While corporate stock buybacks, as well as dividend payments, are receiving significant scrutiny in the face of the coronavirus pandemic as companies look to preserve cash, the same is not currently true for stock purchases by corporate insiders. The Wall Street Journal reported on March 26, 2020, that more than 2,800 executives and directors had purchased nearly $1.19 billion in company stock since the beginning of March, representing the third-highest level on both an individual and dollar basis since 1988, citing data sourced from the Washington Service, a firm that provides data analytics about trading activity by insiders. CNBC, which also reported on the significant recent insider buying activity, noted that the insider buying has not been limited to corporate executives and directors, but that some private equity firms have also been buying shares of their publicly traded investee companies.
Given this recent activity and the potential for further significant insider buying due to current equity valuations, we thought it would be useful to highlight certain considerations for officers, directors and other insiders of public companies who would like to purchase their company’s shares. The discussion that follows is largely focused on open market purchases; however, at the end of this client alert we also discuss certain additional considerations in connection with privately negotiated purchases directly from the company.
Evaluation of Material Non-Public Information. Before engaging in a share purchase, an insider should evaluate whether they possess material non-public information (MNPI) that could affect the insider’s ability to purchase shares. Even when executing a share purchase in an open window period under an insider trading policy, as with any transaction in securities, an insider needs to consider whether they have MNPI that might restrict their ability to trade. Depending on the circumstances, this can include visibility on upcoming financial results or the issuer’s liquidity position; knowledge of pending material transactions such as acquisitions, divestitures or financing activities; information pertaining to relationships with customers, distributors, suppliers, collaborators and other third parties; and other undisclosed material corporate developments or information. MNPI can include not only information obtained from the issuer but also information obtained from third parties. A private equity firm or other institutional investor looking to purchase shares in an investee company needs to consider whether they have received MNPI from the investee company. And if a private equity firm or other institutional investor has a representative on the board of directors of the investee company, they should consider whether they might be “tainted” by information that the board member has received, or whether they have appropriate safeguards in place, including information barriers, to try to mitigate that risk.1
Insider Trading Policy. Before executing a trade, an insider should make sure they comply with the issuer’s insider trading policy. In addition to complying with trading window restrictions, as noted above, insiders must ensure they are not restricted by the possession of MNPI at the time of the trade and that they comply with any pre-trade clearance process provided for by the policy. Private equity and other institutional investors who are seeking to purchase stock of an investee company should review the company’s insider trading policy to determine whether they may be subject to the policy themselves, whether by virtue of having a representative on the company’s board of directors or because the policy captures affiliates.
Section 16; Existing Rule 10b5-1 Stock Sale Plans. Insiders who are subject to Section 16 reporting and short-swing profit disgorgement obligations (generally, directors, executive officers and 10% beneficial shareholders) should confirm that they have no matchable opposite-way sale transactions in the past six months that could give rise to short-swing profit disgorgement, be prepared to hold their shares for at least six months, and ensure that they timely file their Form 4. Insiders should also consider whether they will need to engage in any sale transactions in the following six months (for example, a need to sell shares in the open market upon vesting of an equity award in order to satisfy the tax withholding requirement). To the extent the insider has an existing Rule 10b5-1 stock sale plan in place, the insider should consider whether past or potential future sales under the plan could constitute matchable transactions under Section 16; if such a sales plan is in place, the insider should consider whether to terminate, suspend or modify the plan, and consider the potential implications of doing so (for example, whether any such termination, suspension or modification, or the timing of the same, might call into question the availability of the Rule 10b5-1 safe harbor for past or future transactions under the plan).
13D/13G Updating Disclosure. For an insider who beneficially owns more than 5% of the issuer’s common stock and reports those holdings on a Schedule 13D or Schedule 13G, the insider should consider whether there is a need to amend the applicable schedule in connection with the purchase. In the case of an insider not currently reporting on a Schedule 13D or 13G, the insider should consider whether the purchase will put the insider over the thresholds that would trigger a reporting obligation.
Purchasing Shares Using Credit/Margin. To the extent an officer or director is seeking to purchase shares through secured credit or on margin, they should be mindful of any policies the issuer may have relating to the pledging of company shares to secure loans that may apply to the proposed purchase. In addition to complying with any such policies, officers and directors should be aware that a sale by a lender of pledged shares at a time when the insider has MNPI subjects the insider to potential liability, and the pledge does not qualify as a Rule 10b5-1 trading plan.
Restrictions in Governing Agreements and Other Contracts. For private equity and other institutional investors looking to purchase shares in an investee company, they should consider whether the purchase is subject to any restrictions or limitations pursuant to their governing documentation and agreements (such as limitations on purchasing shares in a public company).
Change of Control Provisions in Contracts. The insider should be mindful of whether the issuer has any change of control provisions in its debt agreements or other material contracts that could be triggered by the purchase as a result of the purchaser crossing change of control thresholds as defined in the issuer’s agreements.
Ownership Limitations. The purchaser should consider whether ownership of the issuer’s common stock is subject to ownership limitations that may be implicated by the purchase; for example, where the issuer is a real estate investment trust (REIT) or where ownership limitations may apply due to industry, foreign ownership or other applicable regulations.
Rights Plan/DGCL Section 203. The insider should consider whether the issuer has a rights plan (i.e., poison pill) that could be triggered by the share purchase. In addition, the insider should consider, if applicable, whether the purchase will result in the insider crossing “interested stockholder” ownership thresholds under Section 203 of the Delaware General Corporation Law (15% of outstanding voting stock), or have implications under other applicable state business combination or anti-takeover statutes.
HSR. Depending on the current ownership position of the insider and the amount of the contemplated purchase, consideration should be given as to whether a Hart-Scott-Rodino (HSR) filing may be required in connection with the contemplated purchase. While numerous factors need to be considered in determining whether an HSR filing is required, the 2020 transaction threshold for HSR filings is $94 million. As a result, if the value of shares currently owned by the insider, taken together with shares the insider desires to purchase, exceeds $94 million (calculated in accordance with HSR rules), consideration should be given as to whether an HSR filing might be required.
Rule 10b-18 Considerations When Issuer Is Also Engaged in Stock Repurchases. Insiders should consider whether they might be an “affiliated purchaser” for purposes of the Rule 10b-18 safe harbor applicable to stock purchases by an issuer and its affiliated purchasers and, if so, whether they should effect their purchases in a manner that complies with the Rule 10b-18 safe harbor. To the extent the issuer is also engaged in stock repurchases at the same time and is seeking to rely on the Rule 10b-18 safe harbor, care should be exercised such that, to the extent the insider might be an “affiliated purchaser” of the issuer, the insider’s purchase does not render the Rule 10b-18 safe harbor unavailable to the issuer.
Considerations When Issuer Is Engaged in or Contemplating an Offering of Its Securities. To the extent the issuer is engaged in or contemplating an offering or other sale of its own securities, an insider should consider limitations that may be imposed on its purchase activities as a result; for example, limitations that may be imposed by Regulation M (a regulation under the Securities Exchange Act of 1934, as amended, that restricts certain activities in an issuer’s securities when an issuer is engaged in a distribution of securities), general market manipulation considerations and fiduciary duty considerations.
Consider the Exit Strategy. Before an insider purchases shares, the insider should consider their exit strategy. The ability to sell the purchased shares at a later date will be subject to many of the same considerations that were applicable to the purchase, such as the seller not being restricted as a result of the possession of MNPI at the time of sale, needing to comply with any insider trading policy restrictions, and, in the case of a Section 16 person, evaluating whether the sale may result in short-swing profit disgorgement as a result of a matchable purchase within six months of the sale. In addition to these considerations, the purchaser should also consider any additional restrictions on their ability to sell as a result of potentially having “affiliate” status (which would generally restrict public sale transactions to Rule 144 “dribble out” sales that are subject to volume and manner of sale restrictions or to sales through a registered public offering).
Consider Implementing a Rule 10b5-1 Stock Purchase Plan. For an insider who is interested in making programmatic purchases over time and seeking to take advantage of the Rule 10b5-1 safe harbor from Rule 10b-5 insider trading liability, the insider should consider establishing a Rule 10b5-1 stock purchase plan. Such a plan can only be established at a time when an insider is not in possession of MNPI. The insider should also confirm that the plan complies with any applicable company policies.
Impact on Ability to Participate in COVID-19 or Other Government Relief and Financing Programs. Certain relief and financing programs being made available by federal and state governments to assist businesses in light of the COVID-19 pandemic restrict stock repurchases, which in some cases may extend to stock purchases by affiliates. In this regard, certain provisions of the Coronavirus Economic Stabilization Act of 2020 under the Coronavirus Aid, Relief, and Economic Stability Act, or CARES Act—including those relating to loans, guarantees and other relief being made available to passenger air carriers and related businesses, cargo air carriers, and businesses critical to maintaining national security—extend stock purchase restrictions to stock purchases by affiliates. An insider should evaluate whether any proposed purchase would be captured by any such affiliate restrictions.
Privately Negotiated Purchases From Issuer. As noted above, the foregoing discussion focuses primarily on open market purchases. To the extent an insider wants to purchase securities directly from the issuer in a privately negotiated transaction, while many of the above considerations will be applicable, there will also be different and additional considerations. While such a transaction is generally beyond the scope of this client alert, we note that in such a transaction, the parties would typically negotiate and enter into one or more agreements specifying the terms of the transaction and the securities to be purchased. Because the transaction would be a related person transaction, the issuer and its board (as well as any potentially interested directors), in connection with approving such a transaction, would want to consider the board’s fiduciary duties and the need to comply with the issuer’s related person transaction approval policies. In addition, the parties will want to ensure that the transaction complies with, or is exempt from, any applicable stock exchange shareholder approval rules and any other applicable stock exchange requirements.
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The considerations to be evaluated in connection with an insider stock purchase transaction, as well as the issues presented, tend to be very dependent on the relevant facts and circumstances. Resolving issues presented often requires the making of significant judgments. You should not hesitate to contact any of the below-named individuals or your regular WilmerHale contact if you would like to speak about any of the matters discussed in this client alert.