The Securities and Exchange Commission (SEC) recently adopted a final rule requiring companies to disclose practices or policies related to the ability of employees (including officers) and directors to engage in hedging transactions with respect to company equity securities held directly or indirectly by employees or directors, whether granted as compensation or otherwise. Companies that do not have such a practice or policy must disclose that they have none or that hedging transactions are generally permitted.
The new disclosure requirement applies to proxy and information statements related to director elections during fiscal years beginning on or after July 1, 2019, for companies that do not qualify as smaller reporting companies (SRCs) or emerging growth companies (EGCs). For SRCs and EGCs, the disclosure requirement first applies to proxy and information statements during fiscal years beginning on or after July 1, 2020.
Under the final rule, which has been adopted as new Item 407(i) of Regulation S-K, companies must provide either a summary or the full text of any practice or policy “regarding the ability of employees, directors or their designees to purchase financial instruments, or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities … including the categories of persons covered and any categories of hedging transactions that are specifically permitted and any categories that are specifically disallowed.”
The new rule does not define the term “hedge,” but the SEC cautioned in the adopting release that the term “hedge” should be applied broadly in determining what policies may require disclosure. Some examples of hedging transactions are variable forward contracts, equity swaps, collars and exchange funds, but it is up to registrants to describe their policies and identify which specific transactions designed to hedge or offset any decrease in the market value of their equity securities are actually covered by their policies.
Some commenters on the new rule have expressed concern that the term hedge could apply to portfolio diversification transactions and other investments in unrelated equity securities, the performance of which may have a negative correlation with a company’s equity securities. Issuers may want to expressly provide in their policies and disclose that portfolio diversification transactions or broad-based index transactions are not covered by the prohibitions in their policies.