On February 9, 2015, the Securities and Exchange Commission (the “SEC”) released proposed rules that would require the disclosure of company policies related to the hedging of downside risk associated with owning company securities by officers, employees and directors, as required pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”). The SEC believes the proposed disclosure would add to the mix of information regarding corporate governance practices; SEC Chair Mary Jo White stated that “[i]ncreasing transparency into hedging policies will help investors better understand the alignment of the interests of employees and directors with their own.” The proposed rule is disclosure-based; it does not prohibit companies from allowing their employees and directors to hedge.
The proposed rules would add to the corporate governance disclosure requirements in Item 407 of Regulation S-K, and would require a company to disclose whether it permits its employees, including officers, and directors to purchase financial instruments or engage in transactions that are designed to, or have the effect, of hedging or offsetting any decrease in the market value of company equity securities held by or granted to such persons in proxy or information statements with respect to the election of directors. For purposes of the proposed rule, equity securities are those registered under Section 12 of the Securities Exchange Act of 1934 and issued by the company and its parent(s), subsidiaries or any subsidiary of its parent(s). While a company that prohibits hedging transactions altogether would be able to simply state that hedging transactions are not permitted, if a company permits hedging, either by a certain category of persons or via certain types of transactions, it would need to disclose the categories of persons and/or transactions that are permitted and those that are prohibited.
Item 402(b)(2) of Regulation S-K already requires the disclosure of company policies regarding hedging by the named executive officers, if material, in the Compensation Discussion and Analysis section. Therefore, the rule proposal includes an addition to the instructions to Item 402(b), such that if information is disclosed pursuant to new Item 407(i) that would satisfy the existing requirement, a company may refer to the Item 407(i) disclosures in its proxy or information statement.
The SEC will be taking comments on the proposed rules for 60 days following the publication of the rule proposal in the Federal Register. Particular areas of interest include whether the definition of “employee” should be limited to only those employees who participate in key operating or strategic decisions that influence the company’s stock price and whether emerging growth companies or smaller reporting companies should be exempted.
Many companies adopted, or considered adopting, policies related to hedging following the adoption of Dodd-Frank. Therefore, companies should consider the potential impact of the proposed rule on such policies (or any potential policy), as well as any potential changes to proxy or information statement disclosures related to hedging.