When Trump launched his wave of Wall Street deregulation, many were convinced that the ensuing free-for-all would lead to an immediate surge in VaR, and a rapid return of pre-crisis conditions, with banks taking on massive amounts of risk fully expecting to be bailed out when things turned sour. And perhaps that will eventually happen but for now, in a surprising development, one regulator has had the nerve to point out something we have been criticizing all along, namely that corporate buybacks are simply a scheme to make shareholders and management exorbitantly rich on the back of creditors who buy corporate bonds to fund stock repurchases. And, in an added twist, corporate insiders are taking advantage of a peculiar quirk in price action to dump the bulk of their stock just as algos and humans (and, in the case of Apple and various other stocks, central banks) are buying.
Specifically, according to an analysis by SEC Commissioner Robert J. Jackson, Jr., company executives have been grossly busing the timing of buyback announcements and selling significantly more of their stock immediately after the news than they do beforehand. taking advantage of price bumps that often accompany share-repurchase announcements.
But what is most infuriating, is that this is perfectly legal, and as the WSJ reports in a speech on Monday, a pissed off Jackson — appointed by President Trump and sworn in this year to fill a Democratic seat at the SEC — may emerge as the most credible SEC employee in years when he urges fellow regulators to review securities laws that provide protection to insiders who capitalize on the timing of buyback announcements.
This is where it gets bizarre: while companies engaging in buybacks have certain constraints, such as following a blackout period, or only selling on a NBBO uptick, insiders who sell stock into buyout bounces aren’t trading illegally and Jackson isn’t accusing them of that. But these price surges can be especially beneficial to corporate executives holding large chunks of corporate stock looking for an uptick to unload shares. And since it is the executives that decide when to buy back stock and when to announce it, it seems that this is yet another way for corporate insiders (literally) to skew the market in their favor. Oh, and the other difference of course, is that when the company, retail investors, algos (and central banks) are buying, corporate insiders - those who know their company better than anyone - are selling.
Almost as if the market is being inefficient and not rewarding those with the best information.
To be sure, Jackson is not happy with the fact that corporate insiders are so grossly exempt from what is so clearly insider trading, that it needs to be exempt:
“The SEC gives an exemption from market-manipulation rules to companies doing a buyback,” Mr. Jackson said in an interview. “The SEC shouldn’t be making it easier for executives to use them to cash out.”
And yet that's precisely what the SEC has been doing for decades. Ironically, it is only a Trump-appointed commissioner who dares to blow the whistle.
Jackson, who is a former law professor, examined stock trades at 385 companies that announced buybacks in 2017 through this year’s first quarter.
He found two things:
- First, the percentage of insiders selling shares more than doubled immediately following their companies’ buyback announcements as many of the stocks popped. Daily stock sales by the insiders rose from an average of $100,000 before the buyback announcements to $500,000 after them. The sellers received proceeds totaling $75 million more than had they sold before the announcement, the study concluded. At 32% of the companies, at least one insider sold in the first 10 days after the buyback announcement.
- Second, the study found that in the days leading up to share repurchase announcements, the companies’ stocks underperformed the broader market by an average of 1.4%. During the 30 days after the announcement, the companies’ stocks outperformed the overall market by an average of 2.5%.
In other words, familiar with the pattern of spiking prices after buyback announcements, corporate insiders have been dumping away to far less sophisticated momentum chasers and algos, who are hoping that a buyback will ensure higher prices indefinitely. If only management teams did not disagree.
To be sure, Jackson is careful to note that his views are his own and don’t reflect those of the entire agency, although now that the cat is out of the bag, not only insider selling into buyback announcements but buybacks themselves may suddenly prove to be problematic, with the investing public suddenly weary of buying when the C-suite is liquidating.
Until then, however, it is a feast for insiders looking to sell into buybacks (which themselves organize). Indeed, as we reported last week, 2018 is shaping up as a blockbuster year for not only announced but executed buybacks which have grown increasingly popular among companies. So far this year, according to Birinyi, buyback announcements from all U.S. publicly traded companies totaled just over $500 billion, on pace to the first ever $1+ trillion total. For all of 2017, companies announced $685 billion in buybacks up from $670 billion in 2016. Meanwhile, as BofA calculated last week, actual spending on buybacks just hit an all time high in Q1.
Of course, the above activity is what some may call a "victimless crime" - after all, everyone is on it, and everyone is making money (except for the shorts). In fact, none other than the president has blessed boosting buybacks with changes to the tax law that made buybacks more attractive for companies. Many investors welcome the deals because they often boost a stock’s price, yet even so some consider them a dubious use of corporate capital if they are made at high valuations or if the returns from buybacks don’t exceed an investment in the business.
But some other management team can worry about that - the current one is making out like bandits. Take the case of Bloomin' Brands. While Jackson’s study didn’t identify specific companies, in Bloomin's case the operator of casual-dining spots including Outback Steakhouse announced its earnings on Feb.22 and noted the existence of a new $150 million stock-repurchase program.
On that day and on Feb. 26, Chief Technology Officer Donagh Herlihy sold a combined 216,562 shares, generating roughly $1.4 million in net proceeds, regulatory filings show.
On March 2, six days after the news, Chief Legal Officer Joseph Kadow sold roughly 281,000 shares generating $5.07 million, according to the filings. Also that day, Chairman and Chief Executive Officer Elizabeth Smith sold 150,000 shares generating $2.5 million, filings indicate.
And the punchline: the sales were executed at prices that were, on average, 7% higher than the closing price the day before the buyback was announced. In lieu of a statement to the WSJ, a Bloomin’ Brands spokeswoman said that “we have had share buyback programs in place continually since December 2014 and in similar or larger amounts."
And that's precisely the problem: at issue is Rule 10b-18 of the Securities Exchange Act of 1934, which advises companies how to proceed with buyback timing and other mechanics, such as prices paid and volume restrictions. And the kicker: the Rule provides a “safe harbor” for officers or directors to trade in the shares during a repurchase without running afoul of antifraud provisions of the securities laws.
Jackson believes that executives who sell into buybacks are benefiting at the expense of shareholders. “If an executive believes a buyback is the right thing for the long term, they should put their money where their mouth is and keep their stockholdings,” he said, and he is absolutely right. However, with a market as broken as this one, in which stocks almost never go down, one is hard pressed to make even an ethical argument that insiders are taking advantage of Joe Sixpack. If anything, the stocks keep going higher, on the back of even more debt-funded buyback announcements (and central bank purchases, thank you SNB).
Jackson is scheduled to present his analysis Monday at the Center for American Progress, a left-leaning think tank in Washington. The study parallels his past academic work on corporate governance issues. He taught law at NYU and Columbia and was founding director of the Columbia Law School’s Data Lab, which used technology to study the reliability of company disclosures.
In the interview with the WSJ, Jackson said the SEC hasn’t looked at buyback rules for more than a decade. With the recent surge in such activity, he said, “it’s time to take another look at these rules.” Just don't make the look too close, because if there is anything that can finally end the stock market's decade-long party, is if something were to happen to the biggest buyer of stocks since the financial crisis:
... corporations themselves.