Final Rules for Disclosure of Hedging Policies (Dodd-Frank)
On December 18, 2018, The Securities and Exchange Commission (SEC) approved final rules to require companies to disclose in proxy or information statements for the election of directors any practices or policies regarding the ability of employees or directors to engage in certain hedging transactions with respect to company equity securities.
SEC Chairman, Jay Clayton said, “These disclosures in themselves, and in combination with our officer and director purchase and sale disclosure requirements, should bring increased clarity to share ownership and incentives that will benefit our investors, registrants, and our markets.”
The final rules, which implement a mandate from the Dodd-Frank Act, will require disclosure of practices or policies in full, or, alternatively, a summary of those practices or policies that includes a description of any categories of hedging transactions that are specifically permitted or disallowed. If the registrant does not have any such practices or policies, it will disclose that fact or state that hedging is generally permitted.
Winston & Strawn Chicago Partner, Mike Melbinger, shared the following additional insights in his Executive Compensation Blog, published December 19, 2018:
SEC Adopts Final Rules on Hedging Policies (Dodd-Frank Section Act 955)
Yesterday, the SEC adopted final rules implementing Dodd-Frank Act Section 955. Section 955 of the Dodd-Frank Act added subsection 14(j) to the Exchange Act, “Disclosure of Hedging by Employees and Directors.” Section 955 requires the SEC to require companies to disclose in their annual proxy statement whether the company permits any employee or director (or any designee of such employee or director) 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 (1) granted to the employee or director by the company as part of the compensation; or (2) held, directly or indirectly, by the employee or director.
Like most of the executive compensation provisions the Dodd-Frank Act, Section 955 was not immediately effective. Section 955 directed the SEC to adopt rules implementing this disclosure requirement but did not give it a deadline for doing so. The SEC first proposed rules on the Dodd-Frank Act anti-hedging policies back in April 2015.
The rules add a new Item 407(i) to Regulation S-K that will require a company to describe any practices or policies it has adopted regarding the ability of its employees (including officers) or directors to purchase securities or other 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 equity securities granted as compensation, or held directly or indirectly by the employee or director. As is typical, we were not able to secure an actual copy of the new rules at press time and we will need to closely read the rules for the details (including the precise definition of hedging), but the press release highlights the following points:
- A company could satisfy this requirement by either providing a fair and accurate summary of the practices or policies that apply, including the categories of persons they affect and any categories of hedging transactions that are specifically permitted or specifically disallowed, or, alternatively, by disclosing the practices or policies in full.
- If the company does not have any such practices or policies, the rule will require the company to disclose that fact or state that hedging transactions are generally permitted.
- Item 407(i) specifies that the equity securities for which disclosure is required are equity securities of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parent of the company.
Companies generally must comply with the new disclosure requirements in proxy statements for fiscal years beginning on or after July 1, 2019. Smaller reporting companies and emerging growth companies” need not comply until proxy statements for fiscal years beginning on or after July 1, 2020. Listed closed-end funds and foreign private issuers will not be subject to the new disclosure requirements.
The obvious aim of this provision was to encourage companies to adopt policies that prohibit hedging transactions. Investors want executives to own large amounts of company stock (not hedged) so they will manage for long term gains, not just a short-term pop with devastating long-term effect. Section 955 does not require any company to adopt such a policy, but nearly all have done so.
More to come.
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