23 February 2015
Practice Groups:
Capital Markets
Corporate/M&A
SEC Proposes Rules Requiring Disclosure of
Hedging by Employees, Officers, and Directors
By Michael A. Hedge and Alexa M. Ekman
On February 9, 2015, the Securities and Exchange Commission (the “SEC”) issued
proposed rules to implement Section 955 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, requiring disclosure of whether an issuer permits or prohibits
hedging transactions by its employees and directors. Section 955 amends Section 14 of the
Securities Exchange Act of 1934 (the “Exchange Act”) by adding paragraph (j), which
mandates the SEC, by rule, to require each issuer to disclose in any proxy or consent
solicitation material whether any employee or member of the board of directors of the issuer
is permitted to purchase financial instruments that are designed to hedge or offset any
decrease in the market value of equity securities.
According to a report issued by the Senate Committee on Banking, Housing, and Urban
Affairs, the purpose behind Section 14(j) is to “allow shareholders to know if executives are
allowed to purchase financial instruments to effectively avoid compensation restrictions that
they hold stock long-term, so that they will receive their compensation even in the case that
their firm does not perform.” In adopting the proposed rule amendments, the SEC seeks to
impose transparency regarding transactions that mitigate or avoid the incentive alignment
associated with equity ownership. To that extent, the SEC has proposed a new paragraph (i)
to Item 407 of Regulation S-K to implement these changes.
Issuers Subject to Item 407(i)
Issuers registered under Section 12 of the Exchange Act, including smaller reporting
companies, emerging growth companies, and listed closed-end funds, would be subject to
the new disclosure requirements. However, the proposed rule is not applicable to foreign
private issuers and other types of registered investment companies, including non-listed
closed-end funds, open-end funds, and unit investment trusts.
Disclosure Requirements of Item 407(i)
Item 407(i) would require issuers to disclose whether any employee or member of the board
of directors of the issuer, or any designee of such employee or member, is permitted to
purchase financial instruments (including prepaid variable forward contracts, equity swaps,
collars, and exchange funds) that are designed to hedge or offset any decrease in the
market value of equity securities. Item 407(i) would also require disclosure of whether an
issuer permits other types of transactions that have the same hedging effects as the
purchase of those instruments specifically identified in Section 14(j). The SEC refrained from
defining the term “hedge,” stating the meaning of hedge is generally understood and should
be applied as a broad principle. The proposed amendment would therefore cover all
transactions that establish downside price protection for the employee or director. The new
disclosure would cover all equity securities (as defined in Exchange Act Section 3(a)(11) and
Exchange Act Rule 3a11-1), issued by the company, any parent of the company, any
SEC Proposes RulesRequiring Disclosure of Hedging by Employees, Officers,
and Directors
subsidiary of the company or any subsidiary of any parent of the company that are registered
under Section 12 of the Exchange Act.
The issuer would also be required to disclose the categories of transactions it permits and
the categories of transactions it prohibits. If it is the case where the issuer only prohibits
certain hedging transactions, the issuer would be able to disclose the categories of
transactions it specifically prohibits, and disclose that it permits all other hedging
transactions, in lieu of listing all of the specific categories that are permitted. The issuer
would also be required to disclose whether it permits some, but not all, of its employees
(including officers) and directors to engage in hedging transactions, and must disclose both
the categories of persons who are permitted to hedge and those who are not.
The proposed disclosure would only be required in proxy statements for meetings involving
the election of directors and would not be required in registration statements under the
Securities Act of 1933 or the Exchange Act, or in Form 10-K.
Noting that some issuers may already be required to disclose hedging policies in their
Compensation Discussion and Analysis, the SEC has proposed to amend the instructions to
Item 402(b) to allow issuers to cross reference disclosures to streamline the proxy
disclosure.
SEC commissioners are divided on the new proposal, as both Commissioners Daniel M.
Gallagher and Michael S. Piwowar have publicly expressed concern over the breadth of the
disclosure. The SEC is requesting comments on items specified in its release on or before
April 20, 2015.
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SEC Proposes RulesRequiring Disclosure of Hedging by Employees, Officers,
and Directors
Authors:
Michael A. Hedge
michael.hedge@klgates.com
+1.949.623.3519
Alexa M. Ekman
alexa.ekman@klgates.com
+1.949.623.3603
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