Reed Smith Client Alerts

Authors: Craig R. Enochs

On February 9, 2015, the Securities and Exchange Commission (the “SEC”) proposed rules that would require disclosure of policies permitting or prohibiting hedging by directors, officers and other employees to hedge or offset any decrease in the market value of their company’s equity securities. The proposed rules, which are mandated by Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, would implement new Section 14(j) of the Securities Exchange Act of 1934. The purpose of the proposed rules, according to the SEC, is to provide transparency to shareholders about whether employees and directors are permitted by the company to engage in transactions that mitigate or avoid the incentive alignment with equity ownership – whether these securities are granted to them by the company as compensation, in the open market or otherwise. The proposed amendments would not require a company to prohibit hedging transactions or adopt practices or policies addressing hedging, but relate exclusively to the disclosure of such policies. Prohibitions on hedging may be included in a company’s securities policy or corporate governance guidelines.

The deadline for comment on the SEC’s proposal is 60 days following publication in the Federal Register.

Requirements of the Proposed Rule In implementing Section 14(j), the SEC proposes to amend Item 407 of Regulation S-K to add new paragraph (i). Specifically, proposed Item 407(i) would require domestic SEC reporting companies to disclose whether they permit directors, officers and employees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds), or otherwise engage in transactions that are designed to hedge or offset any decrease in market value of equity securities (1) granted to the employee or director by the company as part of their compensation; or (2) held, directly or indirectly, by the employee or director. In addition, the proposed rules specify the following:

  • Disclosure or Prohibition Against Hedging If a company permits some, but not all, of its employees (including officers) and directors to hedge, the company would be required to disclose which categories of persons are permitted to hedge and which categories of persons are not. Similarly, if a company permits some types of hedging transactions, but not others, the company would be required to disclose the categories of transactions that are permitted (including sufficient details to explain the scope of such permitted transactions) and which it prohibits; and
  • Covered Securities The equity securities for which disclosure is required are only equity securities (as defined in the Exchange Act Section 3(a)(11) and Exchange Act Rule 3a11-1) of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parent of the company that is registered under Section 12 of the Exchange Act. The proposed rules cover equity securities (1) granted pursuant to compensatory equity grants and (2) other equity securities held by the covered person acquired from any other source, including, but not limited to, open market purchases.

The proposed rules would require disclosure in proxy and information statements with respect to the election of directors, and would apply to companies subject to the SEC’s proxy rules, including smaller reporting companies, emerging growth companies, business development companies, and registered closed-end investment companies with shares listed and registered on a national securities exchange. The disclosure would not be required in Securities Act or Exchange Act registration statements, or in Form 10-K Part III Item 407 disclosure, and foreign private issuers would not be required to provide hedging policy disclosure.

While acknowledging that the JOBS Act (formally the Jumpstart Our Business Startups Act) excludes emerging growth companies from some, but not all, of the provisions of Title IX of Dodd-Frank, and that emerging growth companies and smaller reporting companies are in many instances subject to scaled disclosure requirements – including with respect to executive compensation – the SEC noted that it would be more consistent with its historical approach to corporate governance-related disclosures not to exempt these companies from the proposed disclosure requirement.

To reduce duplicative disclosure in proxy and information statements, the SEC also proposed to add a new instruction to Item 402(b) indicating a company may satisfy its Compensation Discussion and Analysis requirement to disclose material policies on hedging by named executive officers, if material, by including a cross-reference to its Item 407(i) hedging disclosure.

Joint Statement of Commissioners Gallagher and Piwowar Notably, SEC Commissioners Daniel M. Gallagher and Michael S. Piwowar issued a joint statement expressing their concerns with several aspects of the proposed rules. Among their concerns with the proposal were: (1) their applicability to smaller reporting companies, emerging growth companies and listed closed-end funds; (2) the SEC did not exercise its statutorily granted exemptive authority to exempt from the rule disclosure regarding employees that cannot affect a company’s share price; (3) the overbroad application of the rule to company’s securities, as well as securities of the company’s affiliates; and (4) the prioritization given to this proposal over other Dodd-Frank rules germane to the financial crisis. Both the proposing release and the joint statement identify several topics on which the SEC is specifically requesting comments from the public.


Client Alert 2015-038