We continue to receive questions from members in our Q&A Forum (see Topic #11109) and via email about when the SEC will announce the inflation adjustment to the emerging growth company revenue cap that the JOBS Act requires it to issue every five years. Unfortunately, we’ve not heard anything on this front, so to our knowledge, it’s still on the agency’s “to do” list as it was the last time that we blogged about it.
Yesterday, the Senate passed the 755-page Inflation Reduction Act of 2022. Among its other provisions, the legislation imposes an excise tax equal to 1% of the fair market value of any stock that a company repurchases during its fiscal year (see p. 31). I remember a tax prof in law school saying something like excise taxes are always simple, because the government just takes a slice off the top, which probably explains why this part of the statute is only about 6 pages long. This excerpt from a Congressional Research Service report provides an overview of the excise tax provision:
A provision in H.R. 5376 would impose a 1% excise tax on the repurchase of stock by a publicly traded corporation. The amount subject to tax would be reduced by any new issues to the public or stock issued to employees. The tax would not apply if repurchases were less than $1 million or if contributed to an employee pension plan, an employee stock ownership plan, or other similar plans.
The tax would not apply if repurchases were treated as a dividend. It would not apply to repurchases by regulated investment companies (RICs) or real estate investment trusts (REITs). It also would not apply to purchases by a dealer in securities in the ordinary course of business. The excise tax would apply to purchases of corporation stock by a subsidiary of the corporation (i.e., a corporation or partnership that is more than 50% owned by the parent corporation). The tax would also apply to purchases by a U.S. subsidiary of a foreign-parented firm. It would apply to newly inverted (after September 20, 2021) or surrogate firms (i.e., firms that merged to create a foreign parent with the former U.S. shareholders owning more than 60% of shares).
In general, excise taxes can be deducted to determine profits subject to the corporate tax, so that the tax is reduced by the corporate tax rate (21%). That is, for a profitable corporation each dollar of excise tax reduces profits taxes by 21 cents. The language specifies that this tax would not be deductible, so there would be no corporate profits tax offset.
You probably noticed that this summary describes the House version of the bill, but the Senate version appears to be the same. The rationale for the excise tax – beyond the horse trading required to get Senator Krysten Sinema (D – Ariz.) to support the legislation – is that dividends and repurchases should have similar tax consequences. This excerpt from the Center on Budget Policy and Priorities’ statement on the legislation summarizes that position:
Dividends are generally taxable when shareholders receive them. Under a stock buyback, in contrast, shareholders who sell their shares to the corporation at a gain owe capital gains tax but shareholders who don’t sell their shares — typically the overwhelming proportion — see the value of their shares rise but don’t pay tax on the gain until they sell. Their wealth increases but their taxes don’t. By imposing a 1 percent excise tax on share buybacks, this provision is designed to correct this tax policy inefficiency.
The legislation now goes back to the House, where it is expected to pass and subsequently be signed into law by President Biden. Check out this resource for more technical details on the legislative process.
While companies and stockholders are extremely fond of stock buybacks, many other people don’t think as highly of them. In fact, a lot of commentators are vehemently opposed to them. For instance, this excerpt from a 2020 HBR article essentially says that they’re something that only a Bond villain could love:
With the majority of their compensation coming from stock options and stock awards, senior corporate executives have used open-market repurchases to manipulate their companies’ stock prices to their own benefit and that of others who are in the business of timing the buying and selling of publicly listed shares. Buybacks enrich these opportunistic share sellers — investment bankers and hedge-fund managers as well as senior corporate executives — at the expense of employees, as well as continuing shareholders.
Critiques like these have gotten some traction, and to a certain extent are reflected in the SEC’s recent proposals for additional disclosure on buybacks. While I doubt that Ernst Blofeld would oppose a buyback of SPECTRE’s stock, a couple of recent studies have popped up suggesting that buybacks aren’t bad, just mostly misunderstood. The first study, from three finance profs, says that critics who side with the views expressed in the HBR article have it all wrong. Here’s an excerpt from the abstract:
Repurchases account for a tiny fraction of the trading volume in a typical stock, making their price impact too small to facilitate short term price manipulation. Price appreciation following repurchases is modest and does not reverse on average, suggesting prices increase due to repurchases signaling firms’ good prospects. Also, we find no evidence that CEOs of repurchasing firms are paid excessively or that repurchases crowd out valuable investment opportunities.
The second study, from the Bipartisan Policy Center, says that greater attention should be paid to the good things that buybacks enable companies to accomplish, and that repurchases should be evaluated under a dynamic approach that takes into consideration the best ways to ensure the most efficacious use of capital in the U.S. economy:
When one looks at repurchases through a dynamic, instead of a static, approach, the benefits appear to have a much broader impact on society. Repurchases provide investors, including those beneficiaries with 401ks and pensions that are invested market wide, with additional financial resources that they otherwise would not have had. These additional resources may in turn be reinvested or saved, which can provide needed capital for small companies and others to facilitate innovation and growth.
Your mileage may vary when it comes to the arguments on the relative merits of stock repurchases, but there’s one thing that nobody’s arguing about – the amounts involved are huge & getting bigger all the time. According to S&P Global, buybacks by companies in the S&P 500 during the first quarter of 2022 were $281.0 billion. That’s a 4% increase over the record $270.1 billion expended during the 4th quarter of 2021. Furthermore, S&P said that over the 12-month period ending in March 2022, companies spent a record $985 billion on buybacks, up 97.2% from the prior12-month period’s $499 billion.
I’m generally agnostic about buybacks, but those numbers give me pause, because at their current rate, they suggest that our largest public companies can’t more productively deploy nearly $1 trillion of their assets per year in their own businesses. The magnitude of those numbers makes me wonder whether buybacks are a solution to a capital misallocation problem or whether they’re just evidence that our capital markets have a huge capital misallocation problem.
In the May-June 2022 issue of The Corporate Counsel, we covered the disclosure implications of the war in Ukraine and the SEC’s guidance on the topic in the form of a Sample Comment Letter (you can also listen to a Deep Dive with Dave podcast on this topic). We continue to see comments from the Staff that are very much focused on this topic, and the WSJ recently reported on Corp Fin’s efforts in this area using data from Audit Analytics. The article notes that the Staff has pressed several issuers about the financial impact of the ongoing war and their level of continuing investment in Russia, Belarus and Ukraine. As discussed in the Sample Comment Letter, the Staff has particularly noted that companies should provide detailed disclosure, “to the extent material or otherwise required,” regarding:
Exposure to Russia, Belarus or Ukraine, either directly or indirectly, through the company’s operations, employee base, investments in Russia, Belarus or Ukraine, securities traded in Russia, sanctions against Russian or Belarusian individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting Russia or Belarus;
The company’s reliance on goods or services sourced, directly or indirectly, in Russia or Ukraine or, in some cases, in countries supportive of Russia;
Any actual or potential disruptions in the company’s supply chain; or
Business relationships, connections to, or assets in, Russia, Belarus or Ukraine.
The war in Ukraine is also intertwined with global economic conditions, and we have noted that the Staff is particularly focused on disclosure about the impact of these economic conditions on public companies. In particular, in recent comment letters the Staff has been seeking additional disclosure about supply chain disruptions brought about by the war in Ukraine and the lingering effects of the global pandemic, as well as risk factor and MD&A disclosure regarding the impact of inflation and higher interest rates. We predicted the Staff’s focus on disclosure about inflation in the November-December 2021 issue of The Corporate Counsel:
One topic that had largely gone the way of the dinosaur in risk factor disclosure and in MD&A has been the impact of inflation, obviously because we have lived in a particularly prolonged period of very low inflation and interest rates. As the negative impact of inflation has waned from our collective consciousness, the need for specific disclosure about inflation has likewise diminished over time. This is perhaps demonstrated by the fact that Item 303 of Regulation S-K included a specific requirement to address inflation up until a year ago, when the SEC felt comfortable turning to a more principles-based approach because having a specific requirement referencing inflation and changing prices “may give undue attention to the topic.”
As revised, Item 303 still requires companies to discuss the impact of inflation or changing prices if they are part of a known trend or uncertainty that had, or is reasonably likely to have, a material impact on net sales, revenue, or income from continuing operations. Further, Item 303 requires that, where the financial statements reveal material changes from period-to-period in one or more line items, companies must describe the underlying reasons for these material changes in quantitative and qualitative terms, which could result in a discussion of inflation and changing prices.
Rising prices in many sectors, whether ultimately transitory or more permanent, could have a significant impact on the results of operations and financial condition of public companies, and as a result we expect to see more discussion of this topic in both risk factors and MD&A. Some companies may choose to include a separate risk factor regarding risks from inflation, or rather incorporate the discussion into the broader topic of general economic risks. We also expect the inflationary trend to prompt more discussion of the risks associated with rising interest rates, including the risk of increased costs of variable rate debt and refinancing risks for fixed rate debt.
We expect that the Staff may be focused on risk factor and MD&A disclosure about inflation in its upcoming filing reviews, to see if companies heeded the guidance from the adopting release for the 2020 MD&A amendments that such matters must still be addressed even absent the specific line item requirement when such matters represent a known trend or uncertainty that had, or is reasonably likely to have, a material impact on net sales, revenue, or income from continuing operations.
Finally, the Staff’s comments continue to focus on non-GAAP financial measures, including in particular non-GAAP financial measures that seek to adjust for the impact of the war in Ukraine, supply chain issues and inflation or other economic fallout. I often analogize the Staff’s level of interest in non-GAAP financial measures to a swinging pendulum, and it certainly seems from recent comment letters that the pendulum has swung into heightened scrutiny mode in recent months. You can find a comprehensive overview of recent non-GAAP financial measure comments in the September-October 2021 issue of The Corporate Counsel.
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I look forward to joining Mark Borges, Principal, Compensia and Editor, CompensationStandards.com; Ron Mueller, Partner, Gibson Dunn & Crutcher LLP; and Greg Arnold, Managing Director, Semler Brossy for our upcoming webcast on CompensationStandards.com titled “Executive Compensation & Equity Trends in a Volatile Environment.” The webcast will take place on Tuesday, August 16 from 2:00 to 3:00 pm eastern time. This promises to be a very interesting discussion of the compensation challenges that we are all facing in the midst of volatile financial markets.
As I recently noted in the May-June 2022 issue of The Corporate Executive, for the many companies that utilize equity as a key component of their overall employee, director and executive compensation programs, the current spate of volatile markets can upset carefully laid plans and programs. For the participants in those equity compensation programs, volatile markets can create a whole host of issues that must be carefully considered. In that issue of The Corporate Executive, we address the approach that often rears its ugly head in times of significant market volatility: option repricing. The practice of option repricing has long been disfavored by institutional investors and proxy advisory firms, but companies can find themselves attracted to the approach when stock prices drop for an extended period of time. We also revisit the topic of hedging and pledging of company stock by directors and executives, given how that topic comes into sharper focus when stock prices decline, and we explore some of the issues that market volatility can cause when implementing Rule 10b5-1 plans.
As we continue to face volatile markets, our CompensationStandards.com webcast and The Corporate Executive will provide you with the information and tools that you need to respond to your clients, management and directors. If you are not already a member of CompensationStandards.com with access to all of the great resources available on that site, sign up now and take advantage of our no-risk “100-Day Promise” – during the first 100 days as an activated member, you may cancel for any reason and receive a full refund. The prices for an annual membership increase on September 1st, so act now to lock in the best deal! If you do not subscribe to The Corporate Executive, please email us at sales@ccrcorp.com or call us at 800-737-1271.
The SEC recently announced the appointment of Anthony (Tony) C. Thompson to a second term as a Board Member of the PCAOB. Thompson joined the Board at the beginning of this year, and his second term will run until October 24, 2027.
It is hard to believe it is that time of year already – yesterday ISS announced the launch of its Annual Global Benchmark Policy Survey, which is a key part of the overall process for formulating potential policy changes. The survey is slated to close on August 31, 2022, at 5pm ET.
This year’s survey includes a number of questions concerning climate change risk management, including climate-related board accountability, climate transition plans and management “say on climate” resolutions, climate risk as a critical audit matter, and financed emissions for companies in the financial sector. For the U.S. market, the survey includes questions that cover potential benchmark policy exemptions for multi-class capital structures, handling of problematic governance structures, and views on calls for third-party racial equity and civil rights audits.
In addition to the annual policy survey, ISS will conduct regional and topic-specific roundtables and conference calls as part of its annual policy development process, and will then publish for comment the major final proposed changes to ISS policies for 2023.
Effective August 1, the Delaware General Corporation Law has been amended to reflect several significant changes. As this Wilson Sonsini memo notes, the changes will allow Delaware corporations to adopt charter provisions to exculpate officers from personal liability in certain contexts, and the amendments will also give corporations greater flexibility in delegating authority to officers and others to grant stock options and other rights to acquire stock. With regard to the exculpation provision, which John blogged about back in April, the memo notes:
In recent years, stockholder plaintiffs have increasingly named officers as defendants in fiduciary duty litigation. This is in part because officers have historically lacked certain protections that directors have—including insofar as the DGCL long provided that a corporation’s charter could exculpate directors from personal liability for breaches of the fiduciary duty of care but did not authorize such exculpation for officers. Effective August 1, Delaware corporations now can adopt charter provisions that will, in effect, allow officers to be exculpated from breaches of the fiduciary duty of care in certain contexts. Notably, under the amendments, officers now can be exculpated for direct claims by stockholders, which commonly arise in the M&A context. The new amendments will not permit such exculpation of directors in the context of derivative claims, brought by or in the right of the corporation. The statute further provides that the officers who may be exculpated in this manner are only officers who at the time of an act or omission as to which liability is asserted are deemed to have consented to service of process to the registered agent of the corporation as contemplated by 10 Del. C. § 3114(b) (generally, executive officers, officers identified in the corporation’s SEC filings as one of the corporation’s most highly compensated executive officers at the time of alleged wrongdoing, and officers that have agreed in writing to constitute an officer for this purpose). Despite these limitations, the incremental protection available under the amendments should be helpful for officers and in mitigating certain types of stockholder litigation.
On the equity award front, the DGCL amendments harmonize the statutory provisions for issuing stock and granting options and other rights. Under these amendments, the board or a board committee can now permit officers and other agents to have expanded authority in the context of granting options and rights, subject to certain parameters. These changes will provide increased flexibility in designing and implementing equity award plans.
Under the recently effective amendments to the DGCL, a corporation’s stockholder list will no longer need to be made available for inspection during a meeting of stockholders, but it will still need to be available for inspection for a 10-day period prior to the meeting. Further, the appraisal statute has been amended to allow a beneficial owner of stock to demand appraisal directly instead of relying on the record holder, and the stockholder approval required to convert a Delaware corporation to a foreign corporation or any other entity has been lowered from unanimous approval to majority approval. The DGCL amendments also make various adjustments to ease the process for non-United States entities to domesticate to Delaware.
In the latest Deep Dive with Dave podcast, John and I talk about the topics we cover in the July-August 2022 issue of The Corporate Counsel. We discuss the SEC’s recent proxy advisory firm and Rule 14a-8 rulemaking, lessons from case law addressing forward-looking statements and auditor independence. Thanks for listening to the Deep Dive with Dave podcast!
If you do not subscribe to The Corporate Counsel, please email us at sales@ccrcorp.com or call us at 800-737-1271.