Thursday, January 5, 2012

Regulations vs Money-Printing

As recently as three or four decades ago, companies in the US were wary of buying back their own shares because this could be considered illegal price manipulation. In 1982, the SEC enacted a rule that gives companies repurchasing shares safe harbour from prosecution for price manipulation, and this has been a major contributor to the growth of buybacks. But regulations restricting the flow of capital continue to hamper the productive flow of capital, as the following are among the conditions for safe harbour protection, as set forth by the SEC in Rule 10b-18:

- No repurchase is made at a price exceeding the highest current independent bid
price or the last independent sale price, whichever is higher.
- Non-block repurchase volume does not exceed 25% of the average daily trading volume for the preceding four calendar weeks

Clearly, these could be major deterrents for small companies looking to repurchase shares. Fortunately, these are not requirements; they only protect the company from charges of price manipulation. Still, these conditions likely deter many small companies from using this option for returning cash to shareholders.

Furthermore, many of the large companies listed on US exchanges are also listed on exchanges in other countries. The regulations enforcing buybacks in most other countries are much more restrictive, and therefore the US issue can suffer as a result.

For example, consider the formerly dual-listed (in both Canada and the US) Quest Capital, which was prevented from buying back shares when it traded at a large discount to its book value, which was made up of mostly current assets. While Quest's price did eventually trade up to the company's book value, the per-share book value (and therefore, the subsequent price appreciation) would have been higher had management been allowed to buy back more shares than the regulations stipulated.

For a table outlining the buyback restrictions imposed by various countries on their exchange-listed stocks, see Table 1 at the bottom of the following paper, Survey On Open Market Purchase Regulations.

Governments around the world currently lament the large cash accounts carried on corporate balance sheets, forcing governments to spend and/or print money to keep capital flowing. At the same time, however, government regulations are keeping corporations from buying back shares, which would send cash to more productive uses and reduce the onus on governments to stabilize capital markets.

3 comments:

Anonymous said...

Not often I don't agree with you, but in this case I think you are wrong. The rules: - No repurchase is made at a price exceeding the highest current independent bid
price or the last independent sale price, whichever is higher.
- Non-block repurchase volume does not exceed 25% of the average daily trading volume for the preceding four calendar weeks,
serve an excellent purpose as the following illustrates. A (non-North American) company recently announced a repurchase of 10% of its shares at $30, while shares were trading at $24. Due to tight timing, not everyone was able to react. Insiders of course did, and in they received a dividend not available to more distant shareholders by selling out at $30 and buying back at $24. This rule does protect small, non-insider shareholders. Also, buying at $30 when the market price is $24 is wasteful of shareholder funds

Saj Karsan said...

Hi Anon,

That is definitely a problematic situation, but to my mind that should be regulated by insider trading restrictions. If senior managers took advantage of material non-public information in the case you describe (and it appears that they did, based on your description), they should be prosecuted.

E1 asset management reviews said...

From my point of view, this just isn't a wise practice!

Follow by Email