In a recent settled administrative proceeding, the Securities and Exchange Commission (SEC or the Commission) imposed a $20 million fine and a cease-and-desist order on Andeavor LLC, a Texas energy company, in connection with a stock buyback program.1 Andeavor had engaged in the program at the same time as it was allegedly discussing a merger with another company, Marathon Petroleum, with which it subsequently entered into an acquisition agreement. The merger price significantly exceeded the price at which Andeavor purchased shares in the buyback. The Commission alleged that the merger discussions were material inside information. However, the settled charge did not involve fraud or insider trading. Rather, the Commission charged Andeavor with violating Section 13(b)(2)(B) of the Securities Exchange Act, under which companies must develop and follow internal accounting controls that are sufficient to provide reasonable assurances that transactions comply with management's authorizations.
Several competing facts pointed toward a controls rather than a fraud charge. The company had begun merger discussions with Marathon in 2017, but these discussions had paused by October 2017 due to differences in valuation. The discussions remained on hold for approximately four months, but were planned to resume in late February 2018 in an in-person meeting between the CEOs of the two companies. The Andeavor board had authorized a $2 billion stock repurchase program in 2015 and 2016. Days before the planned meeting, pursuant to the existing board authorization, Andeavor's CEO directed the CFO to initiate a $250 million stock buyback, and the Andeavor legal department then approved a 10b5-1 plan to repurchase the stock. The legal department did not interview the CEO as to the status of the potential resumed discussions, which, in the Commission's view, were in fact sufficiently advanced to constitute material nonpublic information, given the importance of the potential transaction.
The case highlights several important considerations for public companies when authorizing stock buybacks. First, the SEC's order serves as a reminder that Rule 10b-5's anti-fraud provisions apply to stock buybacks under a Rule 10b5-1 plan. The affirmative defense that Rule 10b5-1 provides to insider trading depends on the issuer not being aware of material nonpublic information at the time the 10b5-1 plan is authorized.2 While the Andeavor legal department concluded that the merger negotiations were not material, the SEC found this conclusion was erroneous because it was based on a "deficient understanding" of the relevant facts.
Second, regulators remain focused on companies' internal processes and accounting controls. The SEC did not charge Andeavor with insider trading. Rather, it contended that Andeavor failed to have adequate "internal accounting controls sufficient" to establish "reasonable assurance" it was complying with its own buyback policies. Under Andeavor's policies, repurchases had to comply with the company's securities trading policy, which in turn prohibited the company from purchasing or selling shares while in possession of material nonpublic information. The SEC noted that senior executives had information regarding developments relevant to the probability prong of the materiality analysis. The legal department lacked up-to-date information regarding the merger negotiations, having engaged in what the Commission considered an "abbreviated and informal process."
Third, regulators often apply what amounts to 20/20 hindsight in assessing materiality. In Andeavor's case, the SEC determined the probability of Marathon's acquisition of Andeavor was high enough to be material information. But, of course, the discussions had been paused for four months and had previously been unsuccessful. The regulators nonetheless took as significant that the negotiations resumed productively, and within two months, the companies signed a definitive merger agreement.
The Andeavor order underscores the importance of assessing whether the issuer possesses material nonpublic information when it embarks on a 10b5-1 stock buyback plan. It also reflects that even when the facts may evidence a lack of intentional misconduct, regulators will still evaluate the adequacy of the company's internal controls and processes.
Footnotes
1 Andeavor LLC, Release Nos. 34-90208, AAER-4190, File No. 3-20125 (Sec. & Exch. Comm'n, Oct. 15, 2020).
2 Kramer Levin Naftalis & Frankel, LLP, Renewed Spotlight on Rule 10b5-1 Insider Trading Plans: Promoting Transparent Standards for Corporate Insiders Act, (March 21, 2019), https://www.kramerlevin.com/en/perspectives-search/renewed-spotlight-on-rule-10b5-1-insider-trading-plans.html#:~:text=Pursuant%20to%20Rule%2010b5%2D1,the%20trade%20in%20question%20occurs.
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