Arbitrageurs are important players in the buy-back market, primarily because of certain tax considerations. One important driver is the repurchase price a company is permitted to offer in a share buy-back. Particular attention should be placed to secondary market transactions during a share buy-back (e.g., sales of ADRs). Novelties include VWAP-based buy-back programs and buy-backs executed via Dutch auction. 

By Hansjürg Appenzeller / Dieter Grünblatt (Reference: CapLaw-2019-17)

There are various purposes and economic reasons to buy back shares, inter alia the following:

– The buy-back of own shares for subsequent cancellation can be used as an instrument of capital management and distribution policy, particularly to distribute surplus funds to shareholders as an alternative to dividends; as an additional effect, upon their cancellation, the number of outstanding shares is reduced and, thus, the earnings per share of the remaining outstanding shares are increased. 

– Shares may be bought-back for purpose of treasury or market liquidity; the company’s ability to buy back a certain number of its own shares tends to improve liquidity in a tight stock market (e.g., price smoothing, market making, proprietary trading). 

– Shares can further be bought-back for other reasons, such as defense against a hostile takeover, to cover convertible bonds or for satisfaction of delivery obligations under an employee participation program or stock option plan.

Share buy-backs of Swiss companies can be executed in many ways. They are subject to corporate law requirements, Swiss insider and market manipulation regulations and tax consequences as well as, if publicly announced, to tender offer rules. There are certain common rules applicable to all share buy-backs. In relation to each variation of purpose, specific or additional considerations, requirements and limitations apply. 

This article gives an insight into selected areas of publicly announced share buy-backs by Swiss companies, focusing on repurchases of own shares over a second trading line for purpose of cancellation.

1) Share Buy-back for Purpose of Cancellation

a) Players in the Buy-back Market

In principle, share buy-backs may be executed on the regular trading line or a second trading line. However, if shares are bought back for purpose of cancellation, the shares will be deemed liquidated for Swiss tax purposes, and the company buying back the own shares will be liable to 35% Swiss withholding tax (Verrechnungssteuer) on the difference between the purchase price and the nominal value of the shares, except if the shares are bought back against reserves from capital contributions (Kapitaleinlagereserven), which can be repaid free of withholding tax to the shareholders. 

If a company buys back shares on the regular trading line from anonymous sellers against reserves other than reserves from capital contributions, it will not be able to deduct the 35% withholding tax from the purchase price, as required by the Swiss withholding tax legislation, and hence be liable to withholding tax on the grossed-up amount, resulting in an effective withholding tax rate of 53.8% for the company. To avoid this prohibitive tax consequence, a company buying back its own shares for purpose of cancellation against reserves other than capital contribution reserves must use a second trading line, where it is the only buyer, and hence will be able to deduct the 35% withholding tax on the difference between the purchase price and the nominal value as required by the withholding tax legislation. 

A sale on the second trading line is unattractive for shareholders who are private individuals resident in Switzerland for income tax purposes and also for shareholders who are resident outside Switzerland: 

– In the first case, the withholding tax is fully refundable or creditable against income tax. However, irrespective at which price the individual has purchased a share he or she sold into the buy-back, the full difference between the buy-back price and the nominal value of that share will be considered taxable income to such person (except if, and to the extent, the share has been bought back against reserves from capital contributions) while a sale on the regular trading line will normally be a tax-exempt private capital gain (or loss) for such person. 

– In the second case, the 35% withholding tax may be refundable under an applicable double taxation treaty of Switzerland and the country of residence of the selling shareholder to a residual tax of ordinarily 10% or 15%, and exceptionally to a residual tax of 5%, or nil in case the selling shareholder is a pension fund or a shareholder holding directly 10% or 15% percent of the capital of the company buying back the shares, however, in any case subject to the selling shareholder complying with the typically disliked refund procedures. 

Therefore, these shareholders will normally not participate in a second trading line buy-back program and the group of sellers on the second trading line is naturally reduced to Swiss domestic corporate investors who (i) can fully reclaim the withholding tax deducted and (ii) are taxable only on the spread and usually can claim nevertheless participation relief if the shares sold aggregate a value of at least CHF 1m. 

In fact, sellers are normally limited to a few financial institutions in Switzerland, acting as arbitrageurs with access to the stock exchange and technical systems, allowing them to efficiently purchase on the liquid regular trading line and sell on the second trading line for a spread (economically, a spread, if any, may cover financial costs for the cash out until refund of the withholding tax and administrative costs for claiming the refund). 

Selling shareholders may also include institutional investors who can liquidate investments in shares over the second trading line instead over the regular trading line to benefit from a turnover tax-exempt transaction and from participation relief (or tax exemption in case of certain institutional investors).

b) New Tax Regime

Under the current withholding tax law, Swiss companies are completely free to choose whether to pay dividends out of taxable retained earnings or taxable reserves or tax-free reserves from capital contributions. The same choice applies for the buy-back of shares. 

However, the Act on the Tax Reform and the Funding of the Social Security System, which has been approved by the Swiss people on the popular vote held on May 19, 2019, introduces a 50:50 distribution rule for (at least) 50% taxable reserves and 50% reserves from capital contributions. The new distribution rules will enter into force as of January 1, 2020.

Under the 50:50 distribution rules distributions out of reserves from capital contributions made by companies listed in Switzerland (including share buy-backs against reserves from capital contributions) will only benefit from the tax-free withholding tax treatment (and tax-free income tax treatment for Swiss resident private investors) if and to the extent that the company distributes a taxable dividend in the same amount, provided that the company has taxable retained earnings and taxable reserves. Accordingly, a listed company buying-back shares for cancellation against reserves from capital contributions will have to use as of January 1, 2020 for the buy-back of own shares at least 50% taxable retained earnings or taxable reserves.

c) Pricing Considerations to Address Market Manipulation Concerns

The amount of the spread a company may offer to sellers of shares over the second trading line is limited by Swiss market manipulation regulations. A company buying back its own shares must ensure that it does not violate the general market conduct rules and criminal provisions pursuant to articles 142 and 143 of the Financial Market Infrastructures and Market Conduct in Securities and Derivatives Trading Act (FMIA) and articles 154 and 155 FMIA, respectively. 

The rules relating to market manipulation (article 143 FMIA) or price manipulation (article 155 FMIA) are deemed to be adhered to if the share buy-back has a demonstrable economic background that corresponds to genuine bid and ask behaviour (see FINMA Circular 2013 | 08 on Supervisory Rules for Market Conduct in Securities Trading (FINMA Circular 2013 | 08), note 38, see also Message of the Federal Council, BBl 2011 6873, p. 6903). However, where the intended purchases and | or repurchases are technically executed by using nostro-nostro in-house crosses, they must be matched in the stock exchange system independently of one another and without any previous agreement (see FINMA Circular 2013 | 08, note 35).

In respect of the discussion of inadmissible market behaviour and market manipulation (article 143 FMIA), the phrase “misleading signals regarding the supply, demand or price of securities” in article 143(1)(b) FMIA is relatively opaque. While articles 122 through 128 of the Ordinance on Financial Market Infrastructures and Market Conduct in Securities and Derivatives Trading (FMIO) are intended to provide for an exhaustive list of cases in which behaviors which fall under article 142 FMIA and article 143 FMIA are admissible, the cited provisions in general, and article 123 FMIO (buy-back of own equity securities) in particular, do not generally exempt transactions that have a demonstrable economic background corresponding to genuine bid and ask behaviour. The FINMA Circular 2013 | 08, note 38, and the Federal Council’s Message to the preceding provisions, however, are more lenient with respect to these situations. Because of this deviation between the FMIO on the one side and the FINMA Circular 2013 | 08 on the other side and the broad wording in the FMIA itself, an element of uncertainty remains. However, the fact that FINMA is the enforcing authority for regulatory market conduct rules (article 6 of the Financial Market Supervisory Authority Act), we would expect that FINMA would generally apply the practice and standards as set forth in its Circulars.

As far as the spread a company may offer to sellers of shares over the second trading line is concerned, the FMIO provides a safe harbor regulation from the market conduct and behavior rules if, among others, certain specific restrictions on pricing are considered. Generally speaking, the price paid on the second trading line may not be higher than (article 123(1)(d) FMIO):

– the last independent closing price on the regular trading line; or

– the current best independent offer price on the regular trading line, if it is lower than the closing price as described in the previous bullet point. 

However, article 123(4) FMIO stipulates the assumption that the market conduct and behavior rules are not violated if the price paid on the separate trading line, i.e., where only the bank (or the bank or securities dealer appointed to implement the buy-back) is permitted to post buy orders in the order book (separate trading line), is a maximum of 2% higher than:

– the last closing price achieved on the regular trading line; or

– the best current bid price on the regular trading line, provided this is below the price referred to in the previous bullet point. 

In any event, the company may not enter any buy order during the opening and closing auctions, nor during an auction performed by the exchange after a “stop of trading”.

2) Beware of Secondary Market Transaction Restrictions

The rules relating to market manipulation require that the company, and any of its affiliates or representatives acting in the name and on behalf of the company, do not execute transactions or acquisition or disposal orders which could give false or misleading signals regarding the supply, demand or price of the securities. Share buy-backs and other secondary market transactions in own shares could fall under these conduct rules. Article 123 FMIO contains safe harbor provisions which permit such transactions even though they could potentially constitute market manipulative behavior. In order to be exempted from the market manipulation rules, secondary market transactions in equity securities, within or outside the share buy-back program, must comply with – besides the pricing requirements (see section 1c) above) – the reporting requirements and volume restrictions set out in article 123(1) FMIO and circular no. 1 “Buy-back Programmes” of the Swiss Takeover Board dated June 27, 2013 (status as of January 1, 2016, the TOB Circular No. 1).

a) Scope of Application

The market manipulation (article 143 FMIA) or price manipulation (article 155 FMIA) rules apply to all securities admitted to trading on a trading venue in Switzerland. For the purposes of the FMIA, the term “securities” means standardized certificated and uncertificated securities, derivatives and intermediated securities, which are suitable for mass trading (article 2(b) FMIA; see also article 3(b) of the new Financial Services Act (FinSA), enacted by the Swiss Parliament on June 15, 2018 and currently expected to enter into effect on January 1, 2020). Therefore, trading in securities (e.g., shares, bonds, etc) and derivatives (defined as “financial contracts whose value depends on one or several underlying assets and which are not cash transactions”, see article 2(c) FMIA) which are admitted to trading on a trading venue in Switzerland is subject to the market conduct rules under the FMIA.

By contrast, only transactions in equity securities benefit from, and are included in, the safe harbor provisions contained in article 123 FMIO. The term “equity securities” relates to shares, participation certificates, profit-sharing certificates or other participation rights (article 2(i) FMIA and article 2(a) of the Ordinance of the Takeover Board on Public Takeover Offers of August 21, 2008 (TOO); see also article 3(a)(1) FinSA). Therefore, from the letter of the law, one could conclude that transactions in securities other than equity securities are not permitted under the market manipulation rules. This conclusion falls short of a systematic view, however.

In general, Swiss capital markets laws treat equity-linked securities and equity securities alike (e.g., disclosure of shareholdings pursuant to article 120 FMIA; equal treatment and transaction reporting during a public tender offer pursuant to article 9 TOO and articles 38 et seq. TOO, respectively). The same should be true if the scope of the safe harbor provisions contained in article 123 FMIO is defined. Securities whose value are derived, to a certain extent, from the value or performance of equity securities should also benefit from the safe harbor provisions. This applies to equity derivatives as defined in article 15 of the Financial Market Infrastructure Ordinance of the Financial Market Supervisory Authority FINMA dated December 3, 2015, such as conversion rights (e.g., convertible bonds), purchase rights (e.g., call options) and disposal rights (e.g., put options), as well as to other financial instruments the performance of which depends, fully or partly, on the performance of equity securities like American depository receipts (ADRs). 

Extending the scope of the safe harbor means, by contrast, that the reporting and volume restrictions apply not only to equity securities but also to equity-linked securities.

b) Purchases: Reporting Requirements and Volume Restrictions

Purchases of equity or equity-linked securities during a buy-back program are only permissible if the reporting requirements and volume restrictions set out in article 123(1) FMIO and the TOB Circular No. 1 are complied with.

During a buy-back program, the company must publish, on its website at the latest on the fifth trading day following their execution, purchases of equity or equity-linked securities whether executed within or outside of the buy-back program.

Further, the scope of purchases may not exceed 25% per day of the average daily volume traded during the 30 days prior to the publication of the buy-back (article 123(1)(c) FMIO). The number relevant for this 25% threshold is fixed at the time of publication of the buy-back notice and equals the sum of transactions on the regular trading line – both within and outside of the order book at the stock exchange – divided by the number of trading days in the 30 calendar days before publication of the buy-back notice (TOB Circular No. 1, note 23a). Given the extension of the scope of application set out above, companies are well advised to take into account all the secondary market purchases of equity and equity-linked securities whether executed within or outside of the buy-back program. This means, for instance, purchases of shares on the regular trading line outside the buy-back should – together with the purchases within the buy-back program over a second trading line – be considered for the 25% volume restriction.

The volume restriction can be an obstacle for companies whose shares have a low trading volume, as the permitted buy-back volume may result to be insignificant. In such case, the company has no other choice but to obtain an exemption from the Swiss Takeover Board (the TOB) pursuant to article 123(3) FMIO. As such exemption cannot be obtained in the reporting procedure, the company has to obtain formal approval from the TOB.

c) Sales: Reporting Requirements and other Restrictions

Sales of own equity or equity-linked securities during the buy-back program are only permitted if they are made solely to fulfil delivery obligations under employee participation programs. Alternatively, such sales are permissible under the safe harbor rules if they meet the following conditions: 

– they are reported to the stock exchange on the trading day following their execution, 

– they are published by the company no later than the fifth trading day after their execution, and

– their scope does not exceed 5% of the average daily volume traded on the regular trading line during the 30 days prior to the publication of the buy-back. 

These conditions also apply in case of selling equity or equity-linked securities for hedging purposes even if there is a firm intent to repurchase them later for delivery to employees. Such sale transactions do not qualify as being made solely to fulfil delivery obligations under employee participation programs.

The foregoing does, however, not mean that all sales of equity or equity-linked securities are permissible. There might be other restrictions (e.g., under foreign law) which apply to specific securities such as ADRs.

ADRs are generally treated like shares for purposes of the market manipulation and price manipulation rules applicable during a share buy-back program. Accordingly, they benefit from the safe harbor rules contained in article 123(1)(f) FMIO and their sales are permitted from the point of view of Swiss capital markets laws. However, secondary sales of shares (or ADRs) in the market involving U.S. jurisdictional means (e.g., U.S. stock exchange) might need to be registered with the U.S. Securities Exchange Commission (SEC) (an exemption should be available for sales of ordinary shares if they occurred on a Swiss stock exchange). Such sales present a potential violation of section 5 of the U.S. Securities Act of 1933, as amended, which requires every offer and sale of a security involving U.S. jurisdictional means to be registered with the SEC unless an exemption is available. Sales by a company or any of its affiliates would not ordinarily satisfy exemptions available in the case of ordinary secondary market transactions in securities issued by others (e.g., ADRs). If sales do not comply with the registration requirements, the seller would be strictly liable to purchasers. A purchaser needs only show that the securities were subject to registration but unregistered, that he or she bought the securities and that the defendant was the seller thereof.  Recovery would be limited to rescission or, if the plaintiff no longer owns the security, damages based upon the difference between the purchase price and the plaintiff’s resale price. Such a claim would need to be brought within one year of the alleged violation. In addition, section 5 violations could be subject to potential enforcement actions by the competent authorities.

d) Exempted Transactions

Notwithstanding the foregoing, certain secondary market transactions executed during a buy-back must be permissible without being subject to the reporting requirements and volume restrictions contained in article 123(1) FMIO and the TOB Circular No. 1. While there is no specific exemptions in the law, the following transactions should be exempt from the volume restrictions and reporting requirements: 

– market making for the purpose of facilitating client orders and ensuring liquidity in securities on both buy and sell sides to, where appropriate, reduce the bid/ask spread without moving the price of the securities against the market trend or fixing prices artificially, each in compliance with the market conduct rules set forth by FINMA (see FINMA Newsletter 52 (2013) dated November 18, 2013 “Trading own equity securities with the purpose of ensuring liquidity under the new provisions on market manipulation”), if booked on the trading book; 

– purchases and sales of equity or equity-linked securities if they are executed exclusively in order to fulfil delivery obligations under an employee participation program; and

– trading as client dealers in securities in the own name but for the account of clients.

3) VWAP-Based Buy-back Program

As set out in section 1a) above, a Swiss company which executes a share buy-back program for purpose of cancellation is obligated to pass on the withholding tax at a rate of 35% on the difference between the repurchase price, on the one hand, and the nominal value plus reserves from capital contributions, which is reduced or used in the course of the cancellation of shares upon the resolution of the general meeting of shareholders, on the other hand, to the sellers. To that end, share buy-back transactions for purpose of cancellation are executed over a second trading line. Shares are usually sold over the second trading line by financial investors (banks or securities dealers) which are entitled to a full refund of the withholding tax. It is the standard practice that the financial investors acquire the shares over the first trading line and sell them over the second trading line to the company (arbitrage business).

For certain Swiss domestic companies, whose shares are solely listed on a foreign stock exchange, the Swiss Federal Tax Administration permitted volume weighted average price (the VWAP) based buy-back programs bilaterally agreed between the executing agent and the company. However, such bilaterally agreed VWAP-based buy-back programs are not generally permitted for Swiss listed companies. They could be permissible if structured not as a sales agreement or a series of sales agreements with the company (such as in case the company is solely listed on a foreign stock exchange) but as a mandate. 

Therefore, VWAP-based buy-back programs for Swiss listed companies are usually structured as follows:

– The company mandates a bank or securities dealer (the Agent) to execute the share buy-back over a second trading line.

– This mandate includes a delegation of the execution of the share buy-back to the Agent in accordance with article 124(2)(a) and article 124(3) FMIO.

– The Agent, on behalf of and for the account of the company, independently executes repurchases on the basis of trading parameters determined by the company (the Trading Parameters) during a pre-defined trade period; after a match of the bid and ask price on the second trading line, the Agent pays to the seller of the shares the net price (i.e., the repurchase price less deducted applicable withholding taxes) for the shares with funds on an account of the company; the company is responsible for paying the applicable withholding taxes to the Swiss tax authorities.

– The special feature of this mandate is that the Agent receives a compensation if it manages to buy back shares at a better price per share than the arithmetic mean of the daily VWAP of the shares on the ordinary trading line over the term of the mandate agreement. The arithmetic mean of the daily VWAP is inevitably higher than its average purchase price since the average purchase price is volume-weighted, while the arithmetic mean of the daily VWAP is not volume-weighted.

4) Dutch Auctions

In its practice, the TOB confirmed the legality of so-called Dutch auctions in order to determine the buy-back price. In a Dutch auction, the repurchase price is identical for all tendering shareholders and within a price range set by the company. 

The Dutch auction includes the following features:

– In view of determining the repurchase price, each shareholder willing to tender its shares in the buy-back indicates, within the price range and buy-back period (usually ten days) fixed by the company, how many shares such shareholder wishes to sell at which price (the Sale Offer). 

– The repurchase price will be set identically for all tendering shareholders on the basis of all Sale Offers submitted so that the entire planned buy-back volume can be placed and the shares can be acquired by the company at the lowest possible price. 

– The tendering shareholders are able to sell their shares at the price determined in the Dutch auction which is either at the price indicated by them in the Sale Offer or below. Sale Offers of shareholders at a price above the determined repurchase price will not be accepted by the company. 

– If not all shares tendered by shareholders can be repurchased at the price determined in the Dutch auction because the maximum buy-back volume is exceeded, the shares tendered by each shareholder at the level of the determined price will be reduced proportionally.

According to the TOB, the Dutch auction combines elements of a fixed price offer and a buy-back at market price. Depending on whether elements of a fixed offer or market price offer prevail, the TOB treats the buy-back as a buy-back at a fixed price or at market price. Buybacks at a fixed price constitute partial public tender offers which must be open for a minimum period of ten trading days and which are submitted at a specific price. Buybacks at market price represent transactions in which the company announces its intention to buy back on the ordinary trading line or on a second trading line. They last for a maximum of three years and are carried out at a price determined in accordance with the matching rules of the relevant share exchange. Furthermore, in the case of buy-back at market price, the company is not obliged to acquire the securities tendered to it.

In the matter of AP Alternative Portfolio AG, the TOB held that elements of a buy-back at fixed price prevailed since the offer period and the price floor included in the buy-back as well as the identical price paid to each shareholder selling shares warranted a qualification of the buy-back as at a fixed price. As a result, pursuant to the Swiss takeover laws, the buy-back price would need to be fixed at the time the buy-back is announced. However, the TOB granted an exemption to that rule, holding that the Dutch auction complied with the principles of equal treatment, transparency and integrity. The TOB reasoned that the price of the buy-back was sufficiently determined given the price floor and the resulting knowledge of each shareholder of the lowest possible price. The fact that the price could indeed be higher after the auction had taken place was deemed permissible. In a later case, the TOB exempted a share buy-back program from the obligations of the TOB Circular No. 1 subject to the condition that the company is not allowed to be informed about the status, amount and price of the shares tendered by shareholders or to gather any such related information in any other way during the duration of the share buy-back program from the executing bank. This is to ensure that the company cannot influence the repurchase price.

Hansjürg Appenzeller (hansjuerg.appenzeller@homburger.ch)
Dieter Grünblatt (dieter.gruenblatt@homburger.ch)