The Securities and Exchange Commission (SEC) has adopted new rules that will require public companies to disclose their hedging practices and policies for employees, officers and directors in proxy and information statements regarding the election of directors. While the new rules will not be effective for this proxy season, companies may wish to review and revise their practices and policies in anticipation of these new disclosure requirements.
The SEC adopted these rules to implement mandates under the Dodd-Frank Wall Street Reform and Consumer Protection Act. As discussed in the adopting release, the intent behind the requirements is to allow shareholders to understand the extent to which employees or directors may engage in transactions that mitigate the economic risk of company equity ownership in a way that may undermine the alignment of interest between these insiders and the shareholders.
The New Requirements
New Item 407(i) of Regulation S-K will require companies to describe any practices or policies (whether written or unwritten) regarding the ability of employees (including officers), directors or their designees to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds), or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in market value of company equity securities granted to the employee or director by the company, whether as part of the compensation of the employee or director; or held, directly or indirectly, by the employee or director.
Companies may provide the disclosure either: (1) through a summary of the practices or policies that apply, including the category of persons covered and any categories of hedging transactions that are permitted and those that are specifically disallowed; or (2) by providing the practices or policies in full. These options acknowledge that some companies’ practices and policies may be contained in different agreements and corporate governance policies. While the rules do not require or dictate the content of hedging practices or policies, companies that do not have any such practices or policies will be required to state that fact or disclose that hedging transactions generally are permitted.
In adopting the new rules, the SEC specifically declined to define the term “hedge” and acknowledges that the term should be applied in a broad sense, despite concerns that it could include transactions such as portfolio diversification transactions and broad-based index transactions that are not typically considered problematic to investors.
The SEC addresses these concerns by stressing that companies need only describe these broader transactions if their practices and policies address them. Similarly, the SEC declined to define the term “designee” because companies are free to define the scope of persons covered by their policies.
Expanding on Current Proxy Disclosure
While current proxy reporting requirements address hedging, many issuers will need to expand on the disclosure they provide. Item 402(b)(2)(xiii) of Regulation S-K calls for disclosure in the Compensation Discussion and Analysis (CD&A), if material, of a non-exclusive list of items, including a description of the company’s equity or other security ownership guidelines and any company policies regarding hedging the economic risk of such ownership. However, this disclosure may be limited to named executive officers. The final rules allow for cross-referencing between the Item 402 and 407(i) disclosures, but issuers may wish to keep the hedging policy disclosure separate from the CD&A to avoid bringing it within the advisory say-on-pay votes.
Compliance Dates
Companies that do not qualify as emerging growth companies or smaller reporting companies will need to comply with the new disclosure requirements for proxy and information statements with respect to the election of directors during fiscal years beginning on or after July 1, 2019. Companies that qualify as smaller reporting companies or emerging growth companies will need to comply with the new disclosure requirements for proxy and information statements with respect to the election of directors during fiscal years beginning on or after July 1, 2020.
What Companies Should Do Now
Prior to the compliance dates, companies should review the hedging practices and policies they have in place, and consider whether to consolidate and/or update such practices and policies in light of the SEC’s adopting release. In particular, companies may wish to consider whether policies and practices cover the appropriate categories of people and whether such policies and practices should include more detail regarding specific transactions that are permitted or prohibited under such practices and policies, with the understanding that such detail would require disclosure. While the new rules do not require companies to have hedging policies in any particular form, or at all, companies may also wish to consider the views of the proxy advisory firms and their institutional investors in taking a fresh look at company policies and practices.
