Wilson Sonsini discusses SEC Proposal Requiring Disclosure of Hedging Policies for Directors, Officers, and Other Employees

On February 9, 2015, the U.S. Securities and Exchange Commission (SEC) issued a proposed rule related to the disclosure of hedging policies applicable to board members, officers, and other employees. The proposed rule would implement one of the remaining requirements adopted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).[1]

The proposed rule would amend Item 407 of Regulation S-K to require companies to disclose whether they permit directors, officers, and other employees to hedge the company’s securities, including any equity securities of the company’s parent, subsidiaries, or any subsidiary of any parent of the company that is registered under Section 12 of the Securities Exchange Act of 1934 (Exchange Act). Disclosure would be required in proxy and information statements for the election of directors and apply to companies subject to the federal proxy rules, including, among others, smaller reporting companies and emerging growth companies. The hedging activities covered by the rule include the purchase of financial instruments, such as prepaid variable forward contracts, equity swaps, collars, and exchange funds, as well as any other transactions that would have (or are designed to have) the same economic effects as these arrangements. Companies that permit hedging by certain employees must disclose the categories of persons who are permitted to engage in hedging transactions and those who are not. Categories of permitted hedging transactions must also be disclosed.

The SEC is seeking public comment on the proposed rule for 60 days and will then vote a second time on the rule before it goes into effect. For additional information, please consult the SEC press release (http://www.sec.gov/news/pressrelease/2015-26.html) or the text of the proposed rule (http://www.sec.gov/rules/proposed/2015/33-9723.pdf).

Many companies are already disclosing certain information regarding formal or informal policies regarding hedging by company executives, and we generally believe these policies are prudent. The current requirements for Compensation Discussion and Analysis (CD&A) include, as an example of the kind of information that should be provided, if material, the company’s equity or other security ownership requirements or guidelines (specifying applicable amounts and forms of ownership) and any company policies regarding hedging the economic risk of such ownership.[2] Further, ISS and Glass Lewis, the two leading proxy advisory firms, have stated that the hedging of a company’s stock severs the alignment with shareholders’ interests and failure to have a robust anti-hedging policy will negatively impact a company’s ISS QuickScore.

ENDNOTES

[1] Section 955 of the Dodd-Frank Act amended Exchange Act Section 14 to add paragraph (j), which requires the SEC, by rule, to require annual meeting proxy statement disclosure of whether employees or members of the board of directors are 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 company equity securities.

[2] This CD&A disclosure item requirement, which does not apply to smaller reporting companies, emerging growth companies, registered investment companies or foreign private issuers, by its terms addresses only hedging by the named executive officers. In providing their CD&A disclosure, however, some companies describe policies that address hedging by directors and other employees, as well as the named executive officers. The proposed rule would permit a company to satisfy this CD&A requirement by cross-referencing to the newly required disclosure.

The full and original memorandum was published by Wilson Sonsini Goodrich & Rosati LLP on February 10, 2015, and is available here.