In an effort to provide greater transparency to stockholders regarding employee and director incentives, the U.S. Securities and Exchange Commission (SEC) has adopted a final rule implementing a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This new rule requires companies to disclose in proxy or information statements relating to the election of directors any practices or policies (whether written or not) regarding the ability of its directors, officers and other employees (or any of their designees) to hedge any decrease in the market value of equity securities granted as compensation or held directly or indirectly by such individuals. As a result, public companies should review and assess their existing disclosures to determine whether they comply with the new requirements. Moreover, while the new disclosure requirements do not require companies to have any practices or policies regarding hedging or dictate the content of any such practice or policy, companies should assess their existing practices or policies regarding hedging and determine whether it is appropriate to implement or amend such practices or policies.
New SEC Rules
On December 18, 2018, the SEC adopted new rules that require public companies to disclose any practices or policies (whether written or not) related to hedging transactions. If a company has no hedging practices or policies, the company must disclose this or state that such transactions are generally permitted. The adoption of the hedging rule is reflected in new Item 407(i) of Regulation S-K (Reg S-K) as follows:
“(i) Employee, officer and director hedging. In proxy or information statements with respect to the election of directors:
- Describe any practices or policies that the registrant has adopted regarding the ability of employees (including officers) or directors of the registrant, or any of 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 the market value of registrant equity securities —
- Granted to the employee or director by the registrant as part of the compensation of the employee or director; or
- Held, directly or indirectly, by the employee or director.
- A description provided pursuant to paragraph (1) shall provide a fair and accurate summary of the practices or policies that apply, including the categories of persons covered, or disclose the practices or policies in full.
- A description provided pursuant to paragraph (1) shall also describe any categories of hedging transactions that are specifically permitted and any categories of such transactions specifically disallowed.
- If the registrant does not have any such practices or policies regarding hedging, the registrant shall disclose that fact or state that the transactions described in paragraph (1) above are generally permitted.”
In adopting the hedging rule, the SEC did not define the term “hedge.” As such, the new disclosure requirement is intended to cover all transactions that establish downside price protection in a company’s equity securities. Additionally, under the rule, “registrant equity securities” include equity securities issued by the company, any parent of the company, any subsidiary of the company or any subsidiary of any parent of the company.
Compliance Dates and Applicability
The date for complying with the new rules depends on a company’s SEC filer status. A company that does not qualify as an “emerging growth company” (EGC) or a “smaller reporting company” (SRC) must comply with the new disclosure requirements for proxy and information statements with respect to election of directors during fiscal years beginning on or after July 1, 2019. Accordingly, non-EGC or SRC companies with a December 31 fiscal year end will first be required to include the hedging disclosure in their proxy statements in 2020. EGCs or SRCs, on the other hand, have an additional year to comply, with disclosure requirements starting for proxy and information statements with respect to election of directors during fiscal years beginning on or after July 1, 2020. Accordingly, EGC or SRC companies with a December 31 fiscal year end will first be required to include the hedging disclosure in their proxy statements in 2021. Foreign private issuers will not be required to provide the new disclosure.
Manner and Location of Disclosure
A hedging disclosure will be required in any proxy or information statement relating to the election of directors. Hedging disclosures will not be required in registration statements or in annual reports on Form 10-K. Additionally, the new disclosure will not be deemed to be incorporated into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent specifically incorporated. Such disclosure will also not be subject to forward incorporation by reference under Item 12(b) of Form S-3 or under Item 12 of Form S-1.
Relation of New Disclosure Requirement to Existing CD&A Disclosure
The compensation discussion and analysis (CD&A) section of the proxy statement required by Item 402(b) of Reg S-K already identifies hedging policies as potentially material to disclose. However, the new hedging disclosure requirement extends beyond the CD&A disclosure requirements. For instance, EGCs and SRCs are not required to include CD&A disclosure in proxy and information statements, but they will be required to include the new hedging disclosure in their proxy and information statements. Additionally, the CD&A disclosure rules only apply to named executive officers, while the new hedging disclosure rule mandates disclosure of hedging policies with respect to all directors, officers and other employees (or any of their designees).
To reduce the possibility of duplicative disclosure in proxy and information statements, the SEC added a new instruction to Item 402(b) of Reg S-K to specify that if information disclosed pursuant to Item 407(i) satisfies the CD&A’s requirement with respect to hedging, the Item 407(i) disclosure may be referenced in the CD&A. However, since this cross-reference would make the Item 407(i) disclosure subject to say-on-pay votes, some companies may choose to keep the two disclosures on hedging separate.
Impact of New Disclosure Requirements
As a result of these new disclosure requirements, public companies should review and assess their existing disclosures to determine whether they comply. The SEC notes that to the extent a company currently discloses its practices or policies regarding hedging transactions in the CD&A and the disclosure meets the requirements of new Item 407(i), the amendments will not require the company to revise its practices or policies or its disclosure. For example, a company that has disclosed a hedging 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 regard to the company’s other employees or directors.
Moreover, while the new disclosure requirements do not require public companies to have any practices or policies regarding hedging or dictate the content of any such practice or policy, institutional investors and proxy advisory firms may expect companies to implement such policies as a matter of corporate governance. Accordingly, companies should review their existing practices or policies and determine whether to implement or amend such practices or policies.
For more information regarding the new hedging disclosure rule, please see the SEC’s adopting release.