On December 18, 2018, the Securities and Exchange Commission adopted long-awaited rules that require disclosure of hedging practices or policies in any proxy statement or information statement relating to the election of directors.
Background. Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law in 2010 in the wake of the financial crisis, added Section 14(j) to the Securities Exchange Act of 1934, which required the SEC to promulgate rules for disclosure of hedging policies. According to a report issued by the Senate Committee on Banking, Housing, and Urban Affairs, the purpose behind Section 14(j) was 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."
Subsequently, in February of 2015, the SEC proposed to implement Section 955 by adding Item 407(i) to Regulation S-K and explained in its proposing release that the disclosure on hedging policies is “primarily corporate governance-related because it requires a company to provide in its proxy statement information giving shareholders insight into whether the company has policies affecting how the equity holdings and equity compensation of all of a company's employees and directors may or may not align with shareholders' interests." After soliciting comments on the proposed amendments until April of 2015, the SEC fell silent on the matter.
Final Rules Adopted. Over three years later, the SEC has finally adopted Item 407(i) of Regulation S-K and issued a press release on December 18th. Earlier today, on December 20th, the SEC posted the final adopting release, and we plan to update this blog post with a more detailed analysis based on today's posted release.
The new rule will require a company to describe in its annual proxy statement “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." A company may satisfy the requirement either by providing a summary of the practices or policies that apply, or alternatively, by disclosing the practices or policies in full. If a company does not have any such practices or policies, it will need to disclose that fact or state that hedging is generally permitted. Moreover, the rules apply to equity securities of the company, any parent of the company, any subsidiary of the company, or any subsidiary of any parent of the company. According to Chairman Jay Clayton, “[t]hese 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."
Deadline to Comply. Companies generally must comply with the new disclosure requirements in proxy and information statements for the election of directors during fiscal years beginning on or after July 1, 2019. Therefore, for calendar year companies, the disclosure will first be required in their proxy statements filed in 2020. Companies that qualify as “smaller reporting companies" or “emerging growth companies" must comply with the new disclosure requirements in proxy and information statements for the election of directors during fiscal years beginning on or after July 1, 2020 (in other words, calendar year smaller reporting and emerging growth companies may wait until their proxy statements filed in 2021 to comply). As a reminder, our recent blog post explains that the SEC has also recently amended the definition of “smaller reporting company" to expand access to scaled disclosure accommodations like this one.
Next Steps. As a practical matter, many companies already provide similar information in their proxy statements. Proxy advisory firms have strongly favored robust hedging policies. For example, ISS's proxy voting guidelines consider “hedging of company stock" to be an example of a failure of risk oversight that could lead to votes “against" directors in annual elections, and ISS's QualityScore considers whether a company has a policy prohibiting the hedging of company shares by employees.
Given the renewed spotlight on this issue, companies should check their current hedging policies and ensure that their proxy statement disclosure will comply with the new rule. In many cases, companies have included their hedging policies in their insider trading policies, although they can also be adopted as a separate stand-alone policy. Gibson Dunn is happy to assist with the review of your policies and proxy statement disclosure on hedging.
Special appreciation to associate Monika Kluziak for assistance with this post.