Reuters / Joshua Roberts
- Corporate share repurchases are off to a torrid start to 2018, and are on pace to shatter records for both announced and executed buybacks.
- In a speech on Monday, Robert J. Jackson, Jr., a commissioner at the Securities and Exchange Commission (SEC), blasted what he thinks is opportunistic behavior by corporate insiders who stand to benefit from the buybacks.
- Jackson also outlined reforms he said could make the share repurchase process more fair for all shareholders.
For years, corporate share buybacks have been the stock market's dirty little open secret.
That's because during times otherwise devoid of positive catalysts, repurchases have stood tall as a beacon of strength, nudging stock prices higher through the reduction of overall shares outstanding.
And the proliferation of buybacks looks to be just getting started. Goldman Sachs estimates that total share repurchases will hit $650 billion this year, shattering the previous record set in 2007. As for announced repurchases, the firm forecasts they'll swell to $900 billion, also an all-time high.
Buyback enthusiasts have the recently passed GOP tax law to thank for this. With billions of dollars in tax breaks and repatriated overseas cash hitting their balance sheets, they're even more anxious than before to put capital to work. And much of it is expected to be used for - you guessed it - buybacks.
But not if Robert J. Jackson, Jr. has anything to say about it. Recently appointed by President Donald Trump to fill a Democratic seat at the Securities and Exchange Commission (SEC), Jackson is no fan of buybacks - or at least the way he sees corporate executives exploiting them.
One of five current SEC commissioners, Jackson delivered a speech on Monday, unveiling statistical findings that suggest high-ranking officers frequently use buybacks to boost their companies' stock prices before offloading shares.
Jackson analyzed a data set of 385 corporate repurchases and found that insiders transacted roughly $100,000 in daily sales in the days prior to the buyback. On the day of the buyback, and over the subsequent eight days, he found that those same insiders transacted $500,000 in daily sales, a five-fold increase.
The chart below supports these findings, showing that the average total transaction value of insider shares sold is the highest in the days immediately after a buyback.
So there's the smoking gun in terms of corporate executives trading more heavily during post-buyback periods.
And if there was any doubt around efficacy of buybacks in boosting share prices, Jackson also discovered that the same companies' stocks lagged the market by an average of 1.4% leading up to execution, compared to outperformance of 2.5% in the 30 days afterward.
"On too many occasions, companies doing buybacks have failed to make the long-term investments in innovation or their workforce that our economy so badly needs," Jackson said in prepared comments published on the SEC website. "What we are seeing is that executives are using buybacks as a chance to cash out their compensation at investor expense."
Now that Jackson's core argument has been established, it's important to consider the solutions he offered during his speech. At the root of his recommendations is the idea that while buybacks are certainly accretive to stock prices, companies should be using their excess capital to reinvest and grow their businesses organically - something not possible when cashing out of holdings is the foremost concern for management.
First and foremost, Jackson says the SEC should reconsider the so-called safe harbor it's giving companies right now, which puts no limits on the use of buybacks by boards and executives.
"I cannot see why a safe harbor to the securities laws should subsidize this behavior," he said in his prepared speech. "Instead, SEC rules should encourage executives to keep their skin in the game for the long term. That's why our rules should be updated, at a minimum, to deny the safe harbor to companies that choose to allow executives to cash out during a buyback."
Jackson goes on to call for an "open comment period," which would involve the solicitation of comments from the public pertaining to proposed buybacks. The general idea is to give broader shareholders more of a say in how corporate capital is deployed.
Secondly, Jackson says the boards of corporations should keep a closer eye on the degree to which buyback boosts are used to enhance insider compensation.
"If executives will use the buyback to cash out, the committee should be required to approve that decision and disclose to investors the reasons why it is in the company's long-term interests," he said. "It is hard to see why a company's buyback announcement shouldn't be accompanied by this kind of disclosure."
In the end, while Jackson's findings and resulting suggestions are certainly altruistic, any sort of a disruption to the status quo of buyback activity would likely serve as a market headwind. After all, repurchases have served as a safety net of sorts for the market during the leanest of times.
So if the SEC wants to make sure corporate insiders have pure intentions as they do buybacks, it's likely to come at the short-term expense of overall stock market health.