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by Laura Anthony, Esq.

Proposed Amendments To Disclosure Of Hedging Policies For Officers, Directors And Employees

ABA Journal’s 10th Annual Blawg 100

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On February 9, 2015, the SEC issued proposed rules that would increase corporate disclosure of company hedging policies for directors and employees in annual meeting proxy statements.  The new rules are part of the ongoing rule-making requirements mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).  In particular, the new rule would implement Section 14(j) of the Securities Exchange Act of 1934 (“Exchange Act”), which requires annual meeting proxy or consent solicitation statements to disclose whether employees or members of the board are permitted to purchase financial instruments, such as options, swaps, collars and the like, to hedge price decreases in the company securities. 

The proposed rules regulate disclosure of company policy as opposed to directing the substance of that policy or the underlying hedging activities.  In fact, the rule specifically does not require a company to prohibit a hedging transaction or otherwise adopt specific policies.  The rule would require disclosure about whether directors, officers and other employees are permitted to hedge or offset decreases in market value of securities granted by the company as compensation or otherwise held, directly or indirectly, by the officer, director or employee.  The disclosure applies to equity securities of the company, its parent, subsidiaries, and sister subsidiaries with the same parent. 

As reported by the Senate Committee on Banking, Housing and Urban Affairs, Section 14(j) is intended 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.” 

The required disclosures need to be included in 14A proxy and 14C information statements related to the election of directors and apply to all companies subject to the Exchange Act proxy requirements, including, but not limited to, smaller reporting companies, emerging growth companies, business development companies, and 1940 Act registered closed-end investment companies. 

Background

Currently disclosure requirements related to hedging policies are set forth in Item 402(b) of Regulation S-K and are included as part of a company’s Compensation Discussion and Analysis (“CD&A”).  CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers.  Currently Item 402(b) only requires disclosure of hedging policies “if material” and only for named executive officers.  Moreover, currently CD&A is not required at all for smaller reporting companies, emerging growth companies, closed-end investment companies or foreign private issuers.

Hedging transactions themselves may be disclosed in other forms by certain issuers.  For example, Form 4 filings by officers, directors and greater than 10% shareholders would include disclosures of hedging transactions involving derivative securities.  Hedging transactions involving pledged securities would be included in disclosures related to the beneficial ownership of officers, directors and greater than 5% shareholders in filings such as company annual reports, registration statements or proxy materials.  However, there is currently no rule that requires the disclosure of hedging policies and that encompasses all reporting issuers.

The New Rule – Item 407(i)

The proposed rule implements Section 14(j) by amending Item 407 of Regulation S-K by adding a new paragraph (i) requiring companies to disclose whether they permit employees and directors to hedge their company’s securities.  The purpose of the new rule as described in the SEC rule release is to give “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.” 

Item 407 relates to corporate governance disclosures.  The SEC believes that to properly implement Section 14(j) to require disclosure of a company policy affecting all officers, directors and employees and to require such disclosure by all issuers, the rule belongs as an Item 407 corporate governance disclosure as opposed to a CD&A disclosure.  

               Types of Financial Instruments

The new rule broadly requires disclosure related to hedging policies involving all forms of financial securities instruments held by directors, officers and employees, which securities and financial instruments are issued by the reporting company, any parent of such company, any subsidiary of such company, and any other subsidiary of any parent of such company.  The disclosure is required to be had in any proxy statement on Schedule 14A or information statement on Schedule 14C related to the election of directors.

In addition to encompassing the requirement in Section 14(j) that companies disclose whether employees or members of the board are permitted to purchase financial instruments, such as options, swaps, collars and the like to hedge price decreases in the company securities, the new rule also requires such disclosure for any transaction with comparable economic consequences.  That is, the new rule covers all transactions that establish downside price protection, regardless of how they are labeled or characterized.

In its rule release, the SEC focuses on the intent behind the disclosure and that such intent is meant to give meaningful information as to whether “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.”  Accordingly, a technical recital of a hedging policy is not enough if such recital does not ultimately give a clear understanding as to whether executives can engage in any transactions whatsoever that are designed to have a hedging effect. 

Companies that do permit hedging transactions, as broadly defined by the rule, are required to disclose sufficient details to explain the scope of such permitted transactions.  Moreover, disclosures include details of pre-conditions or other parameters of hedging policies, such as, for example, if hedging is allowed for securities that have been held for a specific period of time or securities held by certain categories of executives.   

               Covered Issuers and Securities

New Rule 407(i) covers hedging policies related to equity securities issued by the reporting company, any parent of such company, any subsidiary of such company, and any other subsidiary of any parent of such company.  The rule includes securities issued as part of compensatory grants and all other equity securities held by the executives, directly or indirectly and from any source whatsoever, issued by the covered companies. 

               Persons Covered

New Rule 407(i) covers hedging policies directed to any employee, including officers, and any member of the board of directors or any of their designees.  The new rule is meant to be all-encompassing as to any employee and accordingly, disclosure would include whether any level of employee is excluded from a company policy. 

               Manner and Location of Disclosure

The required disclosures need to be included in any 14A proxy and 14C information statements related to the election of directors.  The new rule will also amend Item 7 of Schedule 14A for clearer cross reference to the new disclosure requirements.  Schedule 14C cross-references disclosure requirements in Schedule 14A and therefore is not being separately amended. 

               Current CD&A

Currently disclosure requirements related to hedging policies are set forth in Item 402(b) of Regulation S-K and are included as part of a company’s Compensation Discussion and Analysis (“CD&A”).  CD&A requires material disclosure of a company’s compensation policies and decisions related to named executive officers.  Currently Item 402(b) only requires disclosure of hedging policies “if material” and only for named executive officers.  Moreover, currently CD&A is not required at all for smaller reporting companies, emerging growth companies, investment companies or foreign private issuers.  To avoid duplicate disclosure, the new rules include adding an instruction to Item 402(b) such that disclosure may be satisfied by cross-referencing the disclosure made in compliance with new Item 407(i). 

               Issuers Subject to the Proposed New Rules

The new Item 407(i) disclosure applies to all Exchange Act reporting companies, including smaller reporting companies, registered closed-end investment companies, emerging growth companies and foreign private issuers.

The Author

Attorney Laura Anthony
LAnthony@LegalAndCompliance.com
Founding Partner, Legal & Compliance, LLC
Corporate, Securities and Business Transaction Attorneys

Securities attorney Laura Anthony and her experienced legal team provides ongoing corporate counsel to small and mid-size OTC issuers as well as private companies going public on the over-the-counter market, such as the OTCBB, OTCQB and OTCQX. For nearly two decades Ms. Anthony has structured her securities law practice as the “Big Firm Alternative.” Clients receive fast, personalized, cutting-edge legal service without the inherent delays and unnecessary expenses associated with “partner-heavy” securities law firms. Ms. Anthony’s focus includes, but is not limited to, registration statements, including Forms 10, S-1, S-8 and S-4, compliance with the reporting requirements of the Securities Exchange Act of 1934, including Forms 10-Q, 10-K and 8-K, 14C Information Statements and 14A Proxy Statements, going public transactions, mergers and acquisitions including both reverse mergers and forward mergers, private placements, PIPE transactions, Regulation A offerings, and crowdfunding. Moreover, Ms. Anthony represents both target and acquiring companies in reverse mergers and forward mergers, including the preparation of transaction documents such as Merger Agreements, Share Exchange Agreements, Stock Purchase Agreements, Asset Purchase Agreements and Reorganization Agreements. Ms. Anthony prepares the necessary documentation and assists in completing the requirements of federal and state securities laws and SROs such as FINRA and DTC for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile.

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