Fifth Circuit rules SEC must fix stock buyback rule

Stock buyback rule
Chamber of Commerce of the United States of America v. the Securities and Exchange Commission
Date: Oct. 31, 2023

Issue:  Whether the Securities and Exchange Commission’s (SEC) Share Repurchase Disclosure Modernization Rule violates the First Amendment and Administrative Procedure Act (APA).

‌Case Summary: In a 3-0 decision, a Fifth Circuit panel declined to vacate the SEC’s Share Repurchase Disclosure Modernization Rule (stock buyback rule), but ordered the SEC to fix the rule by Nov. 30, 2023.

In a 3-2 vote on May 3, 2023, the SEC adopted the stock buyback rule, which curtailed the use of stock buybacks. When public companies have excess capital, they often repurchase their stock to efficiently manage their funds. Share repurchase plans, also called stock buybacks, are a tool companies often use to strategically make financial decisions and provide value to investors. The stock buyback rule required issuers to report day-to-day share repurchase data once per quarter and to disclose the reason the issuer repurchased shares of its own stock. Companies needed to disclose whether certain officers or directors traded in shares within four business days from a repurchase announcement.

The U.S. Chamber of Commerce, Texas Association of Business, and Longview Chamber of Commerce sued to block SEC from implementing the rule under the APA. According to the trade groups, the mandatory disclosure requirements risked the public airing of important managerial decisions. The groups also argued the rationale-disclosure requirement violates the First Amendment by impermissibly compelling their speech, and the SEC acted arbitrarily and capriciously in adopting the final rule by not considering their comments or conducting a proper cost benefit analysis. In response, SEC contended the stock buyback rule complies with the First Amendment, and it reasonably considered the rule’s costs, benefits, and overall economic effects.

The Fifth Circuit rejected the trade groups’ First Amendment argument. In the Fifth Circuit’s view, the rationale-disclosure requirement compels issuers to disclose purely factual and uncontroversial information in the context of commercial speech. The panel also concluded the rationale-disclosure requirement is reasonably related to a legitimate state interest and does not burden the groups’ protected speech.

However, the Fifth Circuit ruled the SEC acted arbitrarily and capriciously in violation of the APA. First, the Fifth Circuit examined the commission’s failure to respond to the trades’ comments. Under the arbitrary-and-capricious standard, the SEC must show it reasonably considered relevant issues and reasonably explained the decision, consider all relevant factors raised by the public comments, and respond to significant points within. According to the panel, SEC admitted it never considered the trade groups’ suggestions. Instead, the SEC blamed the trade groups for not identifying specific data the agency should have used, and not raising points which, if true and adopted, would require a change in an agency’s proposed rule.

Next, the Fifth Circuit examined the SEC’s cost-benefit analysis of the stock buyback rule. The Fifth Circuit explained the rule’s primary benefit—decreasing investor uncertainty about motivations underlying buybacks—was inadequately substantiated. According to the panel, nearly every part of the SEC’s justification and explanation of the rule reflects its concern about opportunistic or improperly motivated buybacks. In effect, the panel reasoned this error permeates and infects the entire rule. However, the panel recognized there was “at least a serious possibility that the agency will be able to substantiate its decision given an opportunity to do so.”  As a result, the panel granted the trade groups’ petition for review and directed SEC to correct the defects in the rule by Nov. 30, 2023.

Bottom Line: On Nov. 22, 2023, the SEC issued an order postponing the effective date of stock buyback rule. As a result, the rule is stayed pending further SEC action.

Documents: Opinion