In Budget, Biden Supports Three-Year Freeze on Executive Share Sales After Buyback

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

Two sentences in President Biden’s FY2023 Budget, ¹ released March 28, 2022, indicate that Democratic lawmakers are still eager to find ways to discourage companies from engaging in stock buybacks.  Recall that a proposal to impose a 1-percent excise tax on corporate share repurchases was part of the November 19, 2021 House-passed Build Back Better (BBB) Act ² (and was also in the December 11, 2021 Senate Finance Committee version ³ of the tax title).

While the excise tax was estimated to raise some $124 billion in additional tax revenue over 10 years, ⁴ the thinking was that the rate might have been low enough that it would not actually have changed the calculus for most companies considering engaging in stock buybacks.  (Whereas if the rate had been set at 2 percent as originally conceived by Senate Finance Committee Chair Ron Wyden (D-OR), that could have more significantly reduced buybacks, as the revenue score for the proposed higher rate is believed to have been about the same. ⁵ )

The FY2023 Budget assumes that all of the revenue provisions in the House-passed BBB Act will become law (an assumption that is not realistic), so a stock buyback excise tax was not contained in the so-called green book ⁶ this time around (the green book details the tax provisions associated with the President’s budget).

But that did not stop President Biden from using the budget to express his support for legislation that would further discourage corporate stock buybacks by “requiring executives to hold on to company shares that they receive for several years after receiving them, and prohibiting them from selling shares in the years after a stock buyback.” ⁷ The apparent rationale behind such legislation is that a buyback artificially increases earnings per share, arguably giving any executives with significant share holdings an incentive to support buybacks to inflate the stock price (without changing the underlying business) and then immediately sell their positions (to the extent permitted by securities laws and stock ownership policies).  According to the FY2023 Budget, the Biden Administration believes such legislation would “discourage corporations from using profits to repurchase stock and enrich executives. . . .”⁸ 

The counter-argument to prohibiting buybacks is that a corporation would presumably buy back its stock only if it thinks it is a good investment relative to other investment options—that is, if it thinks its stock is underpriced—in which case, a buyback may be the best use of capital.  The marketplace may view a buyback as a sign of management’s confidence in a company’s future growth. ⁹ The Biden Administration seemingly would prefer that corporations simply issue excess profits to shareholders as dividends, which deliver an investment return to shareholders without the secondary effect of increasing share price.  However, paying dividends is not a use of capital that takes advantage of underpriced trading value of a corporation’s shares.

President Biden’s proposed support for legislation targeting buybacks likely relates to the Accountable Capitalism Act most recently introduced in 2020 as S. 3215¹⁰ by Senator Elizabeth Warren (D-Mass.).  This legislation would, among other things, generally prohibit certain corporate officers ¹¹ and directors from selling the corporation’s securities:

• During the five-year period that begins when the executive first owned the security; and
• During the three-year period that begins when the corporation engaged in a buyback.

Speaking on CNBC’s Squawk Box on March 29, 2022, Sen. Warren said her proposal was motivated by her belief that buybacks primarily profit corporate executives, who then “cash out quickly.” According to an April 6 report, U.S. stock buybacks for companies in the S&P 500 have hit record highs, with new repurchase announcements for March 2022 reaching about $74 billion (as compared to $54 billion in March 2021). ¹² It is important to note, however, that the proposed prohibition on selling securities during the five-year period beginning when the executive first owned the security goes beyond the context of corporate buybacks and looks more like a universal stock ownership policy.  Moreover, such holding requirement would begin only after delivery of the shares (i.e., on top of any vesting requirements, which are typically imposed for three or four years on equity awards in order for executives to earn the shares).

Sen. Warren indicated that she thinks it makes sense for the White House to support legislation that changes the incentives for corporate executives so that they are less focused on their own enrichment and more focused on longer-term investments in the company and the interests of all shareholders:  “We’d like to see these companies put more money into R&D.  And if the companies really say they don’t have any use for the money, then fine, send it out in dividends to your shareholders,” Sen. Warren said.  “You don’t have to do it in buybacks.  This is just another distortion because of a tax system that doesn’t work.  So there are ways to get the money back to the shareholders.  Pay dividends.” ¹³ 

But is Sen. Warren’s implication—that the tax code motivates executives to engage in stock buybacks—really accurate?  As we explained in a prior report discussing the broad concept of taxing corporate stock buybacks, ¹⁴ the tax treatment of buybacks as compared to cash dividends is not all that different to the shareholder (even if that shareholder is an executive).  Individuals receiving qualified dividend income on vested shares held outright are generally taxed at the same rate as if they participated in a buyback. ¹⁵ 

One difference between the two is that the entire amount of the dividend is generally subject to tax whereas investors can generally reduce the amount realized on their buyback by their tax basis (basis recovery).  A second difference applies to non-U.S. investors who are at risk of being subject to a withholding tax in the case of dividends.  We would not expect that either of these would significantly move the needle when it comes to analyzing the tax consequences facing a U.S. executive from a dividend versus a buyback.

Further, equity awards generally issued to executives (whether they take the form of restricted stock units (RSUs), stock options or some other type of stock-based compensation) are usually structured to align executives’ interests with shareholders’ interests by tracking the value of the underlying shares.  Notably, executives would typically get the economic benefit of a dividend with respect to their RSUs or stock options by way of a dividend equivalent, equitable adjustment or similar mechanism.  Equity awards would also track the value of the underlying share, whether it goes up or down.  Thus, there is no significant reason that executive compensation instruments would motivate management to favor buybacks over dividends— executives’ interests are arguably aligned with shareholders’ in either case.

While we have previously written about some of the unintended consequences of the proposal to tax stock buybacks, we have also cautioned that there is a risk the revenue raiser could be included in a smaller BBB reconciliation deal (likely focused primarily on clean energy, prescription drugs and deficit reduction), if such a deal materializes in the coming months. ¹⁶ A stock buyback excise tax is popular with many Democrats (who may simply view it as another way to tax the rich) and has survived the cut thus far.

That being said, a share-sale freeze imposed on corporate executives such as the one proposed by Sen. Warren may not yet be ready for primetime and may be more of a publicity attempt by President Biden than anything else.  Even before the President’s FY2023 Budget was released, a headline in The New York Times was already trumpeting the development. ¹⁷ 

^{[1] The two sentences are part of the information provided on the President’s priorities (specifically in the “Building a Better America” section) as part of the Budget (https://www.whitehouse.gov/wp-content/uploads/2022/03/budget_fy2023.pdf).}

^{[2] H.R. 5376; See the 11/3/2021 Rules Committee Print 117-18 (https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-117HR5376RH-RCP117-18.pdf) and the subsequent modifications to it reflected in the First Manager’s Amendment, now Rules Committee Print 117-19 (https://rules.house.gov/sites/democrats.rules.house.gov/files/BILLS-117HR5376-RCP117-19.pdf) and the Second Manager’s Amendment (https://amendments-rules.house.gov/amendments/YARMUT_026_xml211118163438621.pdf).}

^{[3] U.S. Senate Committee on Finance, Press Release, Finance Committee Releases Updated Build Back Better Text (Dec. 11, 2021) (https://www.finance.senate.gov/chairmans-news/finance-committee-releases-updated-build-back-better-text).}

^{[4] See JCX-46-21 (Nov. 19, 2021) (https://www.jct.gov/publications/2021/jcx-46-21/).}

^{[5] See our prior reports “Monster Tax Mash:  Spooky Tax Proposals Impacting Pubcos Rise from Fresh Grave of Murdered Corporate Rate Hike” (Oct. 26, 2021) and “Surprising Breadth of Proposed Tax on Stock Buybacks” (Oct. 11, 2021); for the legislative text of the Stock Buyback Accountability Act (S. 2758), see https://www.brown.senate.gov/imo/media/doc/stock_buy_back_accountability_act_bill_text.pdf.}

^{[6] General Explanations of the Administration’s Fiscal Year 2023 Revenue Proposals (https://home.treasury.gov/system/files/131/General-Explanations-FY2023.pdf).}

^{[7] Supra, note 1.}

^{[8] Id.}

^{[9] But see Spencer Jakab, Are Buybacks Signaling a Stock Market Top? Wall St. J., April 19, 2022 (https://www.wsj.com/articles/are-buybacks-signaling-a-stock-market-top-11650375587).}

^{[10] https://www.congress.gov/bill/116th-congress/senate-bill/3215}

^{[11] The term “officer” for this purpose includes the corporation’s president, principal operating officer, principal accounting officer and any vice president in charge of a principal business unit, division or function of the corporation.}

^{[12] Noel Randewich, U.S. buybacks seen at record highs ahead of earnings reports, Reuters, April 6, 2022 (https://www.reuters.com/business/us-buybacks-seen-record-highs-ahead-earnings-reports-2022-04-06/).}

^{[13] Execs selling into a stock buyback is ‘not an alignment of incentives,’ CNBC, March 29, 2022 (https://www.msn.com/en- us/travel/news/sen-warren-execs-selling-into-a-stock-buyback-is-not-an-alignment-of-incentives/vp-AAVCN4X).}

^{[14] “Flurry of Last-Minute Reconciliation Proposals Could Significantly Impact Public Companies” (Sept. 11, 2021).}

^{[15] Assuming an investor satisfies the requirements for qualified dividend income, including the holding period requirement, such income is taxed at the lower capital gains rates.  Nonqualified dividends are taxed at ordinary income rates.}

^{[16] “Corporate Minimum Tax May Be Falling Out of Favor as One of the Payfors to Fund Smaller Build Back Better Bill” (Feb. 4, 2022).}

^{[17] Andrew Ross Sorkin, Jason Karaian, Stephen Gandel, and others, Biden Renews Pushback Against Stock Buybacks, N.Y. Times, March 28, 2022 (https://www.nytimes.com/2022/03/28/business/dealbook/biden-stock-buybacks.html).}