20 February 2015
On February 9, 2015, the US Securities and Exchange Commission (SEC) proposed rules requiring disclosure of hedging by employees, officers and directors.1 This rulemaking is directed by Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Comments are due by April 20, 2015.
The SEC Commissioners acted unanimously on this proposal, without convening a meeting. However, two Republican commissioners issued a joint statement indicating that while they supported the issuance of the proposal for comment, they remain quite concerned by several aspects of the proposal and hope it will receive robust public comment.2 In addition to seeking comments on the proposal generally, the proposing release requested comments on 30 specific questions in its discussion of the proposed amendment, as well as 16 additional comment requests as part of its economic analysis of the proposal.
As proposed, companies would have to disclose whether employees (including officers) or members of the board of directors are permitted to engage in transactions to hedge or offset any decrease in the market value of a company’s equity securities granted to the employee or board member as compensation, or held directly or indirectly by the employee or board member. Specifically a new paragraph (i) would be added to Item 407 of Regulation S-K providing:
(i) Employee, officer and director hedging. In proxy or information statements with respect to the election of directors, disclose whether the registrant permits any employees (including officers) or directors of the registrant, or any of their designees, to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) or otherwise engage in transactions that are designed to or have the effect of hedging or offsetting any decrease in the market value of equity securities—
Granted to the employee or director by the registrant as part of the compensation of the employee or director; or
(2) Held, directly or indirectly, by the employee or director.
The proposed rules are drafted to cover all transactions that establish downside price protection in a company’s equity securities, whether by purchasing or selling a security or derivative security or otherwise. It would cover hedging of any equity security issued by the company, by any parent or subsidiary of the company or by any subsidiary of any parent of the company that is registered under Section 12 of the Securities Exchange Act of 1934. The resulting disclosure would need to make clear what categories of transactions a company permits and what categories it prohibits.
The proposed hedging disclosure would be required in any proxy statement or information statement relating to an election of directors. However, the proposed rules would not require hedging disclosure in registration statements or in annual reports on Form 10-K.
Many public company proxy statements already discuss hedging policies. The compensation discussion and analysis (CD&A) section of the proxy statement required by Item 402(b) of Regulation S-K must disclose all material elements of a company’s compensation policies and decisions for executive officers whose compensation is required to be disclosed in the proxy statement (NEOs). In that regard, Item 402 (b)(2)(xiii) of Regulation S-K identifies policies regarding hedging the economic risk of owning company equity securities as an example of the kind of information that may be required.
The proposed hedging disclosure requirement would extend beyond the current CD&A requirement. For example, the CD&A only requires a discussion of hedging policies affecting the NEOs, while the proposed rules would mandate disclosure of hedging policies with respect to all employees, officers and directors. In addition, the proposed hedging disclosure rules would apply to all companies that are required to comply with the SEC’s proxy rules. Therefore, they would impact companies that are not required to provide CD&A disclosure, such as smaller reporting companies, emerging growth companies, business development companies and registered closed-end investment companies that have shares listed on a national securities exchange. However, foreign private issuers are not required to file proxy statements, thus would not be required to provide the proposed hedging disclosures.
The proposed rules do not require companies to adopt hedging policies. However, in light of the proposed rules, as well as corporate governance concerns that have been raised by certain shareholders, proxy advisory firms and corporate governance rating organizations, public companies may want to review their existing approaches to hedging to consider whether any new or amended policies would be appropriate and whether any changes to existing hedging policies should be made now or when the final rules are adopted.
If a company is considering revising an existing hedging policy, or adopting a new hedging policy, one thing to consider is whether the policy should apply to all employees (including officers) and directors equally, or whether different policies are appropriate for different categories of employees or different categories of hedging activities.
In addition, it will be important to monitor whether the proposed rules are amended to address some of the interpretive issues that are raised by the current proposal. For example, who are employees of the registrant for purposes of the disclosure requirement?
Companies concerned about the impact of the proposed hedging disclosure rules may want to join the debate by submitting comments on this proposal to the SEC.
The proposing release did not discuss any effective date, but given the timing of the release and the comment period, it is unlikely that final hedging disclosure rules could be adopted before the 2016 proxy season.
1 Available at http://www.sec.gov/rules/proposed/2015/33-9723.pdf.
2 Available at http://www.sec.gov/news/statement/020912ps-cdmg-cmsp.html.