On February 9, 2015, pursuant to the mandate in Section 955 of the Dodd-Frank Act, the SEC proposed new rules that, if adopted, would require public companies to disclose in their proxy or information statements relating to director elections whether the company permits employees (including officers) or directors to hedge or offset any decrease in the market value of the equity securities of the public company or its affiliates.  The proposed rules do not prohibit hedging transactions, but rather are intended to provide transparency to shareholders on whether employees or directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with equity ownership.  The proposed rules, which are discussed more fully below, are set forth in Release No. 33-9723.  Public comments on the proposed rules must be received within the 60-day period following their publication in the Federal Register. 

Summary of the Proposed Rules

The proposed rules would add new paragraph (i) to Item 407 of Regulation S-K, which would require disclosure in proxy or information statements relating to the election of directors about whether any employees (including officers) or directors, or any of their designees, are permitted to engage in transactions to hedge or offset any decrease in the market value of equity securities that were either granted to the employee or director by the company as part of their compensation or are held, directly or indirectly, by the employee or director. 

Transactions covered.  The proposed rules use a principles-based approach, requiring disclosure of whether a company permits employees or directors to purchase certain enumerated financial instruments, including prepaid variable forward contracts, equity swaps, collars and exchange funds, or otherwise engage in any other type of transactions that may have the same hedging effect or establish downside price protection.

A proposed instruction to Item 407(i) clarifies that the company must disclose which categories of transactions it permits and which categories it prohibits, noting that a company may, if true, disclose that it prohibits or permits particular categories and permits or prohibits, respectively, all other hedging transactions.  If a company either prohibits all hedging transactions or permits all such transactions, the company is not required to identify certain categories.  A company that permits hedging transactions would be required to provide sufficient detail to explain the scope of such permitted transactions.

Equity securities.  The proposed rules apply to equity securities issued by the company and its parents, subsidiaries or subsidiaries of the company’s parents that are listed on a national securities exchange or otherwise registered under Section 12 of the Exchange Act.  The proposed disclosure would apply to the hedging of equity securities that were granted as compensation and securities otherwise held, directly or indirectly, by the employee or director.

Persons covered.  The proposed rules apply to hedging transactions conducted by any employee or director of the company, or any of their designees.  Employee is interpreted to include everyone employed by the company, including officers.

Companies subject to proposed rules.  The proposed rules apply to companies with securities registered under Section 12 of the Exchange Act, including smaller reporting companies, emerging growth companies and listed closed-end investment companies.  Foreign private issuers and other types of registered investment companies are excluded from the proposed rules. 

Manner and location of disclosure.  While the Dodd-Frank Act called for disclosure in any proxy or consent solicitation material relating to an annual meeting, the scope of the proposed rules is more expansive and would require disclosure in proxy or consent solicitation materials or information statements if action is to be taken with respect to the election of directors, without regard to whether at an annual or special meeting of shareholders or in connection with an action by written consent.  The proposed disclosures will not be deemed incorporated by reference into any filing under the Securities Act, the Exchange Act or the Investment Company Act, unless specifically incorporated by reference.

Public companies, other than smaller reporting companies, emerging growth companies, registered investment companies and foreign private issuers, are already required to disclose in the CD&A section of their proxy statements any company policies on hedging by their named executive officers, if material.  To avoid potentially duplicative disclosure, the proposed rules would allow companies to cross-reference the information disclosed pursuant to proposed Item 407(i) to the extent it satisfies the CD&A disclosure requirement.

Company Considerations

With the negative light that ISS and Glass Lewis have cast on hedging (and pledging) by executive officers, an increasing number of companies already have adopted policies that prohibit hedging and, pursuant to existing CD&A requirements, disclosed such policies in their proxy statements. 

While it is unclear what the final rules may look like or when they may take effect (in no event would final rules apply to the 2015 proxy season), companies should consider the additional proposed disclosure requirements in connection with any review of their existing hedging policies or any determination to adopt a hedging policy.