STARTING A NEW STOCK REPURCHASE PROGRAM OR EXPANDING AN EXISTING STOCK REPURCHASE PROGRAM: A PRIMER FOR BANKS AND BANK HOLDING COMPANIES CRAIG D. MILLER This article provides guidance on how to establish a new, or expand an existing, stock repurchase program. As a result of uncertainty in the financial markets and the subprime mortgage collapse, the stock prices of many banks and bank holding companies have been adversely affected. In response, boards of directors are considering the establishment of new stock repurchase or buyback programs or the expansion of previously existing stock repurchase programs. Establishing a new repurchase program or expanding an existing one, however, should not be done without careful review of the many legal issues associated with such a program. This article provides guidance on how to establish stock repurchase programs. Craig D. Miller s practice focuses on representing corporations and financial institutions in corporate matters including mergers and acquisitions, public and private securities offerings, venture capital financings and corporate governance issues at Manatt, Phelps & Phillips, LLP. He can be contacted at cmiller@ manatt.com. 66
STARTING A NEW STOCK REPURCHASE PROGRAM ESTABLISHING A STOCK REPURCHASE PROGRAM The following guidelines will assist boards of directors and officers of bank holding companies (and California state-chartered banks) as they evaluate the parameters in establishing such a repurchase program. Approval of the Board of Directors The board of directors must approve appropriate resolutions in order to adopt a stock repurchase program. Such resolutions should specify, among other things: the maximum number of shares to be purchased; the time period during which repurchases may be made (usually 12 24 months); the source of funds for the buyback; the intended treatment of the repurchased shares (i.e., retired or treasury shares, as permitted by applicable state law); that repurchases must be made in compliance with the securities laws; the engagement of an investment banker to conduct the repurchases; and the appointment of authorized officers to act on behalf of the company and to direct the investment banker. The establishment of a buyback program does not obligate a company to repurchase its stock; however, at the time a company establishes a buyback program, it must have a bona fide intention to repurchase stock. Compliance with Federal Securities Laws A significant concern when a company repurchases its stock is exposure to claims that it was engaged in market manipulation in violation of Rule 10b-5 of the Securities Exchange Act of 1934 (the Exchange Act ). Rule 67
BANKING LAW JOURNAL 10b-18 of the Exchange Act provides companies and their affiliates with a safe harbor from the prohibitions of market manipulation rules in repurchasing a company s stock. The rules are relatively complex and, accordingly, most companies will retain an investment banking firm to conduct the repurchases in compliance with Rule 10b-18. For purposes of Rule 10b-18, stock purchases by the company as well as its insiders will be aggregated to determine compliance with the Rule. Press Release and Form 8-K Filing The national securities exchanges and the Nasdaq Stock Market regard the establishment of a repurchase program as a material development and would require public companies to issue a press release discussing the adoption of the repurchase program. Public companies would file the press release as part of Form 8-K. A company should follow all applicable stock exchange and Nasdaq procedures for the release of material nonpublic information, including the filing of the press release with the appropriate self-regulatory organization. Banks and bank holding companies which trade in the overthe-counter market should follow a similar protocol. Securities Offerings Regulation M under the Exchange Act is designed to prevent a company from manipulating the price of its securities when the company is about to, or is in the process of, making a securities offering. This would include sales of shares by insiders pursuant to a resale registration statement. Repurchases during specified periods on and around distributions of securities are prohibited. Tender Offer Rules A company will want to make sure its repurchase program does not constitute a self-tender offer. Most repurchase programs made on the open market at prevailing market prices without any defined timeframe and without solicitation of sellers do not constitute a self-tender offer. 68
STARTING A NEW STOCK REPURCHASE PROGRAM Delaware State Law Issues For bank holding companies chartered in Delaware, Section 160 of the Delaware General Corporation Law generally provides that a corporation may not repurchase its shares when the capital of the company is impaired, or when such purchase would cause any capital impairment. Under Delaware law, impairment of capital means the reduction of the amount of a company s assets below the amount represented by the aggregate outstanding shares of the company s capital stock. In addition, Delaware case law provides that a company may not repurchase its own shares of stock if the purchase diminishes the ability of the company to pay its debts or lessens the security of its creditors. California State Law Issues For bank holding companies chartered in California, Section 500 of the California General Corporation Law sets forth certain requirements a company must meet prior to engaging in a distribution, which would include a stock repurchase. Under California law, a repurchase may only be made if either: (a) the amount of the retained earnings immediately prior to the distribution equals or exceeds the amount of the proposed distribution or (b) immediately after the distribution, (i) the sum of the assets of the corporation, exclusive of certain items, is at least equal to 1 1/4 times its liabilities (exclusive of certain items) and (ii) the current assets of the corporation would be at least equal to its current liabilities, or, if the average of the earnings of the corporation before taxes on income and before interest expenses for the two preceding fiscal years was less than the average of the interest expenses of the corporation for those fiscal years, at least equal to 1 1/4 times its current liabilities (provided, however, if the company does not classify its assets into current and fixed categories under GAAP, subpart (ii) is not applicable). Accounting Treatment The company should check with its independent accountants to determine, among other things, the appropriate accounting treatment for the stock repurchases. 69
BANKING LAW JOURNAL Contractual Covenants The company should review its agreements to ensure that there is no restriction on a repurchase program. Many loan agreements and indentures that restrict a company s ability to declare dividends also restrict a company s ability to repurchase stock without the lender s consent. Collateral Securities and Exchange Commission Issues For public companies, stock repurchases may increase the holdings of particular stockholders above certain percentage thresholds that the individuals are required to report. For example, a stockholder who owns less than five percent of the company s securities prior to the implementation of a repurchase program may have to file a Form 13D or 13G with the Securities and Exchange Commission if that stockholder s ownership goes over five percent as a result of the company s repurchase of securities. Federal Reserve Board Issues Section 225.4(b) of Federal Reserve Board Regulation Y sets forth parameters for when a company may repurchase its stock without obtaining prior Federal Reserve Board approval. This Section permits a bank holding company to purchase or redeem its equity securities without providing prior notice to the Federal Reserve Board if the gross consideration for the purchase, when aggregated with the net consideration paid by the company for all such purchases or redemptions within the preceding 12 months, is less than 10 percent of the company s consolidated net worth. In addition, no prior notice is required if the bank holding company, among other things, will meet or exceed the well capitalized thresholds on a consolidated basis both before and after the repurchase, the bank holding company is considered well managed as such term is defined by the Federal Reserve Board, and the bank holding company is not the subject of any unresolved supervisory issues. 70
STARTING A NEW STOCK REPURCHASE PROGRAM Federal Deposit Insurance Corporation and California Department of Financial Institutions Approvals California state-chartered banks without bank holding companies will need to seek the approval of the Federal Deposit Insurance Corporation pursuant to Section 18(i)(1) of the Federal Deposit Insurance Act to repurchase stock and will need to request approval from the California Department of Financial Institutions pursuant to Section 3359(c)(3) of the California Financial Code to engage in repurchases. In addition, depending on the size of the repurchase, an additional approval pursuant to Section 643 of the California Financial Code may also be required. Insider Trading Restrictions A company repurchasing stock is treated like an insider for purposes of the antifraud provisions of the securities laws. Accordingly, the company (as well as any directors or officers) may not engage in repurchases while in possession of material, nonpublic information. Thus, if any of the following material, nonpublic information exists, repurchases should not be made: the company is engaged in merger negotiations; the company has not made a public announcement regarding an activity or action that would be a material deviation from the results of operations, financial condition or prospects of the company as currently presented; the company has not made an announcement of its most recent quarterly or annual financial results or is in the last 20 business days of the end of a financial reporting period; or any other material facts regarding the institution that have not been disclosed to the public. Going Private Finally, companies should take care to ensure that the buyback program would not result in the company going private under applicable regula- 71
BANKING LAW JOURNAL tions, as such an action would be subject to the going private rules (including Rule 13e-3 under the Exchange Act as amended). CONCLUSION Before adopting a stock repurchase program or expanding an existing one, banks and bank holding companies should consult with their legal counsel and their accountants to properly structure an effective, and legally compliant, program. 72