The Securities and Exchange Commission has admitted that it has no ability to enforce the main rule intended to prevent market manipulation when companies buy back their own stock, and has no intention to do so.
SEC Chair Mary Jo White made the acknowledgement in a response to Sen. Tammy Baldwin, D-Wisc., who queried the agency about stock buybacks. Baldwin is one of a growing number of politicians — including presidential candidates Hillary Clinton and Bernie Sanders — who are citing buybacks as an example of deliberate financial engineering that bolsters concentration of wealth and keeps working-class wages stagnant.
Stock buybacks are an increasingly common practice in which corporations take profits, and instead of investing in facilities, research and development, or boosting worker wages, buy shares of their own stock on the open market, thereby boosting demand and driving up its price. Companies bought back over half a trillion dollars’ worth of their own shares last year.
The practice creates short-term rewards for executives who are paid in stock and stock options, and benefit from an increased price. They also make corporate earnings look better by reducing outstanding shares and increasing the commonly reported ratio of earnings-per-share.
Prior to the Reagan era, executives avoided buybacks due to fears that they would be prosecuted for market manipulation. But under SEC Rule 10b-18, adopted in 1982, companies receive a “safe harbor” from market manipulation liability on stock buybacks if they adhere to four limitations: not engaging in buybacks at the beginning or end of the trading day, using a single broker for the trades, purchasing shares at the prevailing market price, and limiting the volume of buybacks to 25 percent of the average daily trading volume over the previous four weeks.
In White’s letter to Baldwin, dated July 13, she admits that the SEC doesn’t collect data that would let it know whether companies breach even these generous limits. “Performing data analyses for issuer stock repurchases presents significant challenges,” White writes, “because detailed trading data regarding repurchases is not currently available.”
Initially, Rule 10b-18 didn’t include any disclosure whatsoever on the part of companies. A 2004 revision requires companies to report monthly buyback totals at the end of each quarter, as part of their 10-Q SEC disclosures. But they do not have to disclose how much they repurchase on a particular day.
“The companies have that information, but the SEC doesn’t collect it,” said William Lazonick, a professor of economics at the University of Massachusetts at Lowell, who has done extensive research on buybacks, and who provided the White letter to The Intercept.
White writes in her letter that the rule is not really a rule at all. Baldwin’s “letter asks for a list of all investigations undertaken by the SEC into possible violations of Rule 10b-18,” White writes, but “because Rule 10b-18 is a voluntary safe harbor, issuers cannot violate this rule.”
“I wouldn’t have thought that she would put it that way, but she said it,” said Lazonick.
White is technically correct, but if the SEC paid any attention to when the corporations left the “safe harbor,” they could then investigate them for market manipulation.
In her agency’s defense, White listed a number of SEC enforcement actions against stock market manipulation, including “pump and dump” schemes, where a company makes false statements to boost its stock price. But none of the four cases White listed involved stock buybacks. In the three decades since Rule 10b-18 has been in effect, investigations into buybacks have been “exceedingly rare,” according to Lazonick.
Rule 10b-18 was shepherded through the SEC by former E.F. Hutton executive John Shad, when he served as SEC chairman. “Shad believed that if you put burdensome reporting requirements on companies it impedes the operation of the capital markets,” Lazonick said. “The rule was a license to manipulate the market.”
In a statement to The Intercept, Sen. Baldwin said, “While I am concerned that the SEC lacks the tools to properly evaluate this issue, I am also disappointed that the SEC’s official response does so little to even acknowledge the stock buyback phenomenon we are seeing in financial markets.”
Last year, companies spent $553 billion to repurchase outstanding shares, just short of the record $589.1 billion in 2007. Large companies like Apple, General Motors, McDonald’s, Pfizer, Microsoft and more have engaged in buybacks in recent years.
Returning profits to shareholders through buybacks and dividends accounted for 95 percent of all earnings in 2014. As a result, each additional dollar of corporate earnings now translates to under 10 cents of reinvestment, according to a study by J.W. Mason of the Roosevelt Institute.
Baldwin tried to attach an amendment to the appropriations bill for financial services agencies requiring the SEC to conduct a study on buybacks, including whether rules like 10b-18 encourage them. But the Republican majority blocked the amendment in the Senate Appropriations Committee on July 23.
In the presidential race, Bernie Sanders called attention to buybacks in an op-ed in the Boston Globe in June, stating, “We must demand an end to stock buybacks.” Hillary Clinton also highlighted the buyback issue in her critique of “quarterly capitalism,” vowing to increase disclosure by forcing companies to deliver information on their buybacks within one day.
Lazonick said he doesn’t believe Clinton’s plan goes far enough. “The practice is the problem,” he said, arguing instead for the repeal of Rule 10b-18 and an end to corporations repurchasing their own shares. “More disclosure might start a discussion about what manipulation is, but we’re way beyond that. Why not recognize that this is manipulation, and say this is something we shouldn’t allow?”
Read the letter here:
Caption: Mary Jo White, chair of the Securities and Exchange Commission, speaks during a Treasury Department meeting of the Financial Stability Oversight Council to vote on its annual report and consider enhancements to its existing transparency policy and bylaws for its Deputies Committee at the Treasury Department on May 7, 2014 in Washington.