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From Securities Regulation Daily, February 9, 2015

SEC proposes new hedging transaction disclosures by employees and board members

By Jacquelyn Lumb

The SEC has proposed new disclosure rules about companies’ hedging policies as mandated by the Dodd-Frank Act. Dodd-Frank Act Section 955 requires companies to disclose in their annual meeting proxy statements whether employees or members of the board are permitted to purchase financial instruments that are designed to hedge or offset any decrease in the market value of their equity securities. The comment period will remain open for 60 days.

The SEC, in its proposing release, explains that the proposal would not require a company to prohibit hedging transactions or to adopt policies or practices that address hedging by any category of individuals. Instead, it seeks to inform shareholders whether employees or directors are permitted to engage in transactions that mitigate or avoid the incentive alignment associated with their equity ownership. 

Expanded disclosure. The current disclosure rules apply to named executive officers and do not apply to smaller reporting companies, emerging growth companies, registered investment companies, or foreign private issuers. The proposed rules would apply to employees and directors of smaller and emerging growth companies, business development companies, and registered closed-end investment companies whose shares are listed on a national securities exchange. The proposal would not apply to foreign private issuers since their securities are not subject to the proxy statement requirements of Section 14.

Hedging instruments include prepaid variable forward contracts, equity swaps, collars, and exchange funds that are granted as part of an individual’s compensation, but also would apply to any types of transactions that have the same hedging effect as those identified in Exchange Act Section 14(j).

The disclosure will apply to equity securities issued by a company, its parents, its subsidiaries, or the subsidiaries of its parents that are registered under Exchange Act Section 12. Employees are defined to include the officers of the company.

Corporate governance. The SEC proposes to implement the requirement by adding a paragraph to Item 407. Since the required disclosure is primarily governance-related, the SEC concluded that it is more closely related to the Item 407 corporate disclosure requirements than to Item 402, which focuses only on the compensation of named executive officers and directors. The proposal would keep all of the disclosure requirements relating to corporate governance matters in a single item in Regulation S-K. The disclosure will be required in any proxy statement on Schedule 14A or information statements on Schedule 14C relating to the election of directors.

CD&A. To avoid duplicative disclosure, the SEC proposes to permit companies to satisfy their obligation in their compensation discussion and analysis (CD&A) by cross-referencing to the information disclosed in amended Item 407 to the extent it satisfies the CD&A requirement to disclose material polices on hedging by named executive officers.

In a news release announcing the proposal, Chair Mary Jo White noted that the proposed rules would provide investors with additional information about the governance practices of companies in which they invest. She said the rules would help investors better understand the alignment of the employees’ and directors’ interests with their own.

Two commissioners’concerns. Following the issuance of the proposal, Commissioners Daniel Gallagher and Michael Piwowar issued a statement explaining that, while they supported its issuance, they have concerns about a number of the provisions which they hope commenters will address. First, they questioned the lack of a proposed exemption for emerging growth companies and smaller reporting companies, given the potential costs.

Second, the commissioners questioned the requirement that closed-end funds comply with the rule since there would be very little employee hedging in connection with these funds. They also expressed concerns that the proposal seeks comment on whether to extend the disclosure requirement to all funds, given that most funds do not hold annual shareholder meetings.

The commissioners believe the SEC should have exercised its exemptive authority to exempt from the rule disclosures relating to employees that cannot affect a company’s share price. They acknowledged that the statute covers these employees, but said the SEC’s exemptive authority permits it to tailor legislative mandates in a way that provides only material information to investors.

Another of their concerns is with the proposal’s reach to the securities of an issuer’s affiliates, including subsidiaries, parents, and brother-sister companies. They believe the reach is too broad and will raise the costs of disclosure.

Finally, the commissioners said this proposal should not have taken priority over other pending initiatives that were implicated in the financial crisis. They also questioned whether it should have taken priority over the Division of Corporation Finance’s comprehensive disclosure review.

Another commissioner’s support. Commissioner Luis Aguilar also issued a statement in which he said that the rule proposal is a positive step, but that many other significant executive compensation related disclosure rules have yet to be adopted. Without the additional transparency, Aguilar said shareholders will find it difficult to hold officers and directors accountable for their executive compensation decisions.

MainStory: TopStory DoddFrankAct CorporateGovernance DirectorsOfficers ExecutiveCompensation Proxies PublicCompanyReportingDisclosure

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