On October 31, the U.S. Court of Appeals for the Fifth Circuit (Fifth Circuit) issued an opinion finding that the U.S. Securities and Exchange Commission (SEC) violated the Administration Procedure Act when adopting recent amendments to its share repurchase rules (as amended, the Rule). Rather than vacate the Rule, the Fifth Circuit provided the SEC with 30 days to correct the errors identified by the Fifth Circuit.
The Rule, adopted by the SEC on May 3, 2023, requires, among other things, the following:
- Reporting of daily repurchase activity in a new exhibit to Forms 10-K and 10-Q.
- Enhanced narrative disclosure regarding an issuer’s repurchase programs and practices in Forms 10-K and 10-Q, including the rationale and objectives for share repurchase plans.
- A checkbox disclosure above the trading activity tabular disclosure indicating whether Section 16 officers and directors purchased or sold shares that are the subject of an issuer share repurchase plan within four business days before or after the announcement of that plan.
- Tagging of share repurchase information using inline XBRL.
In May 2023, shortly after adoption of the Rule, the Chamber of Commerce of the United States, the Longview Chamber of Commerce, and the Texas Association of Business (collectively, petitioners) filed a petition with the Fifth Circuit on May 11, 2023, in which the petitioners claimed that, among other things, the SEC violated the Administrative Procedure Act by not adequately responding to petitioners’ comments during the rulemaking process and not adequately substantiating the Rule’s purported benefits.
Fifth Circuit Opinion
The Fifth Circuit found that the SEC did violate the Administrative Procedure Act by not doing the following:
- Adequately responding to petitioners’ comments, including suggestions for how the SEC could quantify its economic implications analysis.
- Adequately substantiating the Rule’s purported benefits.
Failure to Respond to Comments
The petitioners provided the SEC with three principal suggestions during the comment period that explained how the SEC could quantify the proposed Rule’s effects. Because all three of petitioners’ suggestions provided information that would help quantify the Rule’s expected costs and benefits, the Fifth Circuit ultimately held that the “SEC—by continuing to insist that the [R]ule’s economic effects are unquantifiable in spite of petitioners’ suggestions to the contrary—has failed to demonstrate that its conclusion that the proposed [R]ule ‘promote[s] efficiency, competition, and capital formation’ [and] is ‘the product of reasoned decisionmaking,’” as is required under the Administrative Procedure Act.
Failure to Substantiate the Rule’s Benefits and Costs
In addition to adequately responding to comments, the Administrative Procedure Act also requires that an agency must consider the costs and benefits associated with a regulation to ensure such regulation is not arbitrary and capricious. As part of that cost-benefit analysis, the Fifth Circuit noted in a previous decision that the SEC must identify the benefits that “bear a rational relationship to the…costs imposed” (quoting Mexican Gulf Fishing, 60. F.4th at 973 (citing Pub. Citizen v. EPA,343 F.3d 449, 455 (5th Cit. 2003))). While the SEC argued the Rule primarily helps investors “better evaluate whether a share repurchase was intended to increase the value of a firm” or for an improper purpose such as “providing additional compensation to management,” the Fifth Circuit agreed with the petitioners’ assertion that the SEC’s adopting release did not substantiate its proposition that improperly motivated share buybacks are an issue.
Implications of the Fifth Circuit’s Decision
Rather than vacate the Rule, the Fifth Circuit provided the SEC with 30 days to remedy the deficiencies identified above. The SEC is currently considering the opinion rendered by the Fifth Circuit. If the Fifth Circuit does not vacate the Rule, or the compliance dates related to the Rule are not otherwise delayed as a result of the ruling, public companies should continue to prepare disclosures required by the new Rule in advance of compliance dates set forth in the Rule. As set forth in the Rule, domestic issuers will be required to comply with the Rule in their Forms 10-K or 10-Q beginning with the first such filing covering the first full fiscal quarter that begins on or after October 1, 2023.
We are monitoring this matter and will provide any updates as they are available. If you have any questions about the Rule, please contact the authors or your relationship attorney.