Repurchase Redo: Fifth Circuit Court of Appeals Orders SEC to Correct Share Repurchase Rule Defects

Background

In December 2021, the Securities and Exchange Commission (“SEC”) proposed a host of amendments focused on building out more robust disclosure obligations for public companies engaging in any repurchases of their own equity securities. After opening the administrative record on April 1, 2022, October 18, 2022, and December 7, 2022, for brief windows of public comment, the SEC adopted the Final Rules on May 3, 2023.

Shortly after the Final Rules were announced, the United States Chamber of Commerce, the Longview Chamber of Commerce, and the Texas Association of Business (collectively, the “Petitioners”) filed a Petition for Review with the U.S. Court of Appeals for the Fifth Circuit, on May 12, 2023.

On October 31, 2023, a three-judge panel of the Fifth Circuit granted the petition and unanimously held that the Final Rules were arbitrary and capricious, remanding the Final Rules back to the SEC to correct the procedural defects within 30 days. Although the Court disagreed with a number of the Petitioners’ arguments — for example, that the SEC had not provided enough time for notice and comment and that certain disclosure requirements amounted to impermissible compelled speech under the First Amendment — the Court agreed that the SEC had ultimately failed to adequately respond to public comments and justify the Final Rules.

In its opinion, the Court focused on two of the requirements dictated by the Final Rules: the “daily-disclosure requirement” and the “rationale-disclosure requirement.” The daily-disclosure requirement mandates registrants to compile and disclose daily certain share repurchase data in the new Exhibit 26, filed with the company’s Form 10-Qs and Form 10-Ks — a significant step up from the previously-in-effect requirement to only disclose certain monthly repurchase data with the periodic reports. Information required to be disclosed on Exhibit 26 includes, among other things, for each share repurchase: (1) the date on which the purchase was executed; (2) the total number of shares purchased on the date; and (3) the average price paid per share (excluding brokerage commissions and other costs of execution). Although the data for Exhibit 26 must be compiled and disclosed on a daily basis, the Final Rules only require quarterly reporting of this daily data in the company’s Forms 10-Q and 10-K.

Second, the rationale-disclosure requirement requires companies to make a corresponding narrative disclosure which describes, where applicable:

• the objectives or rationales for each repurchase plan or program and the process or criteria used to determine the amount of purchases;
• the number of shares purchased other than through a publicly announced plan or program and the nature of such transaction(s);
• detailed information regarding publicly announced repurchase plans or programs; and
• any policies and procedures relating to purchases and sales of the company’s securities by its officers and directors during a company repurchase program, including any restrictions on such transactions.²

The Court Grants Petitioners’ Challenge Under the Administrative Procedure Act

In their challenge to the Final Rules, the Petitioners argued that the SEC failed to comply with the Administrative Procedure Act (“APA”) in promulgating these requirements. The Court agreed.

Under the Securities Exchange Act and the Investment Companies Act, when engaging in rulemaking, the SEC is required to both consider “whether [an] action will promote efficiency, competition, and capital formation” and “consider or determine whether an action is necessary or appropriate in the public interest,”³ or “consistent with the public interest.”⁴ In the proposed version of the rules, the SEC had conceded that “[m]any of the [economic] effects . . . cannot be quantified.”⁵ To address that, the SEC “encourage[d] commenters to provide data and information that would help quantify the benefits, costs, and the potential impacts of the proposed amendments on efficiency, competition, and capital formation.”⁶ The Petitioners, and others, heeded that call and proposed at least three different methods the SEC could use to quantify any economic impacts. The Court noted, however, that the SEC ultimately declined to consider or otherwise address any of those proposals. Instead, the SEC justified the Final Rule by reference to qualitative analyses and without additional explanation or justification as to why that analytical approach remained appropriate. Because the agency requested feedback on how quantitative review could be done but then continued to insist that the Final Rule’s economic effects could not be quantified — despite public comments to the contrary — the Court reasoned that the SEC’s actions were not “the product of reasoned decisionmaking.”⁷

The Court further determined that the benefits identified by the SEC as justifying the Final Rules were likewise unsubstantiated. According to the SEC, the Final Rules would primarily help investors to “better evaluate whether a share repurchase was intended to increase the value of the firm” or for an improper purpose such as “providing additional compensation to management.”⁸ However, the Court found that the agency’s rationale only provided sufficient justification if opportunistic or improperly motivated stock buybacks are actually occurring with sufficient frequency and severity as to be a genuine problem for investors. Since the SEC had not demonstrated that this problem actually existed, the Court determined that the agency’s justification of relieving investor uncertainty was unsubstantiated.

The SEC had also posited that the Final Rules were justified because they promote “price discovery,” or in other words, the process of setting or discovering a market price for an asset.⁹ Here too, the Court found the SEC had not substantiated its reasoning, and had in fact provided contradictory reasoning. On one hand, the SEC argued that price accuracy would increase via the availability of additional valuable information that companies do not typically disclose due to “the potential costs of leaking valuable private information to competitors.”¹⁰ But on the other hand, the SEC reasoned that the actual costs of these disclosures to companies would be “relatively modest” since the “new disclosures would not contain valuable information.”¹¹ The Court not only found this internally inconsistent but also noted that the SEC had not conducted any analysis to conclude that the costs to issuers would be as minimal, as it claimed.

For all these defects, the Court concluded that the SEC’s stated justification for its actions fell short of the requirement of reasoned decisionmaking, in violation of the APA. However, the Court elected not to vacate (i.e., set aside) the Final Rules, instead opting to remand the rules back to the SEC without vacatur for the limited purpose of correcting the defects identified within 30 days. Once the SEC is finished, any revised version of the Final Rules may face renewed challenges from the Petitioners.

Fifth Circuit Rejects Petitioners’ First Amendment Challenge

While the Court agreed with Petitioners that the Final Rules violated the APA, it rejected their argument that the rationale-disclosure requirement violated the First Amendment as impermissible compelled speech.

The Court noted that, while typically laws that compel speech trigger the strictest level of scrutiny, a more relaxed standard applies when government compels disclosures in a commercial context. Under Fifth Circuit precedent, an agency may require a commercial business to disclose “purely factual and uncontroversial information” as long as these disclosures are “reasonably related to a legitimate state interest” and not “unjustified or unduly burdensome.”¹² The Court held that the rationale-disclosure requirement was constitutional under this First Amendment precedent.

The Supreme Court, however, has recently granted certiorari to review the same Fifth Circuit precedent cited in Chamber of Commerce. In NetChoice, LLC v. Paxton, the Supreme Court has granted review on the question of whether Texas’ individualized-explanation requirements in H.B. 20, which mandate that social media companies individually explain to customers why certain social media posts were removed, violate the First Amendment.¹³ Thus, depending on how the Supreme Court resolves the NetChoice case, the law governing compelled disclosures for commercial entities might change in a manner that affects the outcome in Chamber of Commerce.

Key Considerations

Although it remains unclear whether the SEC will reopen the Final Rules for public comment or whether it will be able to act within the 30-day period allowed by the court, Chamber of Commerce serves as an outstanding reminder of the value of regulated industry providing robust public comments in response to a proposed rule — particularly where the agency has requested feedback on a particular issue. If regulators fail to grapple with key points raised in public comments, or fail to address those comments in a reasonable way, their actions are subject to being remanded or vacated in federal court.¹⁴ Where a proposed rule raises a material concern, highlighting and addressing those issues in public comments remains an essential prerequisite to preserve the issue for later judicial review.

In the meantime, while the SEC goes back to the rulemaking drawing board, it should be noted that the Final Rules have not been stayed, either by a court order or otherwise — and thus remain in effect.¹⁵ By their terms, the Final Rules went into effect for the first full fiscal quarter that began on or after October 1, 2023. The Fifth Circuit gave the SEC only 30 days to provide supplemental explanation to its rules, but the agency might request an extension from the Fifth Circuit to comply with its order. Moreover, at least to date, the SEC has not extended the compliance deadline in response to the order in Chamber of Commerce. If the SEC fails to issue a revised version of the Final Rules on time and declines to extend the compliance deadlines, it is conceivable that the Petitioners might seek further relief in court — such as a stay of effectiveness, or perhaps outright vacatur. But until such time as the Final Rules’ compliance date is formally changed, registrants are strongly encouraged to work with counsel to both monitor the developing status of the Final Rules and implement the appropriate measures for compliance in the interim. The team at Vinson & Elkins previously outlined several items that companies should take into consideration when preparing for compliance, and remains available to provide further education and guidance going forward.

¹Chamber of Commerce of the U.S. v. S.E.C., No. 23-60255, 2023 WL 7147273 (5th Cir. Oct. 31, 2023).

²A more thorough review of the daily-disclosure requirement may be found at Katherine Terrell Frank, et al., The Wait is Over: SEC Adopts Share Repurchase Disclosure Modernization Rules, V&E SEC Update, (May 8, 2023), https://www.velaw.com/insights/the-wait-is-over-sec-adopts-share-repurchase-disclosure-modernization-rules/.

³15 U.S.C. § 78c(f).

⁴Id. § 80a-2(c).

⁵Chamber of Commerce, 2023 WL 7147273 at *16 (quoting Share Repurchase Disclosure Modernization, 87 Fed. Reg. 8443, 8451 (Feb. 15, 2022)).

⁶Id.

⁷Id. at 8–13 (quoting Motor Vehicle Mfrs. Ass’n of U.S., Inc., v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 52 (1983)).

⁸88 Fed. Reg. 36008.

⁹See 88 Fed. Reg. at 36033 (“The additional quantitative and qualitative disclosures we are adopting are further expected to enhance the information about share repurchases, providing clearer insights into how and why the issuers undertake repurchases and the extent to which they are related to temporary undervaluation of issuer shares, temporary cash windfalls that cannot be deployed to positive-net present value (NPV) investment projects, or other objectives.”). 

¹⁰88 Fed. Reg. 36036.

¹¹Chamber of Commerce, 2023 WL 7147273 at *11 (citing 88 Fed. Reg. 36040).

¹²Chamber of Commerce, 2023 WL 7147273 at *4 (quoting NetChoice, L.L.C. v. Paxton, 49 F.4th 439, 485 (5th Cir. 2022)).

¹³Order Granting Petition for a Writ of Certiorari, NetChoice, LLC v. Paxton, No. 22-555 (U.S. Sept. 29, 2023).

¹⁴See Andrew Chung & John Kruzel, Federal agency powers in the crosshairs at the US Supreme Court, Reuters (July 5, 2023), https://www.reuters.com/legal/federal-agency-powers-crosshairs-us-supreme-court-2023-07-04/ (noting the plethora of lawsuits involving federal agency actions and authority that are likely to be reviewed by the U.S. Supreme Court in the coming terms); Eric Groten, et al, What Does the Supreme Court’s Recent Decision on Climate Regulation Mean for the Energy Industry?, V&E Envir. Update (July 5, 2022), https://www.velaw.com/insights/what-does-the-supreme-courts-recent-decision-on-climate-regulation-mean-for-the-energy-industry/ (noting that the Supreme Court’s reaffirmation of the major powers doctrine in West Virginia v. EPA “is likely to have significant implications for future environmental regulations — and administrative law in general”).

¹⁵See 15 U.S.C.A. § 80a-42(b) (“The commencement of proceedings under subsection (a) to review an order of the Commission issued under any provision of this subchapter other than section 80a-8(e) of this title shall not operate as a stay of the Commission’s order unless the court specifically so orders.”). The Final Rules were not an order issued under § 80a-8(e), and a review of the docket in Chamber of Commerce reveals no such order to stay the Rule.