Buy it back: the ins and outs of repurchasing company stock.

• Author: Lebrecht, Brian A.
• Position: Legal Brief

According to published statistics, during the first four months of 2014, U.S. public companies bought back over $250 billion worth of their own shares. Share buybacks are a hot trend--with good reason. Over the last few years, companies that repurchase their own securities have outperformed market averages. There are several exchange traded funds (ETF) that target companies that are engaged in major buybacks, and they have performed very well too.

Why Repurchases Happen

There are several reasons why management of a public company would choose to spend its excess cash buying its own stock.

* Management believes the company is undervalued in the marketplace. The company may not have met analysts' expectations, there may have been an internal scandal, or the economy may be in an overall downturn that has caused the price of the company's stock to fall to a level that management believes is unwarranted. However, like individuals, a company can be found liable for insider trading if it trades on material, non-public information.

* Improving financial ratios. It follows logic that the same amount of earnings, divided by a smaller number of outstanding shares, increases a company's earnings per share (EPS). Further, if management believes that a lower price to earnings (PE) ratio will be viewed more favorably by the market, then increasing EPS while keeping the price constant reduces the PE ratio.

* Offset issuances from the exercise of management's stock options. When management exercises stock options, more shares are issued from the company's treasury, diluting the existing shareholders and driving down EPS. Repurchases could be used to offset that dilution.

Repurchase Rules

Rule 10b-18 under the Exchange Act provides a non-exclusive safe harbor against allegations of market manipulation under Section 9(a)(2) and Rule 10b-5 for issuer repurchases of securities which are effected in accordance with the four conditions set out in the rule. In order for a company to avail itself of Rule 10b-18, purchases of an issuer's common equity securities by the issuer and the issuer's affiliated purchasers, taken together, must meet all of the following four conditions:

* Single broker. All bids and purchases must be made through only one broker or dealer on any single day.

* Timing. Purchases must not constitute the opening transaction or occur during the last half hour of trading, or the last 10 minutes of trading for issuers who have an average daily...