On Tuesday, cable operator Charter Communications agreed to pay $25m to settle SEC charges related to stock buyback controls violations.

The penalty will settle the SEC’s charges related to these unauthorized stock buybacks, and it underscores the SEC’s commitment to enforcing regulations related to stock buybacks. It also showcases the agency’s continued resolve in this area after crafting new rules for these plans last year to deter insiders from trading on material information not available to investors.

Buying back stock and Rule 10b5-1

The SEC’s investigation revealed that from 2017 to 2021, Charter implemented provisions changing the total dollar amounts available for stock buybacks and the timings of these buybacks following the approval of the plans. SEC Rule 10b5-1 offers protection to companies and individuals from insider trading liability as long as they meet the conditions of the rule, including a requirement that they do not retain the ability to change the planned purchases or sales after they adopt the trading plan.

Since making changes to buyback plans after the adoption of trading plan runs counter to the rule, the SEC said Charter’s actions, carried out in nine pre-approved trading programs over the course of four years, violated the rule.

The SEC said in its order that the Rule 10b5-1 violations were the result of Charter’s insufficient internal accounting controls, in particular, its absence of reasonably designed controls to analyze whether the discretion that certain provisions gave executives to alter the company’s trading was consistent with the board’s authorizations.

“Companies whose boards authorize buybacks using Rule 10b5-1 plans must have controls that reasonably assure that their trading plans meet all of the rule’s conditions,” said Melissa Hodgman, Associate Director in the SEC’s Division of Enforcement. “This includes the fundamental requirement that, to benefit from the protection of Rule 10b5-1, traders have to relinquish their ability to influence the amount or timing of trades after their trading plans go into effect.”

Charter said in a statement that it fully cooperated with the SEC’s inquiry and that its share repurchase plans were well-documented and disclosed in financial statements. “We remain committed to a share buyback program and our previously stated leverage targets,” it said.

Internal controls and Section 13(b)(2)(B)

The order in this case also references Section 13(b)(2)(B) of the Exchange Act, a provision that requires internal accounting controls. The text of the rule spells out the requirements:

1. transactions are executed in accordance with management’s general or specific authorization;
2. transactions are recorded as necessary (I) to permit preparation of financial statements in conformity with generally accepted accounting principles or any other criteria applicable to such statements, and (II) to maintain accountability for assets;
3. access to assets is permitted only in accordance with management’s general or specific authorization; and
4. the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

Section 13(b)(2)(B)’s companion provision, Section 13(b)(2)(A), likewise requires issuers to make and keep “books, records, and accounts” that “accurately and fairly reflect the transactions and dispositions of the assets” of the issuer.

Dissenters focus on internal accounting controls

Hester Peirce and Mark Uyeda issued a joint dissent in this case that revolved around their concern that the SEC’s decision risked uprooting the core concept of “internal accounting controls” (italics in original) from the language, statutory context, and history of Section 13(b)(2)(B). The commissioners said there may be temptation to simply view this provision as a generic “internal controls” requirement, but it’s not. It’s an accounting one, they said, and the flaw in the order is its failure to distinguish between internal accounting controls and other types of internal controls, they said.

Peirce and Uyeda note that the order offers no facts suggesting that Charter’s management used more funds than the board authorized for share buybacks, that management purchased shares at a quantity or time inconsistent with the board’s authorization, or that management failed to properly record the expenditure of corporate funds and consequent purchase of shares on Charter’s books.

“Companies whose boards authorize buybacks using Rule 10b5-1 plans must have controls that reasonably assure that their trading plans meet all of the rule’s conditions.”

Melissa Hodgman, Associate Director, SEC Division of Enforcement.

“Instead, the Order faults Charter because it lacked ‘reasonably designed controls to analyze’ its trading plans for compliance with Rule 10b5-1. Controls designed to answer a legal question – compliance with the regulatory conditions necessary to qualify for an affirmative defense – are simply not internal accounting controls within Section 13(b)(2)(B)’s scope,” they said.

They call the SEC’s order the “the latest application of the unsupportable and ill-considered interpretation of Section 13(b)(2)(B)” and an attempt “to convert an internal accounting controls provision into an ever-unfolding utility tool that magically converts every corporate activity into something the Commission regulates” – constituting inappropriate extensions of the agency’s authority.

Changes to Rule 10b5-1

In December 2022, the SEC adopted changes to Rule 10b5-1 that increased disclosure requirements for stock trades and gifts of securities.

The amendments to rule 105b-1 require the person setting up trades to certify that they are not aware of any material nonpublic information and that they are acting in good faith. The changes also added new conditions to the use of the affirmative defense to insider trading liability, including the establishment of a cooling-off period before any trading can begin.

Rule 10b5-1 permits major holders to sell a predetermined number of shares at a predetermined time. Many corporate executives use 10b5-1 plans to avoid accusations of insider trading, and the new rule gives the public one full trading day to digest the details of the issuer’s quarterly results.

The revised rule also requires issuers to disclose quarterly in their Form 10-Qs and Form 10-Ks: (1) whether any director or officer has adopted or terminated any Rule 10b5-1 plan, or any other written trading arrangement that meets the requirements of a “non-Rule 10b5-1 trading arrangement”; and (2) the material terms of the Rule 10b5-1 or non-Rule 10b5-1 trading arrangement.