On February 9, 2015, the Securities and Exchange Commission, as required by Section 955 of the Dodd-Frank Act[1] , issued proposed rules requiring enhanced proxy disclosure of a company’s hedging policies for its directors, officers and other employees. The proposed rules would require a company to disclose, in any proxy statement or information statement relating to an election of directors, whether its directors, officers or other employees are permitted to hedge or offset any decrease in the market value of equity securities that are either granted by the company as compensation, or held (directly or indirectly) by the individual.
Currently, companies are required to make disclosures regarding their hedging policies in the company’s Compensation Discussion and Analysis (“CD&A”) section of their proxy. In the CD&A section of a proxy, companies are required to disclose material information necessary to an understanding of a company’s compensation policies and decisions regarding its named executive officers. Item 402(b)(2)(xiii) provides that, if material, disclosure regarding a company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership), and any company policies regarding hedging the economic risk of such ownership should be included in the CD&A. The CD&A disclosure requirement does not apply to smaller reporting companies, emerging growth companies, registered investment companies or foreign private issuers. The new proposed rules would expand both the disclosure requirements regarding hedging policies and the types of companies required to make disclosure regarding hedging policies.
The proposed rules would add paragraph (i) to Item 407 of Regulation S-K and would require companies to disclose whether the registrant permits any employees (including officers) or directors, 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 a company’s equity securities. Companies that permit hedging by certain employees would be required to disclose the categories of persons who are permitted to engage in hedging transactions and those who are not. In addition, companies would also be required to disclose the categories of hedging transactions that they permit and those that they prohibit. The new disclosure would apply to all issuers registered under Section 12 of the Exchange Act, including smaller reporting companies, emerging growth companies, and listed closed-end funds, but excluding foreign private issuers and other types of registered investment companies.
The proposed rules do not require a company to prohibit its directors, officers or other employees from engaging in hedging transactions in the company’s securities or to adopt hedging policies. Rather, the proposed rules, consistent with the SEC’s view[2] of the statutory purpose of Section 14(j) of the Exchange Act, are intended to provide investors with additional information, enabling them to ascertain whether a company’s directors, officers or other employees, through hedging transactions, are able to avoid any requirements that they hold stock long-term, and thereby receive their compensation even if their company underperforms. The disclosure aims to give stockholders a better understanding of whether the interests of a company’s directors, officers and other employees are aligned with their own interests.
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[1] Section 955 of the Dodd-Frank Act added Section 14(j) to the Exchange Act. Section 14(j) directs the SEC to require, by rule, each issuer to disclose in any proxy or consent solicitation material for an annual meeting of the shareholders of the issuer whether any employee or member of the board of directors of the issuer, or any designee of such employee or director, is permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds) that are designed to hedge or offset any decrease in the market value of equity securities either (1) granted to the employee or director by the issuer as part of the compensation of the employee or director; or (2) held, directly or indirectly, by the employee or director.
[2] The proposing release cites a report issued by the Senate Committee on Banking, Housing, and Urban Affairs which stated that Section 14(j) is intended to “allow shareholders to know if executives are allowed to purchase financial instruments to effectively avoid compensation restrictions that they hold stock long-term, so that they will receive their compensation even in the case that their firm does not perform.” In this regard, the SEC explained “we infer that the statutory purpose of Section 14(j) is to provide transparency to shareholders, if action is to be taken with respect to the election of directors, about whether employees or directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership.”
