The Securities and Exchange Commission recently proposed amendments to Rule 10b-18 under the Securities Exchange Act of 1934. The proposed amendments are intended to modernize Rule 10b-18 to reflect changes in the market since the Rule’s adoption.
Overview of Rule 10b-18. As currently written, Rule 10b-18 provides a safe harbor from liability for market manipulation if an issuer purchases its common stock in accordance with the rule. To come within the safe harbor on any given day, an issuer must satisfy the manner of purchase, timing, price and volume conditions of Rule 10b-18. Failure to meet any one of the four conditions disqualifies from the safe harbor all of the issuer’s purchases on that day.
The manner of purchase condition requires that an issuer use a single broker or dealer per day to purchase its shares if the purchases are solicited by or on behalf of the issuer. Rule 10b-18 permits the use of a different broker for after-hours purchases. The timing condition prohibits an issuer from being the opening (regular way) reported purchase in the consolidated system, and from purchasing its securities during the last half hour (or last 10 minutes for actively-traded stocks) before the scheduled close of trading on the principal market for the securities and in the market where the purchase is made. The price condition limits an issuer to bidding for or buying its stock at a price (excluding commissions) which is no more than the higher of the highest independent bid or last independent transaction price. Finally, the volume condition prohibits an issuer from purchasing in excess of 25 percent of the issuer’s average daily trading volume (ADTV) for the prior four calendar weeks. Once a week, in lieu of purchasing under 25 percent of its ADTV, an issuer may purchase one “block” of its common stock, as defined in Rule 10b-18.
Timing Condition. The proposal would exclude from the Rule 10b-18 safe harbor an issuer purchase which is the opening purchase in (i) the principal market for the security and (ii) the market where the purchase is effected, in addition to in the consolidated system, as under the current rule. Under the current rule, an issuer may be the opening purchase on its principal market as long as there is an earlier purchase reported on the consolidated system. The Commission believes that opening transactions in the principal market for an issuer’s shares and in the market where the purchase is effected can be a significant indicator of trading in that security and believes that the additional limits are consistent with the objectives of the safe harbor — to minimize market impact of an issuer’s purchases.
The Commission seeks comments on a number of questions in the proposal, including whether the opening purchase timing restriction should also apply to purchases on the OTC Bulletin Board and Pink Sheets, which currently are not subject to this restriction because these markets don’t have an official opening of trading.
Price Condition. The proposal would ease the price condition for certain transactions which are effected based on Volume Weighted Average Price (VWAP). Because VWAP trades are priced on the basis of individual trades executed throughout the trading day, an issuer’s VWAP trade might exceed the greater of the highest independent bid or last independent transaction price on the consolidated system for that security, which would not satisfy the current price condition and thus would be outside the Rule 10b-18 safe harbor. The proposal would except from the price condition 10b-18 purchases made on a VWAP basis if: (i) the security qualifies as “actively traded,” as defined in Rule 101(c)(1) of Regulation M, meaning the security has an ADTV of at least $1 million and a public float of at least $150 million; (ii) the VWAP purchase is entered into or matched before the regular trading session opens and the price of the VWAP matched trade is determined based on a full day’s trading volume; (iii) the VWAP purchase does not exceed 10% of the ADTV; and (iv) the purchase is not effected for the purpose of creating actual, or apparent, active trading in or otherwise affecting the price of the security. VWAP will be calculated as provided in the proposal and the VWAP trade must be reported with a special trade modifier to indicate to the market that the trade is unrelated to the current or closing price of the security.
Among other things, the Staff has sought comment on other types of passive pricing mechanisms, including the mid-point of the national best bid and offer.
Limitation on Disqualification. Under current rules, if one issuer purchase fails to meet the Rule 10b-18 safe harbor, all other issuer purchases that day are disqualified from the safe harbor. The Commission has recognized that the speed of markets has made it difficult for an issuer to ensure that every purchase it effects during the day meets the Rule 10b-18 price condition. Specifically, “flickering” bid quotes, where there are many, and very fast, changes in the current national best bid price during the time that the issuer or its broker identifies the current national best bid and executes the purchase, can result in a particular issuer purchase failing the price condition and resulting in disqualification from the safe harbor of all purchases made that day. Accordingly, as proposed, in situations where an issuer purchase falls outside the price condition solely due to flickering quotes, only the non-compliant purchase, rather than all other purchases made that day, will be disqualified from the safe harbor.
Merger Exclusion Extended in SPAC context. Finally, the proposal would extend the time in which the Rule 10b-18 safe harbor is unavailable in connection with an acquisition by a special purpose acquisition company (SPAC) until the completion of the SPAC’s stockholder vote, in addition to the vote of the target’s stockholders, as under current rules. According to the proposal, this change is consistent with a goal of the current rules, namely to make the safe harbor available to an issuer only during those times when there is no special event that might affect an issuer’s purchasing practices. The stated purpose of the change is to prevent use of the safe harbor where there is a strong incentive for a SPAC to make substantial purchases of its stock solely to ensure it receives a favorable stockholder vote on its acquisition.
The new rules would not affect a SPAC’s ability to purchase its securities pursuant to the safe harbor, subject to Regulation M’s restricted period and any other restrictions, so long as the total of the SPAC’s purchases on any day do not exceed the lesser of (i) 25 percent of the SPAC’s ADTV or (ii) the SPAC’s average daily Rule 10b-18 purchases during the three months prior to the merger announcement. The SPAC may also make block purchases as long as it does not exceed the average size and frequency of block purchases made under Rule 10b-18 during that same three-month period. As a practical matter, however, these are still significant limitations on the ability of SPACs to purchase their shares because SPACs are unlikely to purchase their shares until shortly before the stockholder vote on a business combination, at which time the three-month average size of block trades is likely to be smaller and the three-month average frequency of block trades is likely to be less than the size and frequency of block trades the SPAC would wish to execute in order to influence the outcome of the stockholder vote.
Although the proposal states that open market purchases by SPACs may have the effect of supporting and/or raising the market price of SPAC shares, the proposal offers no support for this statement. Rather, the proposal seems to introduce a new concept into the traditional definition of market manipulation by providing that SPAC purchases effected to influence the outcome of a stockholder vote regarding a SPAC business combination, absent any intent to affect the price of the shares, may raise market manipulation concerns and thus may not be effected pursuant to the safe harbor. This departure from traditional notions of market manipulation may reflect a more fundamental concern of the Division of Trading and Markets with activities undertaken by some SPAC management teams to obtain stockholder approval of a business combination.
The proposed amendments to the price condition and the disqualification provisions will likely be welcome by issuers and brokers who have been challenged by the evolution of market practices and technology, but the amendments to the timing condition and the restrictions on SPACs could result in fewer opportunities for issuers to purchase their own shares under the safe harbor. Comments are due March 1, 2010, and the proposing release may be found at http://www.sec.gov/rules/proposed/2010/34-61414.pdf.
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This article was originally published by Bingham McCutchen LLP.