Key Takeaways:
- SEC has proposed hedging disclosure rules required by the Dodd-Frank Act
- Proposed rules require disclosure of policies permitting or prohibiting directors, officers and other employees to hedge their company's equity securities
- Purpose of the rules is to provide transparency to shareholders about whether directors, officers or other employees are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership
- Disclosure would be required in proxy statements relating to the election of directors
- Proposed rules do not require companies to limit or prohibit hedging or to adopt formal policies
On February 9, 2015, the Securities and Exchange Commission
proposed rules requiring companies to disclose whether directors,
officers and other employees, or any of their designees, are
permitted to hedge or otherwise engage in transactions to offset
any decrease in the market value of equity securities of the
company. The required disclosure would cover equity securities
that are granted by the company as compensation or that are
otherwise held, directly or indirectly, by directors, officers or
other employees. The purpose of the rules, according to the SEC, is
to provide transparency to shareholders about whether a
company's employees or directors are permitted to engage in
transactions that mitigate or avoid the incentive alignment
associated with equity ownership. The proposed rules require
disclosure only and would not require a company to prohibit hedging
transactions or to otherwise adopt practices or a policy addressing
hedging by any category of individuals.
The proposed rules implement Section 14(j) of the Securities
Exchange Act of 1934 (the Exchange Act), which was added pursuant
to Section 955 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act. The proposed rules would require hedging
disclosure in proxy or consent solicitation materials and
information statements with respect to the election of directors,
and apply to companies subject to the federal proxy rules,
including smaller reporting companies and emerging growth
companies. Foreign private issuers, which are not generally
required to comply with the federal proxy rules, would not be
required to provide such disclosure.
Requirements for Disclosure
The SEC proposes to amend Item 407 of Regulation S-K to require
companies to disclose whether an employee, officer or director, or
any of their designees, is permitted 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. Whether someone is a "designee" of an
employee, officer or director would be determined by a company
based on the particular facts and circumstances. The required
disclosure would apply to equity securities issued by the company,
its parent, subsidiary or any subsidiary of any parent of the
company that is registered under Section 12 of the Exchange
Act. The proposed rules are intended to cover all transactions
that establish downside price protection, whether by purchasing or
selling a security or derivative security or otherwise.
A company that permits hedging transactions would be required to
disclose in sufficient detail the scope of such permitted
transactions. If a company permits hedging transactions by some,
but not all, of its employees, officers or directors, then the
company would be required to disclose which categories of persons
are permitted to engage in hedging transactions and which
categories of persons are not. Similarly, if a company permits
certain types of hedging transactions, but not others, then the
company would be required to disclose the categories of hedging
transactions it permits and those which it prohibits.
The proposed Item 407(i) disclosure would not be required in
registration statements or in annual reports on Form 10-K. In order
to avoid the potential for duplicative disclosure, the SEC also
proposes to add an instruction to Item 402(b) of Regulation
S-K providing that a company may satisfy its CD&A
obligation to disclose material policies on hedging by named
executive officers by cross referencing to the Item 407(i)
disclosure.
Despite voting to support the issuance of the proposal,
Commissioners Daniel M. Gallagher and Michael S. Piwowar issued a
joint statement critical of several aspects of the proposed rules,
including the failure to exempt emerging growth companies or
smaller reporting companies, the requirement that certain
investment companies make the disclosures contemplated by the
proposed rules, the requirement for disclosure relating to
employees that cannot affect the company's share price, and the
coverage of securities of the issuer's affiliates, which they
consider to be overbroad. In contrast, Commissioner Luis A. Aguilar
issued a statement in support of the proposal as a positive step in
the direction of providing more information to shareholders as to
whether the interests of corporate insiders are aligned with their
own.
Request for Comments
Among other things, the SEC has requested comments on whether
the hedging disclosure should be implemented by amending Regulation
S-K Item 402 instead of Item 407, as proposed; whether the proposed
definition of "equity securities" as equity securities of
the company or any of its parents, subsidiaries or subsidiaries of
its parents appropriately captures the disclosure that shareholders
would find useful or whether the term "equity securities"
should be limited to only equity securities of the company; whether
the definition of "employee" should be limited to the
subset of employees that participate in making or shaping key
operating or strategic decisions that influence the company's
stock price; whether disclosure of any hedging that has occurred
should be disclosed in Form 4 filings and proxy statements; whether
the disclosure should be limited only to annual meetings, and not
special meetings; whether the proposed disclosure should also be
required in registration statements or Form 10-K filings; and
whether all funds or additional types of funds other than listed
closed-end funds should be required to provide the proposed
disclosure.
Comments are due within 60 days after the proposed rules are
published in the Federal Register.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.