SEC Finalizes Rule Requiring Disclosure of Hedging Policies for Employees and Directors

On December 18, 2018, the U.S. Securities and Exchange Commission (SEC) adopted a rule that will require a public company to disclose whether it has adopted practices or policies regarding the ability of its employees (including officers) and directors to hedge the company’s equity securities. The rule, which implements Section 955 of the Dodd-Frank Act, is intended to inform stockholders as to whether employees or directors are allowed to engage in transactions to mitigate or avoid the risks associated with long-term ownership of a company’s equity securities. The final rule is generally consistent with the rule the SEC proposed in February 2015.

Summary of Final Rule

The rule adds a new paragraph to the corporate governance disclosure requirements in Item 407 of Regulation S-K. Specifically, Item 407(i) will require a company to describe, in any proxy or information statement relating to the election of directors, any practices or policies it has adopted (whether written or not) regarding the ability of its employees (including officers) and directors, or any of their designees, to purchase financial instruments, or otherwise engage in transactions, that hedge or offset, or are designed to hedge or offset, any decrease in the market value of company equity securities granted to the employee or director as compensation or held, directly or indirectly, by the employee or director.

For purposes of Item 407(i):

• the term “employee” specifically includes officers;
• whether someone is a “designee” of an employee or director would be determined based on the facts and circumstances;
• “financial instruments” includes prepaid variable forward contracts, equity swaps, collars and exchange funds; and
• “equity securities” means equity securities issued by the registrant and any parent or subsidiary of the registrant or any subsidiary of any parent of the registrant.

A company may disclose any hedging practices or policies in full or, alternatively, provide a fair and accurate summary of those practices and policies, including the categories of persons covered and any particular types of hedging transactions the company explicitly permits or prohibits. Notably, the rule does not require companies to adopt hedging practices or policies or dictate the content of any such practices or policies. If a company has not adopted any hedging practices or policies, it must disclose that fact or state that hedging transactions are generally permitted. The rule does not require a description of hedging transactions because that disclosure was viewed as largely duplicative of existing Section 16 reporting requirements.

To reduce duplicative disclosure, the rule adds a new instruction to Item 402(b) indicating that a company may satisfy the Compensation Discussion & Analysis (CD&A) requirement in Item 402(b)(2)(xiii) to disclose policies on hedging by named executive officers, if material, by including a cross-reference to its Item 407(i) disclosure. The SEC noted in the Adopting Release that companies have flexibility as to where they present the new Item 407(i) disclosure.

The Item 407(i) disclosure requirement will apply to all companies with securities registered under Section 12 of the Exchange Act, including smaller reporting companies and emerging growth companies, but excluding foreign private issuers, listed closed-end funds and other types of registered investment companies.

Public companies that are not smaller reporting companies or emerging growth companies must comply with the disclosure requirements in proxy and information statements relating to the election of directors during fiscal years beginning on or after July 1, 2019. Smaller reporting companies and emerging growth companies must comply with the new disclosure requirements for fiscal years beginning on or after July 1, 2020.

Practical Implications

Public companies are already required to disclose in the CD&A any policies on hedging by named executive officers, if material. In addition, Institutional Shareholder Services, Inc. (ISS) views any amount of hedging of company stock by directors or executive officers as a “failure of risk oversight” that may lead to voting recommendations against individual directors, committee members or the full board of directors. In response to the CD&A requirement and ISS’ policy position and anticipating the implementation of Section 955 of the Dodd-Frank Act, many public companies already have adopted anti-hedging policies and disclose these policies in their proxy statements.

The SEC explicitly stated in the Adopting Release that, to the extent a company currently discloses its hedging practices or policies in its CD&A (either in full or in a summary that would satisfy the requirements of new Item 407(i)), the new rule will not require the company to revise its practices or policies or related disclosure. Furthermore, the SEC indicated that a company that has disclosed a policy that covers only a subset of employees or directors would not be required to further disclose that it did not have a policy with respect to the company’s other employees or directors.

Although the new disclosure requirements will not be in effect for the 2019 proxy season, companies should take them into account when deciding whether to adopt or revise their hedging practices and policies and when drafting proxy statement disclosure regarding company hedging policies.