Rule 10b-18: The Safe Harbor for Stock Repurchases

A stock repurchase, often called a buyback, occurs when a publicly traded company buys its own shares from the open market. Companies engage in these programs for various reasons, such as returning excess cash to shareholders or signaling that management believes the stock is undervalued. A buyback reduces the number of outstanding shares, which can increase earnings per share and the market value of the remaining shares.

However, these large-scale purchasing programs can create the appearance of unusually high trading volume or artificially influence the stock’s price, raising concerns about market manipulation. The potential for a company to create apparent active trading to induce others to buy a security prompted the creation of a regulatory framework for legitimate repurchase programs.

The Safe Harbor Provision

Rule 10b-18 of the Securities Exchange Act of 1934 provides a “safe harbor” for companies conducting stock repurchases. This provision is not a blanket immunity from securities laws but offers protection from liability for market manipulation under Section 9(a)(2), Section 10(b), and Rule 10b-5. This protection is conditional, applying only when the company’s repurchases strictly adhere to prescribed operating conditions.

By following the rule’s specific guidelines, a company can proceed with a buyback program with greater confidence that its actions will not be legally challenged as manipulative. The safe harbor is non-exclusive, meaning companies are not required to follow its conditions.

A company choosing to operate outside of these conditions does not automatically violate anti-manipulation rules. If a company’s repurchases meet all four conditions of the rule on a given day, it is presumed that those transactions were not manipulative. Failure to meet even one condition for that day means the safe harbor protection is lost for all repurchases made on that day.

Conditions for Safe Harbor Protection

To qualify for the safe harbor, a company’s repurchase activities must satisfy four specific conditions each day concerning the manner, timing, price, and volume of the purchases. These conditions are designed to minimize the market impact of the buybacks.

Manner of Purchase

The manner condition dictates how a company can make its purchases on any single trading day. To avoid creating the appearance of widespread, active trading, the rule requires an issuer to use only one broker or dealer for its bids and purchases.

An issuer may purchase shares from more than one broker in a day if the transactions are not solicited by the company. The company itself cannot be actively creating bids across multiple platforms or firms simultaneously.

Timing of Purchase

The timing condition restricts when during the trading day a company can repurchase its shares. A company cannot make a purchase that constitutes the opening transaction for its security. For most securities, repurchases are also not permitted within the last 30 minutes of the scheduled close of the primary trading session.

For securities that are actively traded, defined as having an average daily trading volume (ADTV) of at least $1 million and a public float value of at least $150 million, this restriction is shortened. These companies are only prohibited from making repurchases during the last 10 minutes of trading.

Price of Purchase

The price condition prevents a company from using its buybacks to drive up its stock price. A company cannot purchase its shares at a price that is higher than the highest current independent bid or the last independent transaction price, whichever is greater. The bid or transaction must be “independent,” meaning it was not made by the company or an affiliated purchaser.

For instance, if a company’s stock has a highest independent bid of $50.10 and the last sale occurred at $50.12, the company may repurchase shares at a price up to $50.12. If it were to place a bid at $50.13, it would violate the price condition for that day’s trades. This ensures the company is a price-taker, not a price-setter.

Volume of Purchase

The volume condition limits the number of shares a company can repurchase on a single day. A company’s total purchases on any given day cannot exceed 25% of the average daily trading volume (ADTV) for its stock. The ADTV is calculated based on the four calendar weeks preceding the week of the repurchase, which prevents a company from dominating the market.

As an alternative, a company may make one block purchase per week, so long as it makes no other repurchases on that same day. A block is defined as a quantity of stock with a purchase price of $200,000 or more, or at least 5,000 shares with a purchase price of at least $50,000. This single block purchase is not counted toward the 25% ADTV limit.

Scope and Exclusions of the Rule

The safe harbor is available exclusively for an issuer’s open-market purchases of its own common stock. This includes equivalent securities like depository shares that represent common stock. The rule is intended to regulate ordinary, daily trading activity on a public exchange.

The rule explicitly excludes several types of transactions from its safe harbor protection. Companies cannot rely on it when engaging in these activities:

• Purchases made as part of a tender offer, which are formal, public solicitations governed by a different set of SEC regulations.
• Privately negotiated repurchases that are off-market transactions directly arranged between the company and a shareholder.
• Repurchases made in connection with a merger, acquisition, or similar business combination.
• Purchases of other classes of a company’s securities, such as preferred stock, warrants, or convertible debt.

Consequences of Non-Compliance

Failing to meet the conditions of Rule 10b-18 does not automatically result in a finding of market manipulation. The consequence of non-compliance is the loss of the safe harbor’s protections for that day’s trades. This means the company can no longer benefit from the presumption that its activities were not manipulative.

Without the safe harbor, the burden of proof shifts. If the Securities and Exchange Commission (SEC) investigates the company’s trading activity, the company must affirmatively demonstrate that its purchases were not manipulative.

A company that complies with the rule’s conditions can point to its adherence as evidence that it acted in accordance with guidelines designed to prevent manipulation. The SEC has stated that no negative inference should be drawn from a company’s decision not to use the safe harbor. However, the practical effect of losing the safe harbor is a loss of regulatory certainty and an increased legal risk if its trading practices are scrutinized.