New SEC FAQ on Rule 10b-18

News Brief

By: Cydney Posner

The SEC has now posted a new FAQ on amended Rule 10b-18You may recall that, on November 10, 2003, the SEC adopted amendments to Rule 10b-18 that allow issuers of actively traded securities to stay in the market longer at the end of the trading day, extend the safe harbor to certain after-hours repurchases, apply a uniform pricing condition for all issuers, increase the volume limit following a market-wide trading suspension, modify the block exception and clarify the scope of the safe harbor with regard to M&A and similar transactions. The FAQ addresses issues related to coverage, the merger exclusion, riskless principal transactions and affiliated purchasers as well as the four rule conditions. Unfortunately, it does not address any of the disclosure issues arising out of the new rules.


  • The SEC emphasizes that technical compliance with the safe harbor will not protect the issuer from liability for violations of the anti-fraud and anti-manipulation provisions of the Exchange Act, such as Rule 10b-5 liability for repurchases while in possession of material, non-public information or repurchases made as part of a manipulative scheme to influence the closing price of a company's securities or to mask other motives, such as inflating or manipulating short-term earnings.
  • The safe harbor is not available for repurchases of securities other than common stock, such as preferred stock, warrants, options or convertible debt, even if related to the common stock. It applies only to open market purchases by an issuer of its common stock (or an equivalent interest, including a unit of beneficial interest in a trust or limited partnership or a depository share).
  • An issuer may effect privately negotiated repurchases (which are outside the safe harbor) without jeopardizing the availability of the safe harbor for its open market repurchases. However, the issuer must consider the applicability of the general anti-fraud and anti-manipulation provisions under the Exchange Act and of any other relevant federal or state law regarding its privately negotiated repurchases.
  • The issuer may not claim the safe harbor for repurchases made outside the United States. Foreign trading volume is not included in a security's ADTV calculation for purposes of applying the safe harbor.
  • To come within the safe harbor, repurchases must satisfy (on a daily basis) each of Rule 10b-18's four conditions. Failure to meet any one of the four conditions removes all of the issuer's repurchases from the safe harbor for that day. For example, if an issuer effects Rule 10b-18 purchases of its common stock throughout the day in accordance with the safe harbor conditions, but effects an open market purchase at the end of the day outside the safe harbor limitations, the safe harbor is lost for that day.
  • Rule 10b-18 is not exclusive and does not create a presumption of manipulation simply because the issuer's purchases do not satisfy the rule's conditions.
  • Rule 10b-18 is available for repurchases by an issuer with two separate classes of common stock publicly traded; however, the issuer must treat each class of common stock separately for purposes of the rule.
  • Rule 10b-18 does not cover privately negotiated (off-market) repurchases, nor are these shares counted in an issuer's daily volume limitation.
  • Following an IPO, an issuer may not use Rule 10b-18 until four weeks after its securities begin to trade (because the volume condition requires four full calendar weeks preceding the week in which the purchase is to be effected).
  • Rule 10b-18 applies to repurchases of OTCBB and Pink Sheet securities. However, OTCBB, and Pink Sheet securities are not reported in the "consolidated system" for purposes of applying Rule 10b-18's price condition (as compared, for example, to Nasdaq SmallCap securities). Bids and last sale prices for OTCBB and Pink Sheet securities are displayed and disseminated on an "inter-dealer quotation system" that displays at least two independent priced quotations for the security. For all other eligible securities, the issuer would need to look to the highest independent bid obtained from three independent dealers (i.e., the "three quote rule").
  • Accelerated share repurchase plans and forward contracts are private (off-market) transactions. Therefore, they are not eligible for the Rule 10b-18 safe harbor, which applies only to open market purchases. Moreover, the Rule 10b-18 safe harbor also is not available for the broker's covering transactions, as these transactions are not agency or riskless principal trades effected on behalf of the issuer.

Merger Exclusion

  • The merger exclusion contains a three full calendar month "look back" period. The calendar months run from the first of the month until the end of the month. For example, if a merger were announced on January 15, 2004, an issuer would look back to its Rule 10b-18 repurchase activity during the three full calendar months of October, November and December.
  • Under the "merger exclusion," the issuer is limited to repurchasing the lesser of 25% of the ADTV in its securities or the daily average amount of its own Rule 10b-18 repurchase activity during the three months prior to the date of announcement of the merger.
  • Following announcement of a merger, an issuer may rely on the new "one block per week" exception during this post-announcement period, so long as the issuer does so in accordance with its prior reliance on the amended "one block per week" exception during the three-month "look back" period.
  • The three-month "look back" period includes "black out" periods (i.e., for insider trading concerns) that may be self-imposed by the issuer.
  • The "merger exclusion" applies to both the acquiring company (repurchasing its own shares and the target's shares), as well as the target company (repurchasing its own shares and the acquiring company's shares).
  • If there are two different dates for the respective companies' shareholder votes, the "merger exclusion" would extend until both shareholder votes have occurred.
  • If a merger agreement has been signed, the target would be considered an "affiliated purchaser" of the acquiror with respect to purchases of the acquiror's securities.
  • For purposes of calculating the issuer's ADTV in its securities, an issuer must look to the trading in its securities during the four calendar weeks preceding the week of the repurchase. By contrast, with respect to the three-month "look back" provision, the period would be the three full calendar months prior to announcement.
  • If an issuer did not make any Rule 10b-18 purchases during the three-month period prior to the announcement of a merger or similar transaction, it would not be permitted to make any Rule 10b-18 purchases in the post-announcement period.

Riskless Principal Transactions

The safe harbor is available only for riskless principal transactions where both legs of the transaction are effected at the same price.

Affiliated Purchaser

An issuer's employee stock option plan (ESOP) [do they mean employee stock ownership plan?] that is administered by a board of directors, including officers and directors, would be deemed an affiliated purchaser of the issuer. Any purchases it effects could qualify for the safe harbor if all of the conditions are met. The ESOP's and the issuer's purchases would have to be effected through the same broker or dealer and all their repurchases would have to be aggregated to determine whether the volume limitation has been met. However, the safe harbor would not be available if the ESOP purchases are effected by or for the ESOP by an "agent independent of the issuer."

Single Broker or Dealer Condition

The "single broker or dealer" condition does not apply to purchases that are not solicited by or on the behalf of the issuer. An issuer may purchase from any number of brokers or dealers in transactions not involving a solicitation by the issuer. Although the term "solicited" is not defined in the rule, disclosure and announcement of a repurchase program would not necessarily cause subsequent purchases to be considered solicited. Whether a transaction has been solicited necessarily depends on the facts and circumstances of each case. An issuer must make all its solicited purchases through the same broker or dealer on a given day in order to comply with the "single broker or dealer" condition.

Timing Condition

  • The amended timing limitation applies an ADTV value test and a public float value test in determining how long an issuer must be out of the market before the scheduled close of trading. In calculating the dollar value of ADTV, any reasonable and verifiable method may be used. For example, it may be derived from multiplying the number of shares (i.e., publicly reported for a security during the four calendar weeks preceding the week in which the Rule 10b-18 purchase is effected) by the price in each trade, or from multiplying each day's total volume of shares by the closing price on that day. "Public float value" (i.e., the aggregate market value of common equity securities held by non-affiliates of the issuer) is to be determined in the manner set forth on the front page of Form 10-K, even if the issuer is not required to file Form 10-K. For reporting issuers, the public float value should be taken from the issuer's most recent Form 10-K or based upon more recent information made available by the issuer.
  • A limited safe harbor is available for Rule 10b-18 repurchases effected after the close of the primary trading session until the termination of the period in which last sale prices are reported in the consolidated system. The Rule 10b-18 purchase must not be the opening transaction of the after-hours trading session and must be made at a price that does not exceed the lower of the closing price of the primary trading session in the principal market for the security and any lower bid or sale prices subsequently reported in the consolidated system. The issuer must also stay within the Rule's volume limitation, but may use a different broker or dealer to effect after-hours purchases from that used for purchases during the primary trading session.

Price Condition

  • The issuer cannot pay a price higher than the highest current independent published bid or the last independent transaction price, whichever is higher, reported or quoted in the consolidated system. The last transaction price is the last transaction price reported prior to execution of the order, not placement of the bid by the issuer.
  • The highest current independent published bid must be exclusive of any commission paid to a broker acting as agent, or commission equivalent, mark-up or differential paid to the dealer.
  • In order to qualify for the safe harbor, Rule 10b-18's conditions need not be satisfied at the time the order is entered, but must be satisfied at the time the order is executed.

Volume Condition

  • Under amended Rule 10b-18, an issuer's total repurchases on any single day, including its block-size purchases, must satisfy the rule's 25% ADTV volume limitation. However, an issuer can include its block-size purchases when calculating its security's four-week ADTV. As amended, Rule 10b-18 also provides issuers with a choice when making any particular block purchase. Either the block purchase must comply with the 25% ADTV volume condition, like any other repurchase, or the block purchase need not comply with the volume condition, but the issuer can make no other repurchases on that day and all other block purchases effected during that week must comply with the 25% volume condition.
  • If an issuer relies on the "one block per week" exception, the issuer must deduct those shares from its four-week ADTV calculation.
  • If no trading occurs in an issuer's common stock for one or more trading days during the four calendar weeks preceding the week in which the Rule 10b-18 repurchase is effected, the amount of trading volume added to the numerator of the ADTV calculation is zero. The denominator is the total number of trading days, including those days when the trading volume was zero, during the four-calendar week period. However, if no trading occurred because a certain day was a holiday and the markets were closed, then that day would not be included in the denominator.
  • An issuer may choose to either buy a block of shares or repurchase within its 25% ADTV limit, but may not do both For example, if an issuer's 25% ADTV limit on a particular day is 25,000 shares and the issuer repurchased 15,000 shares, the issuer could not then buy a block of 30,000 shares (under the "one block per week" block exception to Rule 10b-18's volume condition) that same day and still fit within the safe harbor. A block-size purchase of 10,000 shares, however, is permissible because it would not exceed the issuer's 25% ADTV limit (i.e., 25,000 shares) for that day.
  • The block definition provides that a block shall not include any amount that a broker or dealer, acting as principal, has accumulated for the purpose of sale or resale to the issuer, if the issuer knows or has reason to know that the amount was accumulated for that purpose. The volume limitation cannot be avoided by having the broker-dealer purchase additional stock to meet the block definition. Therefore, for example, if the issuer knows that a broker owns a large amount of stock not constituting a block, the broker cannot purchase additional stock to create a block in order to take advantage of the "one block per week" exception. Similarly, if a market maker acquires 2,000 shares of an issuer's common stock in market-making activities during one week and the following week, it acquires another 3,000 shares, the issuer could not avoid the volume limitation by treating the purchase of 5,000 shares from the market maker as a block.
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