Instead, the adopted language clarifies that the safe harbor is not available for repurchases that are effected during the period from the time of the public announcement of the transaction until the earlier of the completion of such transaction or the completion of the vote by target shareholders, with the following exceptions to the exclusion:

• transactions in which the consideration is solely cash and there is no valuation period;

• ordinary Rule 10b-18 purchases effected after the announcement of a covered transaction (subject to Regulation M and any other applicable restrictions) as long as the total amount of the repurchases effected on any single day does not exceed the lesser of 25% of the securities’ four-week ADTV or the issuer’s average daily Rule 10b-18 purchases during the three full calendar months preceding the date of the announcement of the covered transaction; and

• block purchases pursuant to paragraph (b)(4) of the Rule (the provision that allows for block purchases under certain conditions), provided that the issuer does not exceed the average size and frequency of block purchases effected pursuant to (b)(4) during the three full calendar months preceding the date of the announcement of the covered transaction.

• Timing. Recognizing that the original timing condition dictating when an issuer was to be out of the market was in some circumstances unnecessarily long for issuers with highly liquid securities, the SEC modified the timing condition by adding an ADTV value and public float value test. Issuers having an ADTV value of $1 million or more and a public float value of $150 million or more are now allowed in the market until ten minutes prior to the scheduled close of trading. All other issuers continue to be subject to the current thirty-minute limitation.

• Price. As opposed to the original price limitation that could vary depending on the market for an issuer’s stock, the SEC adopted a uniform price condition for all securities, regardless of where they are traded, based on the "highest independent bid" and/or "last transaction price" price tests. Under the new amendments, for securities quoted or reported in the consolidated system (e.g., the New York Stock Exchange or the Nasdaq National Market) issuers are required to repurchase their stock at a purchase price that does not exceed the highest independent bid or the last independent transaction price, whichever is higher. For those securities that are not reported or quoted on the consolidated system (e.g., those quoted on the OTC Bulletin Board), an issuer is required to make purchases at a price that does not exceed the highest independent bid or the last independent transaction price, whichever is higher, displayed or disseminated on any national securities exchange or on any inter-dealer quotation system that displays at least two priced quotations for the security. For all other securities, Rule 10b-18 purchases are required to be effected at a price no higher than the highest independent bid obtained from three independent dealers.

• Volume. In the final rule release, the SEC commented that block transactions, which were exempt under the original volume condition, represented one-half of all market activity and therefore had a substantial impact on market prices. As such, the SEC stated in the final release that the elimination of the original block exception was essential in order to maintain a limit on the amount of repurchase activity that is protected under the safe harbor. Under the amended condition, an issuer’s total volume of Rule 10b-18 purchases cannot exceed 25% of the ADTV in its security, including block-size purchases made for that day. In calculating the four-week ADTV, however, issuers may include their block-size purchases made during the four-week period. In order to alleviate concerns of commentators on the proposed rules that the elimination of the block exception would negatively affect issuers with moderate or low average daily trading volumes that rely heavily on block purchases to implement their repurchase programs, the SEC decided to allow issuers to make one block purchase per week, so long as the issuer does not make any other such purchases on that day. These purchases, however, would be excluded from an issuer’s four-week ADTV calculation.

• After Hours Trading Sessions. The SEC has decided to extend the safe harbor for issuer transactions effected after regular trading sessions (generally 9:00 a.m. – 4:00 p.m.) at prices that do not exceed the lower of the closing price of the primary trading session in the principal market for the security and any lower bids or sale prices subsequently reported in the consolidated system by other markets. In addition, issuers are required to meet the other Rule 10b-18 conditions with several modifications. For practicality, an issuer would not be required to use the same broker or dealer as it used in a primary trading session. Also, issuers are precluded from effecting a Rule 10b-18 transaction as the opening transaction of the after-hours trading session. Issuers can, however, repurchase until the termination of the period. Finally, the Rule’s volume calculation would carry over from the regular trading session.

• Rule 10b-18 Alternative Conditions. The SEC decided to amend the safe harbor alternative conditions that would be applicable during the trading session immediately following a market-wide trading suspension by increasing the 25% volume limitation to 100% of a security’s ADTV. In adopting this amendment, the SEC recognized the need for enhanced liquidity and issuer flexibility during rare, but critical, periods of severe market decline.

In order to enhance the transparency of issuer repurchases, the SEC has adopted amendments to Regulations S-K and S-B and Forms 10-Q, 10-QSB, 10-K, 10-KSB and 20-F to require periodic disclosure in tabular form of all issuer repurchases of shares or other units of any class of the issuer’s equity securities that are registered by the issuer pursuant to Section 12 of the Exchange Act, whether or not a purchase was effected pursuant to Rule 10b-18. As mentioned above, the new disclosure is required in reports on Forms 10-Q, 10-QSB, 10-K and 10-KSB for periods ending on or after March 15, 2004 and in reports on Form 20-F for fiscal years ending on or after December 15, 2004.

The new disclosure is meant to provide investors with information regarding whether an issuer had followed through on an announced repurchase plan, repurchase activity that may be important in assessing stock price (similar to periodic disclosure of earnings and dividend payouts), and the expiration or termination of a repurchase plan.

The new table in Forms 10-Q/QSB (new Item 2(e)), 10-K/KSB (new Item 5(c)) and 20-F (new Item 16E) includes disclosure of (i) all issuer repurchases of Section 12 registered equity securities (both open market and private transactions) for the last fiscal quarter (or for the last fiscal year in the case of a foreign private issuer reporting on Form 20-F), including the total number of shares purchased, (ii) the average price paid per share, (iii) the total number of shares purchased as part of a publicly announced repurchase plan or program, and (iv) the maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs.

The amendments also require footnote disclosure to the table of the principal terms of any publicly announced repurchase plan or program including (i) the date of the announcement, (ii) the share or dollar amount approved, (iii) the expiration date of the program, if any, (iv) each program that expired during the period covered, and (v) each program that the issuer has determined to terminate prior to expiration or under which the issuer does not intend to make further purchases.

In addition, issuers are required to provide brief footnote disclosure regarding the nature of the transaction for purchases made other than pursuant to a publicly announced repurchase plan or program.

The following is an example of how the new table would look in a Form 10-Q covering the first fiscal year quarter during which there is repurchase activity.