- Economic uncertainty as a result of the COVID-19 pandemic has caused a decline in trading prices for debt and equity securities and liquidity and covenant compliance issues.
- BDCs and CEFs, and their affiliates, can repurchase shares of their securities at a discount to real value through tender offers or exchange offers, open-market purchases, privately negotiated transactions or contractual repurchase mechanisms to take advantage of lower trading prices or to restructure their liabilities.
- Issuers and their affiliates, should consider the potential pitfalls of repurchase transactions, including “creeping” tender offers and compliance with the 1940 Act and other securities laws, state laws, tax issues and contractual restrictions.
- Tender Offers/Exchange Offers
- Open-Market Purchases and Privately Negotiated Transactions
- Contractual Mechanisms
Tender Offer/Exchange Offer
Issuers should be aware that the tender offer rules differ for purchases of non-public equity and purchases of debt versus purchases of public equity.
- a minimum offer period of 20 business days (although, for tender offers for non-convertible debt securities that meet certain conditions, issuers may be able to reduce the offer period to as little as five business days);
- a prohibition on purchases outside the offer; and
- other antifraud and anti-manipulation provisions.2
- make the offer to all security holders at the same price;3
- file disclosure documents related to the tender offer with the Securities and Exchange Commission (the “SEC”);4 and
- disseminate certain documents related to the tender offer to stockholders.5
Open-Market Purchases and Privately Negotiated Transactions
- Unintentional or “Creeping” Tender Offer
- Tax Issues
- Section 17 and Section 57 of the 1940 Act
- 1940 Act Rules Governing Repurchases
- Insider Trading/Rule 10b-5
- Disclosure and Reporting
- Market Manipulation
- State Law Issues
- Covenant Compliance
- Main Street Lending Program
Unintentional or “Creeping” Tender Offer
- Active and widespread solicitation of public security holders;
- Solicitation of the holders of a “substantial percentage” of the issuer's securities;
- An offer made at a premium over the prevailing market price;
- An offer containing terms that are firm, rather than negotiable;
- An offer contingent on the tender of a fixed number of securities, often subject to a fixed maximum number to be purchased;
- An offer open only for a limited period of time;
- Offerees being pressured to sell their securities; and
- A public announcement of a purchasing program precedes or accompanies rapid accumulations of large amounts of the target's securities.7
- buying through brokers or dealers;
- keeping purchases independent of one another, including the separate negotiation and pricing of each purchase with no advance announcement of an intention to make the purchases;
- contacting only larger institutional holders to acquire the securities;
- determining in advance the security holders to be approached; and
- conducting the repurchases over a long period of time without a deadline (or any other form of pressure) for the holders to sell their securities.
Not every cancellation of debt results in COD Income. For example, the cancellation of a debt may be excluded from gross income if the discharge occurs in a bankruptcy case or at a time when the debtor is insolvent. If an amount is excluded from gross income as a result of a discharge in a bankruptcy case or insolvency, however, a taxpayer is required to reduce its tax attributes, including net operating loss carryovers and adjusted bases of property, to the extent of the amount excluded. This reduction results in the reduction of future tax benefits. Issuers should always consider any exceptions and limitations to these rules when evaluating the tax consequences of a repurchase transaction.
Section 17 and Section 57 of the 1940 Act
Issuers should always be cognizant of their general fiduciary duties and any potential conflicts when considering transacting with affiliates. BDCs and CEFs should ensure that any purchase from an affiliate in connection with a repurchase transaction is conducted pursuant to terms that have been negotiated at arm’s length and that such purchase is in the best interest of the BDC or CEF.
1940 Act Rules Governing Repurchases
- the purchase must be for cash;
- the purchase must not be from an affiliate;
- the BDC or CEF must maintain compliance with asset coverage requirements; and
- the price per security must be the lower of NAV or market price per security.10
Insider Trading/Rule 10b-5
Issuers can establish a defense (though not a complete safe harbor) against insider trading claims if the trades occur pursuant to a written plan that meets the requirements of Rule 10b5-1(c).14 A valid 10b5-1 trading plan can only be adopted when the issuer is not then in possession of material non-public information and typically is subject to a cooling-off period before trades begin under the plan. The plan must meet certain other requirements to ensure the issuer does not have discretion over the trades such that it could take advantage of material non-public information. Issuers should ensure that any plan suspensions and terminations do not undermine the effectiveness of the defense in connection with a repurchase transaction.
Disclosure and Reporting
Regulation FD generally prohibits selective disclosure of material non-public information to securities market professionals, such as the issuer’s security holders, as well as broker-dealers, investment advisors and investment companies.15 In the context of a repurchase transaction, potential material non-public information that becomes known to potential and actual counterparties and intermediaries includes (a) the company’s engagement in a repurchase transaction and (b) information about the company’s business provided to ensure the company is not trading on the basis of material non-public information. In some cases, concern surrounding the disclosure of the repurchase transaction is mitigated by the issuer’s generic disclosure in its periodic reports that it may engage in repurchases from time to time. A company can also ensure compliance with Regulation FD by entering into a confidentiality agreement with recipients of material non-public information or by publicly disclosing such information.
Issuers also have an affirmative obligation under Item 703 of Regulation S-K to disclose repurchases of equity securities in their periodic reports on Form 10-K and Form 10-Q.16 MD&A and related party transaction disclosure may also be appropriate.17 Issuers entering into a material definitive contract in connection with a repurchase transaction must also consider whether disclosure on Form 8-K is necessary. In addition, pursuant to stock exchange rules, issuers must notify the exchange of material developments, including the implementation of repurchase plans, before making a public announcement of such developments.18 The NYSE requires reporting of repurchases booked as treasury stock, and Nasdaq requires reporting of repurchases that result in a greater than 5% decrease in outstanding shares.19
Trades of an issuer’s securities by affiliated purchasers (including officers, directors and owners of more than 10% of the issuer’s shares) involving a class of equity securities registered under the Exchange Act may be reportable on Forms 4 or 5 under Section 16 of the Exchange Act and may also impose short-swing liability for opposite-way transactions (a purchase and sale, or sale and purchase) that are fewer than six months apart.20 Additionally, Sections 13(d) and 13(g) of the Exchange Act require persons or groups who own or acquire beneficial ownership of more than 5% of an outstanding class of registered equity securities of an issuer to file a Schedule 13D or 13G with the SEC.21 The schedule must be amended upon any material change to the facts set out in a previously filed schedule, such as an acquisition or disposition of 1% or more of the class of equity securities owned by the filer.
Issuers should also be aware that the acquisition of voting securities by a person other than the issuer could require prior reporting under the Hart-Scott-Rodino Antitrust Improvements Act and, in certain circumstances, could implicate other investment laws such as review by the Committee on Foreign Investment in the United States (or CFIUS).
- All repurchases must be made in reliance on the safe harbor on any given day must be made by the same broker.
- The repurchase trades must not be the first opening (regular way) trade of the day, and must not be traded within 30 minutes of opening or closing of trading on the issuer’s principal market. This 30-minute restriction is reduced to 10 minutes from opening or closing for companies with a public float of $150 million and ADTV of $1 million. “ADTV” is defined in Rule 10b-18(a)(1) as “the average daily trading volume reported for the security during the four calendar weeks preceding the week in which the purchase is to be effected.”
- The price paid may not exceed (a) the highest independent bid or (b) the last independent transaction price, whichever is higher, quoted or reported at the time the purchase is made.
- The maximum aggregate amount that may be purchased by an issuer or any affiliated purchasers on any given day may not exceed 25% of the issuer’s ADTV. Once each week, in lieu of purchasing under the 25% of ADTV limit for that day, the issuer (or any affiliated purchaser) may make one block purchase.
Issuers should consider that the Rule 10b-18 safe harbor only applies to repurchases of common stock. In addition, the safe harbor does not apply to tender offers and is not a defense for violations of the insider trading restrictions under Section 10(b) of the Exchange Act and Rule 10b-5.
In addition, Rule 10b-18 does not provide a safe harbor for violations of Regulation M. Generally, Regulation M prohibits an issuer, its selling security holders, offering participants and affiliated purchasers of offering participants from bidding for, purchasing or attempting to induce any person to bid for or purchase a covered security that is the subject of a “distribution.”25 These restrictions apply during a restricted period, which begins one to five business days before pricing of a distribution and ends on the completion of the distribution. Regulation M is intended to prevent an issuer and its underwriters from engaging in manipulative practices that would artificially inflate the price of a security, or create a false appearance of active trading in the security, during a distribution. A distribution is defined as an offering of securities distinguished from ordinary trading by the magnitude of the offering and the presence of special selling efforts and selling methods. An issuer that plans to conduct a distribution of its securities generally suspends any repurchase program, regardless of the method, for the duration of its distribution. Regulation M also prohibits an issuer from making a distribution of shares of the class involved in a tender offer for up to five business days after the tender offer closes.
State Law Issues
Additionally, many states have laws that apply specifically to repurchases, including the requirement that the issuer have a “surplus” sufficient to permit repurchases and that the repurchase does not render the company insolvent. Under Section 160 of the Delaware General Corporation Law, a company may not use cash or other property to repurchase its own shares if the issuer’s capital is impaired or if the repurchase would cause an impairment of the issuer’s capital.26 To avoid impairment, an issuer may use only “surplus” to purchase shares of its own stock. In Delaware, “surplus” is defined as the excess of net assets (total assets minus total liabilities) over the aggregate par value of the outstanding stock.27 With respect to repurchases by Delaware statutory trusts, the trust’s governing documents generally control and typically give the trust broad flexibility to repurchase securities of which it is the issuer, subject to the fiduciary principles imposed by state law.28
Most issuers are also subject to the Uniform Fraudulent Transfer Act, which prohibits the use of corporate cash or assets to repurchase stock if the repurchase would impair the ability of the issuer to pay its debts and liabilities or render the issuer with insufficient capital as a result of the repurchase.29 Some states, including Delaware and Maryland, impose personal liability on directors for violation of the statutory repurchase requirements. Importantly, this is one of the few areas in Delaware where a company is not permitted to exculpate its directors from personal liability for money damages.30
Main Street Lending Program
2 17 CFR 240.14e-1 et seq.
3 17 CFR 240.14d-10
4 17 CFR 240. 13e-3; 17 CFR 240. 13e-4; 17 CFR 240. 14d-3
5 17 CFR 240. 13e-3; 17 CFR 240. 13e-4; 17 CFR 240. 14d-4
6 17 CFR 240. 13e-4; 17 CFR 242.100
7 Wellman v. Dickinson, 475 F.Supp. 783 (SDNY 1979).
8 15 U.S. Code § 80a–17; 15 U.S. Code § 80a–2
9 15 U.S. Code § 80a–23
10 15 U.S. Code § 80a–23(c)(1)
11 15 U.S. Code § 80a–23(c)(2)
12 Investment Company Act Release No. 33817 (Mar. 13, 2020), available at
13 15 U.S.C. § 78j; 17 CFR § 240.10b-5
14 17 CFR § 240.10b5-1(c)
15 17 CFR Part 243
16 17 CFR § 229.703
17 17 CFR § 229.303; 17 CFR § 229.404
18 NYSE Listed Company Manual § 202.5; NYSE Listed Company Manual § 202.6; Nasdaq Listing Rule 5250(b)
19 NYSE Listed Company Manual § 204.25; Nasdaq Listing Rule 5250(e)(1)
20 17 CFR § 240.16a-2
21 17 CFR § 240.13d; 17 CFR § 240.13g
22 17 CFR § 240.9a-2; 17 CFR § 240.10b
23 17 CFR § 240.19b-18
25 17 CFR 242.100 et seq.
26 8 Del C. § 160
27 8 Del C. § 154
28 12 Del C. § 3806(a)
29 E.g., Del. Code Ann. tit. 6, chapter 13; see also 11 U.S. Code § 548
30 5 Del. C. § 174; 5 Del. C. § 102(b)(7)
31 Press Release, Federal Reserve Board announces it is expanding the scope and eligibility for the Main Street Lending Program (April 30, 2020), available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20200430a.htm.
32 The Federal Reserve exercised its discretion to impose the repurchase restrictions applicable to direct loan programs under the CARES Act on the Main Street Lending Program in the program’s terms and conditions. See Frequently Asked Questions, Main Street Lending Program (April 30, 2020), available at https://www.federalreserve.gov/monetarypolicy/files/main-street-lending-faqs.pdf; Coronavirus Aid, Relief, and Economic Security Act, H.R. 748, 116th Cong. § 4003(c)(3)(A)(ii) (2020).