SEC Proposes Requirement to Disclose Hedging by Employees and Directors, as Required by Dodd-Frank | Practical Law

SEC Proposes Requirement to Disclose Hedging by Employees and Directors, as Required by Dodd-Frank | Practical Law

The SEC issued a proposal that would implement Section 955 of the Dodd-Frank Act to require hedging disclosure in a proxy statement or information statement relating to an election of directors.

SEC Proposes Requirement to Disclose Hedging by Employees and Directors, as Required by Dodd-Frank

by Practical Law Corporate & Securities
Published on 10 Feb 2015 • USA (National/Federal)
The SEC issued a proposal that would implement Section 955 of the Dodd-Frank Act to require hedging disclosure in a proxy statement or information statement relating to an election of directors.
On February 9, 2015, the SEC issued a proposed rule that would implement Section 955 of the Dodd-Frank Act, as codified in Section 14(j) of the Exchange Act. Section 955 requires that a registrant's annual meeting proxy statement disclose whether employees or members of the board of directors are permitted to engage in transactions to hedge or offset any decrease in the market value of equity securities either:
  • Granted to the employee or board member as compensation.
  • Held, directly or indirectly, by the employee or board member.
The purpose of the proposal is to provide transparency to shareholders regarding whether employees or directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership. The SEC is accepting comments on the proposal until April 20, 2015.

Proposed Item 407(i) of Regulation S-K

The proposal would add new paragraph (i) to Item 407 of Regulation S-K, as summarized below.

Transactions Subject to the Proposal

Proposed Item 407(i) would require disclosure of 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).
  • 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.
Instructions to proposed Item 407(i) would provide clarification on:
  • Permitted and prohibited transactions. A company would be required to disclose which categories of transactions it permits and which categories of transactions it prohibits. However, if a company specifically prohibits certain hedging transactions, it would disclose the categories of transactions it specifically prohibits and could, if true, disclose that it permits all other hedging transactions, instead of listing all of the specific categories that are permitted. Conversely, if a company specifically permits certain hedging transactions, it would disclose the categories of transactions it specifically permits and could, if true, disclose that it prohibits all other hedging transactions, instead of listing all of the specific categories that are prohibited. If a company does not permit any hedging transactions, or permits all hedging transactions, it would state so and would not be required to describe them by category.
  • Scope of permitted transactions. A company that permits hedging transactions would be required to disclose sufficient detail to explain the scope of the permitted transactions. For example, a company that permits hedging of equity securities that have been held for a specified period of time would need to disclose the period of time the securities must have been held.
  • Persons permitted to hedge. If a company permits some, but not all, of the categories of persons covered by the proposal to engage in hedging transactions, the company would disclose both the categories or persons who are permitted to hedge and those who are not. For example, a company might disclose that it prohibits all hedging transactions by executive officers and directors, but does not restrict hedging transactions by other employees.

Equity Securities Subject to the Proposal

Proposed Item 407(i) would apply to the equity securities (as defined in Exchange Act Section 3(1)(11) and Exchange Act Rule 3a11-1) issued by the company, any of its parents, any subsidiary of the company or any subsidiary of any parent of the company that are registered under Section 12 of the Exchange Act.

Employees and Directors Subject to the Proposal

While Section 14(j) of the Exchange Act covers hedging transactions conducted by an employee or member of the board of directors or any of their designees, the proposal interprets "employee" to include everyone employed by an issuer, including its officers. Therefore, the proposal would cover any employees, including officers, or directors of the registrant, or any of their designees.

Implementation of Proposal

Manner and Location of Disclosure

The proposal would amend Items 7 and 22 of Schedule 14A to require disclosure under proposed Item 407(i) if action is to be taken with respect to the election of directors, whether by vote of security holders at a meeting or by an action authorized by written consent. The disclosure would need to be included in proxy or consent solicitation materials and in information statements filed on Schedule 14C. The disclosure would not be required in Part III of Form 10-K even if a company incorporates disclosure by reference to its proxy or information statement.

Relationship to Existing CD&A Obligations

Among other things, Item 402(b) of Regulation S-K requires that a company's Compensation Discussion and Analysis (CD&A) contain disclosure of any policies regarding hedging the economic risk of company securities ownership, to the extent material. The CD&A applies only to named executive officers and is part of the Item 402 executive compensation disclosure that is required in Securities Act and Exchange Act registration statements, annual reports on Form 10-K, and proxy and information statements relating to the election of directors. Smaller reporting companies, emerging growth companies (EGCs), registered investment companies and foreign private issuers (FPIs), however, are not required to provide CD&A disclosure.
To reduce potentially duplicative disclosure in proxy and information statements, the proposal would amend Item 402(b) to add an instruction that a company may satisfy its CD&A obligation to disclose material policies on hedging by named executive officers by cross-referencing the information disclosed under proposed Item 407(i) to the extent that the information disclosed there satisfies the CD&A disclosure requirement.

Issuers Subject to the Proposal

The proposal would not exempt:
  • Closed-end funds.
  • Smaller reporting companies.
  • EGCs.
These companies would be required to comply with the requirements of proposed Item 407(i). The proposal would not apply to FPIs because securities registered by an FPI are not subject to the proxy requirements of Section 14 of the Exchange Act.
To learn more about required disclosure in proxy statements, see Practice Note, Proxy Statements.