Buybacks: Why Brexit came at a bad time for banks

Trader brexit reaction
Russell Boyce | Reuters

We are entering earnings period, which also means that some companies are entering a blackout period where they cannot buy back stock.

There's a significant trader mythology around this period, the implication being that the market is in trouble because companies cannot buy back their stock.

It's not that simple.

The first problem is that this Brexit thing has come at a rather inopportune time. A lot of companies have seen significant price declines, and may see more in the coming week or so. You can bet they would like to buy back stock at these lower prices, but to the extent they are restricted due to a blackout period it could be an issue for them.

The first to be reporting will be the big banks, including JPMorgan on July 14. That means some banks may not be able to buy back stock at precisely the moment the stocks have dropped to much lower levels than a month before.

But not all blackout periods are the same, indeed, not all companies follow the blackout period.

That's because there is no federal law or even a rule that mandates a blackout period.

The reason blackout periods exist at all is because corporate executives as well as corporations buy back stock. These company executives may have access to inside information, particularly in the period when they are gathering corporate financial information immediately before an earnings report. The goal of the blackout is to prevent insider trading.

Companies are allowed to buy back their shares, but they have to do it in a certain manner to avoid the appearance that they are manipulating the stock. Under a rule created in 1982 by the SEC (it's called Rule 10b-18, if you really need to know), companies cannot buy back their stock at the very beginning or end of the trading day (in the last 10 minutes), they have to use a single broker for the trades, they have to buy shares at the prevailing market price, and they can't be more than 25 percent of the average trading volume over the previous four weeks.

A separate SEC rule (Rule 10b5-1) allows companies to set up regular plans to buy or sell their stock. As long as they adopt a specific "Trading Plan" to sell stock at some kind of pre-established buying or selling program they can be protected from accusations that they are buying or selling stock based on inside information.

Unfortunately, companies don't provide much color on how they decide to buy back stock. They are required to provide quarterly reports on how much they are buying broken down by month, but there's usually not much more than that.

So, for example, a company could start a plan to purchase X amount of shares if it hits a certain price. Or it could say, buy 1 million shares a day as long as the price is lower than X price, or higher than X price. Or it could say, buy 50,000 shares every day at the prevailing market price throughout the day.

Get the point? Every company conducts a buyback in a different manner.

Let's get back to this "blackout" period: each company decides how long their blackout period should be. Generally, they don't tell us what the period is because the SEC does not "mandate" that there should be a specific blackout period. And the company does not want shorts to know when they may or may not be buying back stock.

Still, there are "rules of thumb" that a lot of traders use. Most traders assume that companies stop buying at least a week or more before, and start buying again a few days after their earnings report. So it's certainly reasonable to assume most companies have at least a two-week blackout period each quarter.

Here's where it gets confusing: while most companies may have blackout periods, it is perfectly legal to continue to repurchase shares during the blackout period as long as the company is adhering to a 10b5-1 plan.

In other words, we can't really make any generalizations that companies are invariably not buying back their stock, even during the period around their earnings report.

You can see this in some company reports. If all companies really stopped buying back stock in the month of their earnings report, you would think there would invariably be a big dip in buybacks in that first month.

But you don't always see that. Take Wal-Mart as an example. They reported earnings on February 18th. In their quarterly earnings report, they noted that they bought back stock pretty consistently in all three months: 13.8 million shares in February, 13.9 million in March, 12.5 million in April. So there was no dip in February when they reported earnings.

Why not? It's likely they had a 10b5-1 plan and stuck to it, even buying through their blackout period..

And how did they determine when they were buying back their stock? This is all they said: "The Company regularly reviews its share repurchase activity and considers several factors in determining when to execute share repurchases, including, among other things, current cash needs, capacity for leverage, cost of borrowings and the market price of its common stock."

Not much to go on, eh?

Or take JPMorgan. They reported January 14. But they bought back the most stock in January: 14.1 million shares, 8.0 million shares in February, and only 6.9 million shares in March.

This looks like they continued to buy back stock right through their earnings period, again likely using a 10b5-1 plan.

To make things more complicated, companies don't have to use 10b5-1 plans to buy back stock. They can just do it manually. If they do that, they certainly would have to adhere to blackout periods to avoid accusations that they are buying back their shares when they are in possession of materially relevant information.

The bottom line: blackout periods certainly exist, but they may not be the big drag on the market that everyone thinks they might be.

But that doesn't mean this Brexit thing has not come at a bad time. Look at the banks. JPMorgan is down 10 percent in two days. Remember February 11, when Jamie Dimon turned the market around by announcing he was personally purchasing $25 million in JPMorgan stock?

He did that because he had reported earnings on January 14th and was well outside any blackout period. This was a special, unannounced buyback so he certainly would not have done anything like that near his earnings. The company announced a $1.9 billion buyback a month later.

But JPMorgan is reporting in less than two weeks. Highly unlikely that bank executives would come out and make any announcements about any buybacks in this period leading up to earnings.

But I bet they would like to!

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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