By John McCrank
NEW YORK, April 27 (Reuters) - U.S. companies are on track
to buy back a record amount of their own stock this year, but a
decades-old markets rule aimed at preventing manipulation makes
these trades easy to game and has probably cost companies
billions in recent years.
Stock buybacks were banned in the United States until 1982,
when rules were set as to how companies could repurchase their
shares without falling afoul of anti-manipulation provisions.
But the "safe harbor" rules have not been revised since 2003
and critics say they do not reflect the electronic, fragmented
nature of today's markets, which makes share repurchase orders
easy to spot and trade in front of by high-speed trading firms,
leading to higher prices for companies that buy back stock.
"Everybody knows there is a corporate order flow so they
front-run it and that just pisses me off because they will raise
the price high enough where then they will sell it back to me.
That's just not fair," Gary Barth, assistant treasurer at United
Parcel Service Inc, told Reuters.
UPS has a $1 billion share repurchase program in place this
year and has bought back around $15.3 billion of its own stock
Under a condition of the U.S. Securities and Exchange
Commission's Rule 10b-18, companies must bid to buy back their
stock at the last purchase price set by another investor or at
the best bid available in the market. But they cannot buy shares
at the best offer available, because that could cause the
company's shares to move and be deemed manipulative.
Given that companies must announce their repurchase plans,
the restrictions make it easier to detect stock buyback
activity, said Ted Morgan, chief executive officer of brokerage
Abel Noser, which executes share buybacks on behalf of corporate
"It's a lot easier than it is to detect other types of
institutional flow," he said.
Since 2010, S&P 500 companies have spent nearly $4 trillion
on share buybacks, according to S&P Dow Jones Indices. (Graphic:
Based on buyback announcements so far, 2018 repurchases are
expected to "smash totals from all other previous years" in the
wake of the tax-cut bonanza companies received under the Trump
administration, according to research firm TrimTabs.
There are no estimates how much high-speed traders make, but
even if the difference in price is mere pennies, exploiting the
buyback vulnerability can translate into huge profits, while
doing nothing for others in the market and effectively forcing
companies to waste some of the buyback money because they cannot
mask their activities.
FLASH BOYS PETITION
Exchange operator IEX Group has petitioned the SEC to let
firms buying back shares do so using hidden orders that only
execute at the midpoint between the best bid and the best offer.
That would make it difficult to move the stock price while
making the activity harder to spot.
"The change we are arguing for could save public companies
millions of dollars or more in execution costs," IEX CEO Brad
Katsuyama said in a statement to Reuters.
The share buyback petition is the latest cause taken up by
IEX, which launched its exchange in August 2016 and was earlier
featured in Michael Lewis's book "Flash Boys: A Wall Street
Revolt," which followed Katsuyama and his colleagues as they set
out to create a market that they saw as fairer to investors.
The exchange features a so-called speed bump that slows down
trades to prevent the fastest traders in the market from trading
ahead of slower investors. Like other exchanges, and private
markets known as dark pools, it also features midpoint order
Because those order types are hidden, it would make it much
more difficult for trading firms' algorithms to spot buyback
trading patterns, accumulate the shares and then sell them back
to the issuer at successively higher last sale prices.
The SEC declined to comment on the petition, but had itself
suggested allowing midpoint share buybacks in 2010 as part of a
proposed revamp of the safe harbor rules.
But the proposal was dropped in the wake of the May 2010
stock market flash crash, which, along with Dodd-Frank rule
making following the financial crisis, overwhelmed the
Eight years later, UPS's Barth said he is still waiting for
the SEC to take action.
Current SEC Chairman Jay Clayton said on April 10 that the
regulator "should listen to investors and market participants
about where Commission rules are, or are not, functioning as
intended," and do retrospective reviews on those rules.
"The time has come," Barth said. "They still haven't done
anything. Come on guys, help a poor guy out here. Let's get into
the 21st century!"
(Reporting by John McCrank)
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