On February 9, 2015, the SEC proposed long-awaited rules that would require a public company to disclose whether its employees (including officers) and directors are permitted to hedge the company’s equity securities. The proposed rules, which are mandated by Section 955 of the Dodd-Frank Act, are intended to inform stockholders as to whether employees or directors are allowed to engage in transactions to mitigate or avoid the risks associated with long-term ownership of a company’s stock–and thereby eliminate the incentive alignment associated with equity ownership.
Public companies are already required to disclose, in CD&A, any policies on hedging by named executive officers, if material. In addition, in 2012, Institutional Shareholder Services (“ISS”) announced that it views any amount of hedging of company stock by directors or executives as a “failure of risk oversight” that may lead to voting recommendations against individual directors, committee members or the full board of directors. In response to the CD&A requirement and ISS’ policy position and anticipating the implementation of Section 955 of the Dodd-Frank Act, many public companies already have adopted anti-hedging policies and disclose these policies in their proxy statements.
Summary of Rule Proposal
The rule proposal would add a new paragraph to the corporate governance disclosure requirements in Item 407 of Regulation S-K. Specifically, proposed Item 407(i) would require disclosure, in any proxy or information statement relating to the election of directors, of whether any employee or director, or any of their designees, is permitted to purchase any financial instruments 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 that are granted to the employee or director by the company as compensation or held, directly or indirectly, by the employee or director. Notably, the rule proposal does not require companies to prohibit hedging by employees or directors.
As used in proposed Item 407(i):
the term “employee” specifically includes officers;
whether someone is a “designee” of an employee or director would be determined by a company based on the facts and circumstances; and
“equity securities” means equity securities registered under Section 12 of the Exchange Act and issued by the company and its parents, its subsidiaries or any subsidiary of the company’s parent.
The Item 407(i) disclosure requirement would apply to all companies with securities registered under Section 12 of the Exchange Act, including smaller reporting companies and emerging growth companies and listed closed-end funds, but excluding foreign private issuers and other types of registered investment companies.
When making disclosures under proposed Item 407(i), a company would be required to disclose the particular types of hedging transactions it permits and those it prohibits. It would also have to specify whether any permissions or prohibitions apply to certain, but not all, persons covered by the proposed rules (e.g., executive officers but not other employees).
To reduce duplicative disclosure, the rule proposal would add a new instruction to Item 402(b) indicating that a company may satisfy the CD&A requirement in Item 402(b)(2)(xiii) to disclose policies on hedging by named executive officers, if material, by including a cross-reference to its Item 407(i) disclosure.
Comment Period and the 2015 Proxy Season
The SEC will seek comment on the proposed rules for 60 days following their publication in the Federal Register. SEC Commissioners Gallagher and Piwowar have issued a joint statement expressing their concerns with certain aspects of the proposed rules, including their applicability to smaller reporting companies, emerging growth companies and listed closed-end funds. Both the proposing release and the joint statement identify several topics on which the SEC is specifically requesting comments from the public.
Although the proposed disclosure requirements will, of course, not be in effect for the 2015 proxy season, companies should take them into account when deciding whether to adopt or revise their hedging policies and when drafting proxy statement disclosure regarding company hedging policies.