Stock buybacks: the fraud of the century

Reading time: 5 – 8 minutes

Stock buybacks are a multi-trillion dollar fraud that has been perpetrated on long-term investors for over thirty years, under the benevolent gaze of the US Securities and Exchange Commission.  Buybacks drain away company assets, reduce cash dividends, and weaken the finances of issuers.  However, the fraud is so cleverly concealed that, it has been said, one would have to be a fool not to be deceived.

This blog and the accompanying site, Center for Capital Flow Analysis, have, perhaps, the largest collection of articles and critiques of the practice of corporate stock buybacks on the Internet.

I first became aware of the incredible scope of the buyback fraud in the 1990s, when I noticed huge distortions in Federal Reserve flow of funds accounts. Since then, I have been researching and writing about this phenomenon.

The Federal Reserve statistics showed that corporations had been buying back their own equities, while private investors, on balance, had been selling equities, during a time when the S&P 500 index was steadily rising.

In other words, companies, instead of going to Wall Street to raise money, were doing exactly the opposite, while investors were selling out — but nevertheless, stock prices were rising.

Could this be really happening?

What could explain this apparent reversal of the normal function of capital markets as taught in Economics 101?

Why were so few people talking about this?

Many are involved in the scam

Corporate stock buybacks are the drug that have kept US equity markets on a perpetual high since 1983 when the US Securities and Exchange Commission gave issuers permission to manipulate prices upwards so that executives could earn fat bonuses on their stock options.

Many market players, who should know better, defend stock buybacks, each for their own reasons:

1. Politicians like buybacks because they push stock prices upwards and many people look to the S&P 500 as an indication of the success of government economic policy.
2. Corporate employee-executives love buybacks because they can earn multi-million dollar bonuses on the theory that stock market prices reflect their ‘performance’.
3. Mutual fund managers adore buybacks because by manipulating prices upwards artificially the SEC Total Return on their portfolio is improved, making them appear to be more competent.

SEC recruiting propaganda: flexible hours, high pay, nice offices, feel good about ‘protecting the little guy’, But don’t ask about Bernard Madoff, or SEC Rule 10b-18, you won’t get the job.
4. Ordinary investors don’t mind buybacks because as long as the value of their portfolios seems to be increasing, they are happy.  Most modest investors owning mutual funds have no way to judge the intrinsic value of their holdings and rely, instead, on SEC Total Return.
5. SEC Commissioners love buybacks because rising stock prices please the politicians to whom they report and the corporate executives and fund managers who may give them employment when their term is over.

However, stock buybacks, in the long-run, are bad for ordinary investors, draining away the assets of the company, reducing cash dividends, and weakening financial integrity of issuers.  Stock buybacks are a fraud perpetrated on long-term investors by company management.

The smartest investors understand

Although the negative effects of stock buybacks are still largely unknown to ordinary investors, I am not the only voice speaking out:

The virus of corporate stock buybacks has infected equity markets since 1983, when implanted by the US SEC.

1. Benjamin Graham, Warren Buffett’s teacher, wrote against stock buybacks in the investment classic, “Security Analysis’, published in 1933.
2. Warren Buffett, has criticized stock buybacks in the 2005 Berkshire Hathaway annual report.
3. Moody’s Investor Service has criticized corporate borrowing to finance buybacks.
4. M.A. Gumport, CFA, has published research showing that stock buybacks have not turned out well for investors.
5. Suzanne McGee and Greg Ip wrote an article in the Wall Street Journal on “Stock buybacks are not always good news”.

However, criticism of stock buybacks is still not generalized.

Finding out how to protect yourself

There are over five dozen articles on stock buybacks on this blog.

Featured articles on this topic are show at the bottom of the front page. Essays on buybacks have links in the left sidebar.

This site has all the information you’ll need to protect yourself against this fraud and from not be misled by fast-talking stockbrokers.

For an easy, non-technical place to start, I would suggest the essay, “Stock Buybacks, a Simple Fable”.

The articles on these sites cover various aspects of the buyback issue, from accounting matters, SEC regulation, investor fraud, flow of funds evidence, arguments pro and contra, corporate governance, and the interests of long-term investors.

Try these links for articles about stock buybacks:

• Stock buybacks (category);
• Stock buybacks (tag);
• Corporate governance;
• Executive stock options;
• Fraud;
• Market manipulation;
• SEC Rule 10b-18;
• Total returns;
• US SEC;